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The economics of... state vs market
Who can better provide goods and services? / 56
What should the state do? What should better be part of the private sector?
Should the state bake bread? Operate railways? Maintain an army?
Or should that be the task of private providers?
A lot is so self-evident that we no longer ask ourselves why something is done by the state, and other domains are run by companies.
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Some people believe that important things should be provided by the state. Because only the state could ensure that those things are always available for everyone.
But why does the state not run bakeries, then? (Bread is an important staple food, isn't it?)
The simple answer: Because bread is usually not in short supply. It is made available in sufficient quantities via private markets.
So there must be another reason (not the importance for society) why some things the state can handle better than private providers. And why for other things, it's the other way around.
The question "state or market?" is, in principle, simple to answer.
Economics knows only two reasons why goods and services are not provided well or sufficiently within private markets, that is, whenever the good or service is non-excludable and/or non-rivalrous.
What is meant by that?
A good or service is broadly assigned two fundamental characteristics, a degree of excludability and a degree of rivalry.
Excludability means that the supplier can prevent the "free" consumption of a good.
Rivalry means that the consumption of a good by one consumer prevents simultaneous consumption by other consumers.
If a product is rivalrous and excludable, economics call it a private good.
Rolls are a private good. They are excludable (the baker can prevent people from "free" consumption), and rolls are also rivalrous (a roll can't be eaten twice).
That's why baking bread in private hands is in good hands.
It is different, for example, with street lighting in cities. Neither can one be barred from accessing, nor can one be charged for paying while "using" streetlamps at night.
We call goods that are non-excludable and non-rivalrous public goods.
Street lighting is a public good. So are national security, common languages, law enforcement or public parks.
We do know now private goods and public goods. But there are also mixed forms.
Goods can be rival in consumption and non-excludable. Such goods are called: Common-pool goods.
And goods can be excludable but not rivalrous in consumption. They are then called: Club goods.
Here is the matrix that arises from these four types, it is called the fourfold model of goods.
Next to public goods, the government is usually responsible for common-pool goods; and enterprises are generally responsible (next to private goods) for the production of club goods.
This is because, with club goods, the market problem (resulting from non-excludability) can be healed by enterprises that offer club models like cable television or golf courses.
Common-pool goods, in contrast, are harder to provide by markets.
An example of a common-pool good is fishing. Fisheries harvest fish from a shared common resource pool of fish stock. Fish caught by one group of fishermen are no longer accessible to another group, thus being rivalrous. However, oftentimes, due to an absence of property rights, it is difficult to restrict access to fishermen who may then overfish.
Summary: To understand whether a good is better produced by the state or by enterprises, one has only to examine whether the respective good or service is excludable and rivalrous.
Isn’t it fascinating that it only takes two criteria to determine what the state should and shouldn't do?