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Solving the "Problem" of Free Riding

Mises Daily: Tuesday, November 13, 2007 by

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With the almost constant statist apologetics we hear from many government and academic economists[1] it is hard to believe that the discipline of economics was once a thorn in the side of the state and its political elite. So commonplace are fallacious economic arguments advocating state control that it sometimes seems that refutation of all of these arguments has become a case of cutting the heads off the Hydra — a tiring and fruitless endeavor.

But if economics is to become an instrument of freedom and prosperity instead of an instrument of statism,[2] then there are certain fundamental fallacies that must be continually challenged and discredited. Chief among these is the persistent non sequitur from externality to coercion — that is, the bogus conclusion that coercion is a proper means to solve problems involving economic externalities.

One of the most blatant examples of this non sequitur occurs in discussions of the "free rider problem" and the alleged solution of government provision of so-called "public goods."[3] This is a particularly insidious economic theory that bears a great deal of the responsibility of derailing economics into the ditch of statism.

The "problem" of free riding

The "free rider problem" occurs in situations in which a person derives a "positive externality" from the actions of another — that is, a benefit that he did not pay for. This occurs in situations where the beneficial effect of an action is "nonexcludable," meaning that the benefits cannot be withheld from people who had nothing to do with the action.

For example, a beekeeper may keep bees solely as a means of producing honey. However, an ancillary effect of this activity — an externality — is that the bees will pollinate flowers in surrounding properties, benefiting the owners of those properties at no cost to them.[4] Nor is there any practical means by which the beekeeper can produce his honey without conferring this benefit on his neighbors. Thus, the "good" provided to surrounding property owners is nonexcludable.

Observe that this situation involves no detriment to anyone, let alone any violation of rights. The beekeeper chooses to buy the bees because he expects to be better off by virtue of this action. Moreover, as an unintended consequence of his purchase, surrounding property owners also find themselves enjoying a benefit from the bees, at no cost to them. This may seem like a fortuitous event — even something to be celebrated.

And yet, there is a "problem" — or, to be more precise, a free rider "problem." The problem is not that anyone has aggressed against anyone else. It is not that anyone's rights have been violated. It is not even that anyone has suffered any detriment at all. Rather, it is a "problem" only when compared to what might have been done instead — a problem of allegedly inefficient underproduction of the good in question. In other words, the problem is that, if not for the nonexcludability of the good, things could potentially have been even better.

To illustrate how things might have been better, consider again our beekeeper and his neighbors. If the beekeeper possessed some means to prevent surrounding property owners from benefiting from his bees, without detracting from his own enjoyment, then he would be able to negotiate with them to pay him for the benefit. Since he would then derive an additional benefit from his bees — the payment — he would have an incentive to keep even more bees, benefiting both himself and his neighbors to an even greater extent. Nor is this merely a zero-sum game. Rather, under certain assumptions,[5] it turns out that there is some level of payment at which the surrounding property owners would be indifferent between the excludable and the nonexcludable situation, whereas the beekeeper would be demonstrably better off — i.e., there would be a Pareto-efficient gain.[6]

This kind of analysis has led many economists to conclude that the ancillary benefit from the bees is a "public good" and that, therefore, the neighbors should be forced to contribute to the cost of this good. This is supposed to be justified on the basis that the neighbor will enjoy a benefit that will, according to the economist, outweigh the cost. And yet, regardless of the benefits that they enjoy, it cannot be said that the neighbors have in any way solicited this good or the forced arrangement advocated by the economist. Thus, the essence of this proposal is that the neighbors be forced to pay for an unsolicited good.[7] Moreover, this is not merely a special case. Rather, the theory of "public goods" is a doctrine that advocates forced payment for unsolicited goods as a general economic ideal, applicable whenever a person obtains any benefit that is nonexcludable and which does not detract from the enjoyment of the good by others.

Finding a Pareto-efficient solution

In assessing arrangements to solve the "problem" of free riding, economists claim to be guided by the principle of Pareto efficiency. That is, they claim to put forward arrangements that will make at least some people better off without any detriment to others, in terms of their own happiness. If they are serious about this efficiency criterion then any proposed arrangement must surely accord with the preferences of the people involved, as revealed through their actual behavior. It follows that the ultimate test of any allegedly Pareto-efficient arrangement must surely be to convince all of the parties affected that they are better off (or at least, no worse off) under the proposed arrangement. Indeed, the consent and agreement of all parties must be regarded as the sine qua non of Pareto efficiency.

Unfortunately, this is not usually how economic analysis of these problems proceeds. Rather, such analysis is frequently conducted on the basis that the economist knows more about the preferences of the people involved in the situation than those people do themselves. In particular, dubious mathematical assumptions are often used to steamroll the implicitly revealed or even explicitly declared preferences of those actually taking the actions — to "prove," on the basis of a mathematical model, that they are really happier under the economist's desired arrangement, even if they may complain to the contrary.

"The consent and agreement of all parties must be regarded as the sine qua non of Pareto efficiency."

In considering such analyses, it is important to note that theorems in mathematical economics that are used to demonstrate the potential for Pareto-efficient gains are often crucially dependent upon certain doubtful assumptions, such as low transaction costs, that may or may not be present in actual situations involving nonexcludable goods.[8] While mathematical models may be highly useful as an approximating tool for predicting, explaining, or even suggesting human action, these models must not be used to trump the revealed preferences of people taking the actions as a test of Pareto efficiency.

Perhaps, in our beekeeping situation, there is some arrangement that can be made between the beekeeper and his neighbors to make them all happier, and perhaps there is not. A mathematical model may shed light on this question and may even be used to convince the beekeeper and his neighbors of the merits of a particular arrangement. This would be an entrepreneurial solution, which does not involve coercion against any of the parties involved. It is one thing to propose a voluntary arrangement on the basis of an idealized mathematical analysis, but it is entirely another to propose a coercive arrangement under which the utility curves concocted by the economist are allowed to trump the revealed preferences of the parties themselves.

It is dubious to suggest that an arrangement that could be undertaken voluntarily by the parties, but is not, will make them all better off. And it is especially dubious to suggest that such an arrangement must be imposed on them by force rather than by their own agreement. After all, if all parties genuinely stand to gain from some arrangement, according to their own preferences, then there is no reason why they should refuse to undertake such an arrangement voluntarily. Or, to put it another way, the absence of any voluntary activity by the parties — especially when proposed arrangements are put to the parties and declined — is prima facie evidence that there is no potential for Pareto-efficient gains.

Even if we have no objection to coercion per se,[9] there are nonetheless sound economic reasons to reject coercive "solutions" to any alleged inefficiency problem due to free riding. Since an entrepreneurial arrangement involves no coercion against any of the parties, it ensures that all of the parties will enjoy ex ante gains. However, there is no such guarantee under a coercive arrangement, and it is nonsense to suppose that the government is able to determine arrangements for Pareto-efficient gains any better than those parties who actually stand to gain from such arrangements. Indeed, arguments in public-choice theory, not to mention our actual experiences with government provision of goods and services, give us every reason to believe that at least someone will get screwed.

Thus, even if there were some arrangement that could be made between the parties to affect such an efficiency gain, it would by no means follow that this arrangement must involve government provision of goods or any other coercive measure.[10] On the contrary, this is the opposite of what we should expect. If all of the parties stand to gain, then there is no reason to expect that coercion will be required; there is every reason to expect an entrepreneurial (i.e., noncoercive) solution. Indeed, there is a fundamental contradiction between the criterion of Pareto efficiency and the use of force against those who are to be made "better off."

The Ultimate Free Rider Myth

Those who advocate government provision of goods or other coercive measures as the solution to the "problem" of free riding frequently suffer from a lack of imagination in considering entrepreneurial solutions. In fact, there are plenty of ways in which entrepreneurial activity may allow the parties to arrange their affairs to take advantage of Pareto-efficient gains. Our beekeeper may enter into an assurance contract with his neighbors, whereby he agrees to purchase the bees — or purchase more bees — only if they will pay him some of the cost. He may decide to buy out his free riding neighbors if he feels that the benefit he is about to provide to their property makes it a good deal. Or he may think of some other idea for a voluntary agreement. And of course, it may even be that there is no way to achieve a Pareto-efficient gain due to high transaction costs, or some other reason.

Thus, although the "problem" of free riding does indeed identify situations that involve the potential for further gains, it most certainly does not follow that government provision of goods or other coercive arrangements will improve the situation. Those who advocate coercive arrangements to obtain Pareto efficiency gains are forced to ignore the revealed preferences of the people involved, and thereby commit a fundamental economic error. By arguing for coercion as a means of solving the "problem" of positive externalities, they elevate the policy of forced payment for unsolicited goods to the status of an economic ideal. This is surely one of the most conspicuously tyrannical arguments in modern economics.


Ben O'Neill is a researcher at the Australian National University and a political advisor in the Liberal Party of Australia. This article represents his personal views and not the views of the Liberal Party. Send him mail. Comment on the blog.

Notes

[1] With the notable exceptions of the Austrian School and, to a lesser extent, the Chicago School (and of course, many other economists).

[2] This should not be taken as a suggestion that economics should not be a value-free science. Rather, it is a suggestion that economics should be correct, and that if it is, it will most certainly promote individual liberty at the expense of state coercion.

[3] For a refutation of the fallacy of the economic theory of "public goods" see Hoppe, H.H. (1989) "Fallacies of the Public Goods Theory and the Production of Security." The Journal of Libertarian Studies 9(1). Hoppe summarizes the situation as follows:

In spite of its many followers, the whole public goods theory is faulty, flashy reasoning, ridden with internal inconsistencies, non sequiturs, appealing to and playing on popular prejudices and assumed beliefs, but with no scientific merit whatsoever. (p. 27)

[4] Similarly, surrounding property owners may plant more flowers in their garden solely for the aesthetic benefit they provide. However, as an ancillary effect — another externality — the beekeeper will benefit from the greater supply of flowers for pollination by his bees.

[5] Such as the absence of, or at least a low level of, transaction costs.

[6] A Pareto-efficient gain is one in which at least one person is made better off and no other person is made worse off.

[7] Hoppe presents a reductio ad absurdum of this principle:

You, gentle reader, have never hired me as an economic consultant. You have not taken advantage of this marvelous opportunity open to you. However, whether you know it or not, whether you realize it or not, whether you appreciate it or not, you actually benefit from my economic analysis. You are thus a selfish, chiseling free-rider on these multifaceted benefits I have long provided for you, gratis. But now it is time to stop you from exploiting me regarding these spillover gains you have long enjoyed for free. It is time for you to pay your fair share! Accordingly, I am hereby presenting you with this bill for $100,000, a bargain at the price.

See Hoppe, H.H. (2003) The Myth of National Defense: Essays on the Theory and History of Security Production, p. 310.

Of course, as is evident from legal prohibitions on demands for payment for unsolicited goods and service (usually enacted under consumer-protection laws), governments will not allow such an absurd principle to prevail in private industry. And hence, as is common in government action, absurdity is compounded by manifest hypocrisy.

[8] This is not to say that mathematical economists are "incorrect" in formulating their models. It is notoriously difficult to construct mathematical models of human behavior and some degree of idealization is almost invariably required. The point is that these models are often used incorrectly as a basis to tell people what really makes them happy, despite their protestations to the contrary.

[9] And of course, we should have an objection.

[10] To those unfamiliar with arguments in political economy, the government provision of goods is coercive because it involves taxation, i.e., the coercive acquisition of money by government.