Free Riding and Forced Riding in Public Goods

As energy prices have surged recently, quite a few people have voiced difficulties bearing the burden of energy-related public utility charges. The government does have a role to play in difficult times. In particular, its role is important for vulnerable groups and those in need of social consideration. However, the government cannot, and also should not, intervene in every aspect of life. That is because government is not an omnipotent god. Moreover, government operates on taxpayers’ money. Therefore, principles that the public can agree with must be upheld.

Public goods are said to have the characteristics of non-rivalry and non-excludability. For that reason, they are also said to be a cause of market failure because they are not supplied sufficiently in the market. David Hume pointed out long ago that it is difficult to concretely design the voluntary roles of members for a common objective, and even more difficult to carry them out. From this, one can see the logic that social overhead capital such as roads, ports, airports, and the military must inevitably be built by the government.

In other words, public goods are generally assumed to be better supplied by the government because they are not provided sufficiently in the market. However, relying on government to provide public goods can create problems of free riding and forced riding. Not only is it difficult for the government to know the optimal quantity of public goods to supply, but even if it could know that quantity, it has weak incentives to provide the optimum amount. Therefore, public goods are highly likely to be over-supplied or under-supplied relative to actual demand. Models such as those of Niskanen and Migue-Belanger imply that public goods are supplied in excess of the socially optimal level. Meanwhile, because of the problem of free riders with respect to public goods, it may be mistakenly perceived that public goods are under-supplied.

This suggests that the public’s tax burden for public goods may become unnecessarily excessive. By contrast, for goods and services traded in the market, the price mechanism adjusts the necessary quantity demanded and supplied. Because users who need the goods and services clearly pay the cost, resources are not wasted and are used efficiently.

In fact, it is hardly an exaggeration to say that there are almost no public goods in the true sense. This is because roads, ports, airports, and the military mentioned above are, strictly speaking, excludable. In other words, a market price can be charged for them. With creative ideas and technological development, public goods and public services can be supplied efficiently by the private sector as much as needed. This would reduce tax waste and distortions in resource allocation caused by excessive government provision of public goods.

The deficits of public enterprises arising from the provision of public goods below cost will ultimately fall on someone. Since anyone can use public goods, one might assume that everyone may bear the cost, but questions arise over who should pay how much, when, and by what means.

For example, if the deficits of public enterprises are covered by government support, taxes must be paid regardless of whether or to what extent one uses the relevant public good or public service. In contrast to the problem of free riding, this creates the problem of forced riding, in which people must pay taxes for a level of public goods provision they do not want. In addition, excessive issuance of public enterprise bonds by heavily loss-making public enterprises also disrupts financial markets.

Recently, demand has flocked to KEPCO bonds, which guarantee relatively high returns, pushing up funding rates in financial markets and increasing borrowers’ interest burdens. In the end, borrowers in financial markets are indirectly subsidizing electricity users who receive power below cost. In the bond market, the concentration of demand in KEPCO bonds has made it difficult to issue ordinary corporate bonds, adding to firms’ difficulties in raising funds. This causes distortions in the bond market. Moreover, KEPCO’s continued and excessive operating losses have damaged its corporate value.

Over the past decade or so, the value of energy-related public enterprises listed on the KOSPI, including KEPCO, has shown a continuing downward trend. Ordinary shareholders of those public enterprises have suffered considerable losses due to excessive government regulation of public utility charges.

About 50 years ago, the oil depletion predicted by global resource and environmental experts did not become reality because market prices sent appropriate signals for action to both consumers and suppliers. On the demand side, higher oil prices induced greater conservation and economizing; on the supply side, they made it possible to profit from producing more expensive oil. Regulation is an imperfect instrument. Excessive regulation must not turn away from reality, become tilted toward political objectives, or be trapped by the performance-driven mindset of government ministries. Uniform regulatory policy only creates further distortions and increases social costs.

Youngshin Kim, Professor, Department of Economics and International Commerce, Keimyung University

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Original title: 공공재의 무임승차와 강제승차

Author: Young-sin Kim

Date: 2023-03-20

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=25470