Friday, February 27, 2009

One rationale for the public provision of public goods

Amidst all the current talk about nationalization, it is worthwhile to think when the provision of private goods by public entities is indicated. Generally the argument is that the good is a natural monopoly and the particular industry is difficult to regulate. But are there other reasons?

Hanming Fang and Peter Norman provide an intriguing alternative explanation: when a government provides a private good, it learns more about the consumer and is thus better able to tax in the sense of optimal taxation. The basic idea is that it is difficult to configure properly a tax system because of information problems. In this particular case, there is private information about how much households value different goods, and the government tries to determine the optimal price à la Ramsey pricing. In addition, Fang and Norman show that the optimal pricing would call for a tax on the private good to subsidize the public good. This tax would be dependent on whether the household also consumes the public good.

While this is an interesting argument, one can question how this translate into practice. The authors suggest that the government should bundle the goods. This is something that is done aplenty in the private sector (think of bundling phone, cable TV and internet access), but this is done for similar goods. I cannot think of examples where public and private goods could be bundled in a reasonable way and that would be informative.

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