Multiplying the impact of government: market-based pricing and some examples from California.

• Author: Bornstein, Irwin B.

The South Coast Air Quality Management District's "Smog Market" represents one of the largest-scale implementations of market-based pricing concepts in the United States to date.

Within the past two years, many people involved with or working in the public sector in the United States have come to realize that the ways of doing government's business in the 1990s simply cannot stay the same in light of changes in today's environment. There have been numerous studies and writings on the subject, probably the most popular being David Osborne and Ted Gaebler's book Reinventing Government.

For government finance professionals, one of the most intriguing notions brought forth in that book, as well as by others in the field, is the concept of utilizing market incentives instead of laws and regulations to affect individual behaviors. Osborne and Gaebler described this idea as "market-oriented government."(1) The League of California Cities' Committee on 21 had as the focus of its work in 1991 the same topic, which they called "market-based pricing." To this writer, a participant on that committee, it became clear that this concept is one of a number of very promising tools to allow governments to become even more effective in addressing the growing lists of demands despite having fewer resources at their disposal.

Many governments have been utilizing this approach on a small scale. Larger-scale implementation has been less prevalent yet promises even greater benefits. Recently, however, one regional government organization in California has approved one of the largest-scale implementations of market-based pricing concepts to date in the United States: the RECLAIM project, approved by the South Coast Air Quality Management District (SCAQMD) on October 15, 1993, is the nation's first "smog market."(2)

What is Market-based Pricing?

Osborne and Gaebler describe market-oriented government as "structuring the marketplace" and "utilizing market-based incentives instead of traditional command-and-control methods." Market-based pricing (MBP) has a similar, but slightly narrower, definition: "To make prices reflect the full social cost of goods, from a can of soda to a kilowatt of electricity."(3) But the overall goal of MBP is the same as Osborne's and Gaebler's: to have market forces and private decision makers, rather than government officials, do the work of achieving societal goals. In so doing, governments can "multiply their impact a thousand-fold," say Osborne and Gaebler.

MBP goes beyond traditional full-cost recovery definitions of typical user-fee studies. MBP argues that societal costs (what economists call "negative externalities") must be included in the price of a good or service, especially the costs of using up limited natural resources, if proper market incentives are to be built into prices.

Government in a New World

Many now agree that the ways that governments have been providing services and regulation for the past 60 years are out of sync with the changes that have occurred in our society and the world. For example, there is a growing consensus that there simply are not enough resources in the world economy that are available to governments to allow them to solve the problems and provide the services at the same levels that have been previously demanded by individuals. This realization has major significance. Professor Robert Biller at the University of Southern California has said that this crisis of resources is on par in significance with the other two major American government crises: the Civil War and the failure of the Articles of Confederation. Not only has there been tremendous change in the world during the past 10 years, but the rate of change continues to accelerate as well. Advances in technology and communication have created abilities for instantaneous communication worldwide and for true global markets. Many of these changes have created new demands on government. Yet most governments have responded in the same ways that they have for the past several decades. Not surprisingly then, many of these government efforts to address these new and changing societal issues have been unsuccessful. Record numbers of Americans now have lost faith in their governments and their leaders to be able to effectively address the issues that are important to them.

Governments typically have been supply-oriented, rather than demand-oriented, in addressing a problem or issue. They have traditionally supplied more of a service or a higher level of service or a new program in response to a new issue or demand presented to them.(4) In a previous era when resources were more plentiful and there was an ability to raise revenues to finance these additional services and programs, this basic approach seemed to work, and there was little incentive to change it. This is often no longer the case, however, given both the advent of tax rebellions and the growing complexity...