The June 2017 issue of Cato Unbound looks at how the private sector could provide public goods. It considers the idea of what Alex Tabarrok calls a Dominant Assurance Contract.
The dominant assurance contract adds a simple twist to the crowdfunding contract. An entrepreneur commits to produce a valuable public good if and only if enough people donate, but if not enough donate, the entrepreneur commits not just to return the donor’s funds but to give each donor a refund bonus. To see how this solves the public good problem consider the simplest case. Suppose that there is a public good worth $100 to each of 10 people. The cost of the public good is $800. If each person paid $80, they all would be better off. Each person, however, may choose not to donate, perhaps because they think others will not donate, or perhaps because they think that they can free ride.
Now consider a dominant assurance contract. An entrepreneur agrees to produce the public good if and only if each of 10 people pay $80. If fewer than 10 people donate, the contract is said to fail and the entrepreneur agrees to give a refund bonus of $5 to each of the donors. Now imagine that potential donor A thinks that potential donor B will not donate. In that case, it makes sense for A to donate, because by doing so he will earn $5 at no cost. Thus any donor who thinks that the contract will fail has an incentive to donate. Doing so earns free money. As a result, it cannot be an equilibrium for more than one person to fail to donate. We have only one more point to consider. What if donor A thinks that every other donor will donate? In this case, A knows that if he donates he won’t get the refund bonus, since the contract will succeed. But he also knows that if he doesn’t donate he won’t get anything, but if does donate he will pay $80 and get a public good which is worth $100 to him, for a net gain of $20. Thus, A always has an incentive to donate. If others do not donate, he earns free money. If others do donate, he gets the value of the public good. Thus donating is a win-win, and the public good problem is solved.
I think of a public good as a special case of a more general problem, which is that it is often the case that average cost exceeds marginal cost. In fact, one of my main complaints about courses in basic microeconomics is that they focus on the opposite situation where marginal cost exceeds average cost, which is is not so often observed in reality.
For example, if you are building a cell phone network, the fixed cost of the infrastructure will be high. However, once you have the infrastructure, the marginal cost of transmitting a gigabyte of data will be low. If you charge this low marginal cost, you will never recover your fixed cost. Instead, you need customers to “donate” to pay for the infrastructure. The “donation” comes in the form of a monthly subscription fee.
In a typical cell phone pricing model, the charge for using data is zero until you reach your limit, and then it is ridiculously high. This model helps facilitate price discrimination. You pay a higher subscription fee to be in a higher data tier, meaning that you face the zero price at higher levels of data usage. Price discrimination of this sort helps the cell phone company recover fixed cost while making sure that most customers are charged low marginal costs most of the time.
The cell phone company has the ability to exclude non-subscribers from getting its service. With a public good, such as national defense, you no longer can exclude particular individuals. Either everybody gets it, or nobody gets it. Call this the non-excludability property.
Note: The textbook definition of a public good is one that is non-excludable and non-rivalrous. What I am suggesting here is any good that has very low marginal cost is “pretty close to” non-rivalrous. These “pretty close to” non-rivalrous situations are very common. {And with the Internet, they become more common. As maps turned into Google Maps, the marginal cost of producing a tryptich plummeted. As travel agents became TripAdvisor, the marginal cost of vacation planning services plummeted. etc.] Those that are also non-excludable, and therefore meet the textbook definition of public goods, are less common.
Governments, like private firms, can and do use price discrimination and bundling to cover fixed costs. People pay different tax amounts. People receive bundles of services–you pay for trash collection and government schools, even if you desire one but not the other.
Non-excludability is a different issue. Governments typically solve the problem of non-excludability by using coercion–you are forced to “donate.” Coercion produces the “everybody gets it” outcome instead of the “nobody gets it” outcome.
Alex’s contract is an alternative to coercion. The idea is that a typical consumer will receive a small benefit in the “nobody gets it” outcome, but only if that consumer is willing to donate. With the “everybody gets it” outcome, the consumer gets a benefit above that consumer’s willingness to pay. That is the sense in which either outcome is a win for a consumer who is willing to donate, so that it is in the consumer’s interest to be willing to donate.
My problem is that I cannot see a way to combine Alex’s contract with price discrimination and bundling. And I think that price discrimination and bundling are very important for funding government in practice.
Really interesting. Food for thought. “Non-rivalrous” is the limiting case of diminishing marginal cost, where marginal cost is always zero.
BTW: I read the new Three Languages of Politics yesterday. Since I’ve been reading the blog since its start (and you intermittently since AIMST), I was afraid it would feel “been there done that.” But it was more like a live concert by a good band. And it probably took less time.
One market I would like to understand in terms of government deregulation is the power generation/distribution market. The 1950 – 1990 managed local monopoly with large economies of scale is no needed and this needs to be updated. I do think Texas has the closest competitive electric company system in the country and I wondering how we can best model that for other states. Additionally , the California deregulation experiment is another good failed data point to use here as well.)
1) In terms of oil, gas, and coal extraction companies, the problem is consumers still pay the electric company prices. So fossil fuels may claim to be the cheapest but the power companies get to decide. So in California, solar is going up everywhere in the desert because we pay $.30+ during summer hours so solar is competitive here. (Especially on new construction.)
2) We do need states to stop mandating which power source to use either renewal goals (California) and fossil fuel (Wyoming).
3) As great as Texas is, shouldn’t the wind power generating companies (mostly small companies) be allowed to sell power to other states or Mexico? Seems like basic supply side reality and weird protect for extraction and Texas power companies.
4) I bet if the government deregulates, nuclear dies quickly with too much fixed cost and liability.
5) I know we are still far off on electric cars but that is growth opportunity for local utilities.
I’m trained in the field. There are three keys.
1) Pricing needs to include a margin for grid storage. Solar etc does not work at night. Backup power; coal, gas, nuclear make losses by day if solar is above 14%. Most pricing locked in the wholesale and retail prices so tight that there was no margin for storage and non renewable’s made losses. With Trump and the sidelining of the IPPC that’s over. In Australia where I live that change came last week. Still flawed but better.
2) If all power producers are selling to grid storage then the grid storage companies sell to all customers regardless of state.
3) Some of the interstate restrictions are hardware problems I.e. the old cables can’t handle some power sources so they have to be directed elsewhere. Most thing once power is pumped into the grid it is uniform but voltage fluctuations and other like phase accuracy matter.
4) The R & D for grid was handled by a pay per service private NGO. But that changed with Obama. Reverting it will take a while.
5) Crowdfunding grid security, hackers, is one of the items being added.
I hope this helps. Pricing is a separate problem to crowdfunding public goods.
The original document is too technical for me to follow, but based on your summary I question whether this type of crowd-funding wouldn’t fall under the federal or state securities laws, and thereby involve myriad legal and compliance issues?
Warren Meyer, who blogs at “Coyote Blog,” worked out a private-public partnership agreement with the state of Tennessee to rehab and operate two state recreational parks. Check out his presentation, in which he explains the “win-win” terms of the agreement:
http://www.coyoteblog.com/coyote_blog/2017/06/me-in-my-actual-day-job.html
That’s been dealt with. The securities people tried it on a few years ago. All major parties at state and federal level told the securities people to pull there head in and those people at the Securities commission were promptly moved on after the last election. I believe one remains and is vocal but powerless. There really is no where else to go and even the hard left and wall street corporatism fans knows it.
It seems to me that there is a lot of low hanging fruit in terms of ways of using technology to turn things which were once thought to be ‘natural’ public goods into private goods. I drive on a high-speed EZ-Pass toll road with variable congestion pricing every day. Obviously its easier to track and exclude automobiles from roads than people from, say, city parks, but nearly everyone is carrying around a smartphone with GPS and automatic payment apps these days, and I’m sure some clevel Silicon Valley entrepreneurs could be developing all kinds of ways to see whether people are really willing to pay the cost of us of various pubic amenities. A simply privatization would be the outright sale of most public lands, though that is an unpopular proposal.
As for price discrimination, I think one can already see something like this on kickstarter. People are being offered different bundles packages of goods and services for different levels of donation / investment, to include guarantees of low future subscription rates for some online games. It seems to me that it wouldn’t be too hard to allow for variable DAC commitments in exchange for variable outcomes, and that these could be used to achieve the necessary bundling and price discrimination functions.
It feels like there’s a lot of potential for collusion. For example, if A and B “represents” that the public utility is worth $100, but really doesn’t care about it, then they have incentive to throw the game and split the refund.
Also, with the volatility of the electorate, I’d be nervous as a supplier. All your polls say people will like this product, then in the middle of your campaign, someone charismatic speaks out against it, and you end up failing and are now on the hook for a refund.
I suppose in the end, though, everything would just be insured, with insurance companies backing a large number of contracts, supplying the refund for the failures, and taking a cut of those contracts which are successful.
Alex has to make a huge assumption to argue that dominance assurance contracts solve the public good problem. In his example, there’s a specific pool of people who can donate, and the project will fail if just one of them doesn’t donate. So the probability that you don’t donate and the project raises enough money anyway is 0. In real situations it’s possible to not donate yet still have the fundraiser succeed, which still makes free riding the best strategy in a lot of cases.
Taxes don’t solve the free rider problem either if 40% are not paying any net tax. Also the target size of an appeal is always set to a significant buffer so it does not get blocked by one single donor. Crowd funding demonstratively works for public goods. All categories of public goods have shown up on crowdfunding sites and got funded. Even a few really stupid ones, clear rip offs got funded. Note these are not dominant assurance contacts but they have worked.
Arnold Kling I’ve been talking about this for years and can do price discrimination and bundling in my version of that system. My blog on it is in the Website tab.
For price discrimination and bundling you simply do a user pays system with crowdfunded trusts for the people that can’t afford the price. Bundling would be a little more limited.
Most big systems like defence would be sub divided with defence entities and industry allowed to run big million dollar internal cross crowdfunding. However these would need to be publicly gazetted with oversight and auditing.
I would also use insurances since the trust recipients can afford higher risk premiums. I.E. preexisting conditions trusts for specific categories crowdfunded as you describe [Alex Tabarrok described] so the premium signal is not distorted in the market. There is some small sacrifice in privacy in crowdfunded trusts. The recipient may not need to be named but must be described loosing some anonymity. In essence the crowdfunded trusts back end the poor after the price signals. I would also add crowd funding of research and competition prizes to drive price/ cost reduction.
Lastly if you throw in a few discretionary fund crowdfunding appeals for prominent leaders the last gaps are covered. With such people using their reputation and expertise to get the money instead of wasting the time and money on politics. Again how that money is spent needs to be publicly gazetted and audited.
http://appliedimpossibilies.blogspot.com.au/2012/05/crowd-funding-government.html
In case the above web link is not visible to all.
Most don’t know that Alex Tabarrok wrote a version of his dominant assurance contract system into Bitcoin and its fully implemented and working. They successfully crowdfund several public goods and they have also crowdfunded some really silly and strange things. It works!