Public Services: Excerpt from Economics in Two Lessons

by John Quiggin on December 28, 2016

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

In the section over the fold, I’m looking at public goods and publicly funded services

As we saw earlier, Lesson 1 does not apply to public goods, which can be used all, without any diminution of their usefulness, and for which no price can be charged. Many of the core activities of government may be regarded as providing public goods. These include public health measures, the control of air pollution, urban planning, police services and national defense.

More abstract services such as the legal system, the definition and enforcement of property rights, systems of weights and measures and so on are also public goods. Less obviously, macroeconomic management is a kind of public good (or sometimes a public bad). The level of economic activity, the rate of inflation, exchange rates and interest rates affect everyone, though in different ways.

Most advocates of Lesson 1 recognise at least some of these forms of public good provision as essential. The big disputes arise over services such as health, education and welfare services, which have long been provided, or at least funded, by governments. These services are commonly referred to as ‘human services’, and typically involve a personal relationship (doctor-patient, teacher-student, caseworker client and so on) between the service provider and the recipient.

Although these services are sometimes referred to as public goods, they don’t, in general, meet the criteria economists use to define public goods. A hospital bed or school place provided to one person isn’t available to others, and prices can be charged for access to these services.

On the other hand, neither do these services the standard conditions of Lesson 1. There are two central problems that arise. First, these services are expensive and recipients are rarely in a position to pay for them directly. As a result, all of the problems of risk and insurance, discussed in Chapter 10 …, apply to the financing of these services.

The second problem is that the relationship between providers and recipients typically involves an imbalance of information, power or both. A student is not in a good position to judge whether the education she is receiving is good or bad. Similarly, a patient must rely on their doctor’s expertise and professional ethics to get the appropriate treatment. In other cases, such as that of police services, there is also an imbalance of power, which may be misused.

Advocates of Lesson 1, such as Milton Friedman in Free to Choose have generally accepted the need for public funding to overcome the problems of financing education and, at least in some instances, health care. However, Friedman and others have assumed that any other problems can be overcome by market competition and consumer choice. Indeed, they have argued that market competition will help to prevent corruption and abuses of power that arise when governments provide services directly.

As a result, market advocates have favoured policies based on concepts such as ‘contestability’ and ‘contracting out’, in which for-profit firms compete to provide publicly funded services. The archetypal example is the perennial proposal for school ‘vouchers’, that is, funds allocated to students or their parents which can be paid to whichever school they choose to attend.

This idea was elaborated into a complete ‘reinvention of government’ by writers like Osborne and Gaebler in the late 20th century and implemented, to a large extent, in the wave of market liberal reform led by the Thatcher government in the UK. As a result, we have accumulated plenty of experience of market contestability and for-profit provision.

Theoretical analysis doesn’t give any clear answer as to which model of provision is likely to be best for services like health and education. However, after several decades of experience with market-oriented contestability, the empirical evidence is stark. For-profit provision of such services is at best problematic, and at worst disastrous.

The only other model with success comparable to that of public service provision is not-for-profit provision by organisations with a charitable or activist mission. Church-run schools and hospitals, and activist-run services like women’s shelters and services for the unemployed and homeless, have complemented the public sector, meeting needs that have been unrecognised or underserved.

The issue is not, in the end, one of public versus private. Rather it is the fact that market competition and the profit motive inevitably associated with it is antithetical to the professional and service orientation that is central to human services of all kinds.

{ 25 comments }

1

peter moylan 12.28.16 at 4:24 am

Good luck with your work John-Peter Moylan

2

nastywoman 12.28.16 at 5:33 am

– or let’s say it like it is?

There are countries where ‘human services’ in education and health are widely accepted as ‘the governments duty’ and so – they are not ‘up for privatization’.
And as these ‘human services’ might become the most costly services in so called ‘advanced economies’ and thus depend on… let’s call it: ‘widely solidaric contract’ -(like everybody HAS to have a health insurance and everybody HAS to pay her or his share for it) – economies which still will try to have such serviced ‘privatized’ will be ‘privatized f…d’!

3

Yankee 12.28.16 at 6:35 am

It’s also antithetical to the quality, safety, and usability of every damn thing delivered to the paying customer.

4

peterv 12.28.16 at 8:00 am

When a provider has a profit motive, there is a clear and sensible system for the provider to allocate the provider’s scarce resources (capital, attention, time) between competing recipients (patients, students, etc): prioritize the more profitable recipients over less profitable ones. Most economists would call this approach “rational”.

Most normal people, however, would expect a publicly-funded provider not to do this, but instead to treat all recipients equally, eg, on a first-come, first-served basis (FIFO).

When Telecom Australia was created from the PMG department in 1975, management switched from a FIFO basis in fixing faults to one where large customers were prioritized over small ones. This was felt to be unfair by the staff fixing the faults, and against the ethos of a publicly-owned organization. From the management’s point of view, staff were unwilling to change and move with the times. From the staff’s position, management had adopted an alien set of values, inappropriate or even immoral for the public sector.

It would be nice if mainstream Economics had something sensible to say about this issue, instead of just name-calling people on one side of the issue as “irrational”. It is an issue where resource allocation methods meet political philosophy at the micro level.

5

Philip 12.28.16 at 8:54 am

I like this part.

This sentence looks like it has a word missing ‘On the other hand, neither do these services the standard conditions of Lesson 1.’

It might be a good idea to mention positive externalities to show why the market would overcharge and underproduce human services. I’d also talk about choice as whether it is vouchers for schools in USA or direct payments for social care in the UK the price is set by one buyer, the government, so you don’t have competition leading to choice. Then there is the question of who is the ‘customer’, the government, the commissioning body, or the service user? In the UK there have been a number of scandals of for profit residential care homes which show that contracting out does not protect people from abuse of power, search for Winterbourne View for a high profile case.

I’ve never really seen what these attempts at marketisation are meant to achieve aprt from ‘efficiency gains’. I expect these would disappear under proper regulation and oversight except through eroding conditions for workers.

6

Mat 12.28.16 at 10:34 am

In the case of education, many countries have completely privatised pretty school sectors. In the UK, for example, there are limited vouchers for children of certain ages and children of low-income families, but otherwise it is a mix of for-profit and not-for-profit providers. It would be interesting to use this sector as an example.

There have been some problems where providers in London are reluctant to accept vouchers because the value was perceived to be not high enough to cover costs.

Is it true that for-profit education providers are necessarily disastrous? It seems to me that many of the selection problems associated with for-profit providers could be avoided by mandating lottery admissions procedures where the provider has no control over the intake.

However, I suspect that a mixed, partly for-profit system could not work without top-up fees, since the govt as a monopsony would just keep lowering the voucher until all profits are eliminated, squeezing out all but the stingiest providers. Do you think that’s a reasonable intuition?

7

Mat 12.28.16 at 10:35 am

Should say preschool, not pretty!

8

J-D 12.28.16 at 11:09 am

nastywoman

There are countries where ‘human services’ in education and health are widely accepted as ‘the governments duty’ and so – they are not ‘up for privatization’.

Are there? which ones would those be?

9

reason 12.28.16 at 11:40 am

Actually, my main concerns about private versus public education are completely orthogonal to this discussion. One major advantage of almost universal public education (as exists in Germany where I live) is that it acts as common experience for the whole society (as National Service also used to) which is a countervailing force against the forces of polarization and division.

10

reason 12.28.16 at 11:42 am

To say that slightly differently, public schools will tend to have an ethos of inclusiveness whereas private schools try very often instead to be exclusive.

11

P.M.Lawrence 12.28.16 at 1:19 pm

Echoing Philip, “… neither do these services [meet? fail? what?] the standard conditions of Lesson 1”.

“The second problem is that the relationship between providers and recipients typically involves an imbalance of information, power or both. A student is not in a good position to judge whether the education she is receiving is good or bad. Similarly, a patient must rely on their doctor’s expertise and professional ethics to get the appropriate treatment.”

A month and a half ago, following a cardiac episode requiring an ambulance trip (two within an hour, to be more specific), I was in just this situation at the Monash Medical Centre here in Melbourne. Even though I repeatedly made it clear that I would not accept any surgical procedures or medication unless and until I had had them explained to me and I had found them acceptable on the basis of supporting material (some of which was statistical nonsense, like describing the risk of a repeated episode for someone who doesn’t give up smoking without giving any figures for the odds for those who do), and that I would not take statins under any circumstances, they repeatedly tried to slip me statins and once attempted to inject me with something not previously described late at night when I was presumed sleepily compliant. Not only did one doctor have the nerve to tell me that he was the supporting material, but also when I insisted on first contacting my brother as next of kin and ensuring after care was in place before undergoing a surgical procedure (the supporting material, unlike the doctors, had indicated that this would be necessary), they refused to proceed and discharged me with documentation (sent, naturally, to the wrong postal address, much as they sent me to the wrong department to pay for medication) falsely asserting that I myself had refused surgery! Oh, and after care still hasn’t taken place, apart from my own follow up visit to my G.P.’s locum (I’m going again next week, to chase up after care and to sort out a medication side effect of bleeding that, unsurprisingly, I was not warned about).

“The issue is not, in the end, one of public versus private. Rather it is the fact that market competition and the profit motive inevitably associated with it is antithetical to the professional and service orientation that is central to human services of all kinds.”

That is conspicuously silent as to whether alternatives, say as practised at the Monash Medical Centre, are themselves antithetical to the professional and service orientation that is central to human services of all kinds.

12

Lee A. Arnold 12.28.16 at 2:33 pm

The case for central provision of some kinds of goods & services is often couched in the negative, i.e. that markets don’t do it as well. There is a positive statement to be made, which is that central provision is ubiquitous, in various forms, because it reduces costs.

Two days ago I finished a series which tries to illustrate this. There are 20 mini-videos (total time about 20 minutes, with a few musical interludes) showing how this works in the following groups: family, friends, neighbors, religious community, school, sports team, business firm, city with suburbs, tribe, nation, bank with customers:

13

JimV 12.28.16 at 5:40 pm

“public goods, which can be used all” – should that be “used by all”?

The final paragraph is great, in my opinion.

Biological evolution has lessons that apply here, it seems to me. Conservatives who are economists tend to emphasize competition, but some of evolution’s greatest successes have been due to cooperation.

14

H Horan 12.28.16 at 9:11 pm

Urban Transport Infrastructure (transit, expressways) raises critical public ownership issues but doesn’t quite fit the categorization in your draft. Most aspects are natural monopolies; its economics are dominated by a huge peaking problem (so the most valuable aspects of the service are the most expensive to produce); users don’t literally preclude other users (as with hospital beds) but impose externalities on them (delays, crowding); it has little or no way to recapture external benefits created (property development, access to dispersed employment opportunities); it requires standard pricing (zero for most expressways) but price elasticities within the large user base vary widely so that any attempt to ration peak capacity by price is actually an attempt to ration use by income level.

All privatisation efforts reduce general economic welfare because they create opportunities to capture economic rent; they reserve capacity for the wealthy (tollroad Lexus lanes) while imposing huge travel time penalties on everyone else, or by undersupplying total capacity (reducing development/employment benefits).

Taxis are a unique aspect of urban transport infrastructure that is structured as a tightly regulated market of private operators. Uber should be seen as an attempt to privatize this aspect of public infrastructure (control shifting from public regulators to Silicon Valley billionaires) without going through any democratic decision-making process about whether the privatization would benefit anyone but Uber’s owners. The results will be the same as tollway privatization–underprovision of capacity and external benefits, rationing of peak capacity by price (eliminating the only late night transit option for lower income workers), and monopoly rent-extraction.

Intercity transport privatisation works because there is no comparable peaking problem; variable pricing does not automatically become income-based rationing, and markets have no natural tendency towards the levels of concentration that supports rent-extraction and serious capacity undersupply.

15

Jonathan Monroe 12.28.16 at 9:19 pm

I think the paragraph about the Thatcher government is misleading, in that it implied that Thatcher oversaw a significant expansion in the role of for-profit businesses in public services. In fact the “internal markets” the Thatcher government set up in health and education involved competition between public sector providers.

The big increases in the for-profit role in U.K. public services are the Private Finance Initiative (set up by Major, but hit the big time under Blair as a way of borrowing money off-the-books to fund public sector construction projects) and Compulsory Competitive Tendering (also a Major initiative, partially reversed by Blair, and which mostly affected ancillary services like catering).

The first time a for-profit company was responsible for clinical care in an NHS hospital was Hinchingbrooke in 2011.

16

Mike Huben 12.28.16 at 9:46 pm

Would the concept of “club goods” be better for some of these?

You might also point out that:
* government is also not-for-profit
* other non-profits are underfunded to serve the demand.

One important thing you left out. A common libertarian accusation is that government services are inefficient because they are non-market. Yet because multiple local government services (such as roads) are not competitive, they can share cost-saving methodologies and cost information, letting political managers ensure that they are getting the bang for their buck..

A possibly useful quote for you:

“This is why books entitled Economics in One Lesson must evoke from us the advice: ‘Go back for the second lesson.'”
— Paul Samuelson, “A Modern Post-Mortem on Bohm’s Capital Theory: Its Vital Normative Flaw Shared By Pre-Sraffian Mainstream Capital Theory”. Journal of the History of Economic Though. V. 23, N. 3. 2001.

17

Collin Street 12.28.16 at 11:13 pm

I’ve never really seen what these attempts at marketisation are meant to achieve aprt from ‘efficiency gains’. I expect these would disappear under proper regulation and oversight except through eroding conditions for workers.

That’s all they’re meant to achieve. The difference is, they peg the possible scope for “efficiency gains” higher than you do.

[because they all think they have brilliant ideas that will radically reshape service delivery that are only blocked by the feather-bedded time-servers and parasites at the government agency. In reality, of course, or let’s be honest almost always the reality is, that their ideas were already considered and rejected on account of some big-picture impact that the proposer hadn’t considered. Typically we’re talking narcissism, to think that they know better than the people doing the job, and a general theory-of-mind problem of not realising different people want different things: like I keep saying, there’s literally nothing in right-wing thought that isn’t symptomatic of some form or another of empathy impairment.]

18

Collin Street 12.28.16 at 11:18 pm

Further, of course: externalities, positive and negative, are delocalised and generally won’t show up on an individualised / overly-reductionistic analysis [“there is no society”… and what cognitive conditions are associated with an excess of reductionism…?]

19

John Quiggin 12.29.16 at 1:01 am

Thanks everyone for useful comments

20

Mike Huben 12.29.16 at 1:24 am

D’oh! Now I see that I got the Samuelson quote from you, JQ.

21

maidhc 12.29.16 at 7:48 am

There’s a third option: co-ops.

Here’s an example:
http://www.bbc.co.uk/news/technology-37974267

Note the discussion of the free rider problem when installation of infrastructure is involved.

22

Kiwanda 12.29.16 at 4:20 pm

Harping on this again: software, and especially software standards, should be public goods. Html not Word/Powerpoint/ formats, OpenOffice not Office, Diaspora not Facebook, Linux not Windows, R not S, numpy not matlab, etc.

When public goods go bad: sometimes the reward structure is corrupt or encourages corruption. Theft by cop (“civil asset forfeiture”) at $5B/year now matches the total of all other theft in scope. The funding of local government by trumped-up fines results in the horrific regressive systems in place in, for example, Ferguson, Missouri.

23

J-D 12.30.16 at 9:57 pm

reason

One major advantage of almost universal public education (as exists in Germany where I live) is that it acts as common experience for the whole society

You don’t think the commonness of the experience is qualified by the difference between Gymnasium and other kinds of school?

24

Kurt Schuler 12.31.16 at 10:52 pm

There are few examples of pure public goods. Even those you mention near the start have some measure of excludability. Police protection downtown benefits all law-abiding people downtown, for instance, but its effect uptown may be quite weak; separate protection is needed. Nor do I think it is accurate to say that no price can be charged. Taxes can vary depending on the overall level of service provided. The connection with the level of service is looser than it is when you buy a haircut, is still there.

25

ZM 01.01.17 at 12:18 pm

John Quiggin,

“The issue is not, in the end, one of public versus private. Rather it is the fact that market competition and the profit motive inevitably associated with it is antithetical to the professional and service orientation that is central to human services of all kinds.”

I think it depends on various issues, such as scale and standards.

For instance in Australia’s universal healthcare scheme Medicare the public hospitals are run by health organisations under the State government department of health, but the GP doctors all just have their practices in private clinics except for maybe community clinics run under the government department.

It seems to work fine for GPs to be private and people just choose their GP like its a market, and then Medicare pays for the doctors appointments with people making up the gaps in some cases (I have a healthcare card so my GP appointments are free under bulk billing).

Hospitals must be better to run under the government department, but in our local hospital it uses the GPs who have their private practices as doctors, so its a bit of a mix of public and private.

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