The market for local public goods.

Author:Banzhaf, H. Spencer
 
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ABSTRACT

Markets are an efficient way to allocate goods and services in an economy, but sometimes markets are said to "fail," such as when they are unable to provide public goods. I argue that for a wide class of environmental and other public goods--namely, local public goods provided by local jurisdictions--a market-like process does provide and allocate those goods. This argument, originally articulated by Charles Tiebout in 1956, has been criticized in recent decades as ignoring a jurisdictional choice externality, in which too many households crowd into desirable communities in an attempt to free ride on the public goods provided by neighbors. However, zoning is a key mechanism for closing the commons and preventing overcrowding. Proponents of the critique have offered various types of empirical evidence purporting to support their point of view and the ineffectualness of zoning. However, I argue that the empirical work to date on this issue either fundamentally misunderstands the issues or actually imposes the critique as a maintained assumption, rather than testing it. I present empirical evidence that is consistent with the idea that zoning achieves the desired end of pricing access to local public goods.

CONTENTS INTRODUCTION I. PUBLIC GOODS: MARKET FAILURE OR MARKET PROVISION? A. Non-Excludability and Non-Rivalry B. Overcoming the Excludability Problem: Closing the Commons 1. Clubs. 2. Bundling and Weak Complementarity II. A MARKET IN LOCAL PUBLIC GOODS A. Excludability in Local Public Goods B. Rivalry and Non-Rivalry in Local Public Goods C. The Price People Pay D. When Cities Compete: A Consumer's Menu of Options E. Market Discipline F. Empirical Evidence III. POTENTIAL FLIES IN THE OINTMENT A. Property Taxes 1. Jurisdictional Choice Externalities 2. Capital Distortions B. Renters IV. THE ROLE OF ZONING A. Prices under the Consensus View B. Prices as a Two-Part Tariff C. Empirical Evidence CONCLUSION INTRODUCTION

One definition of an economy is a social process that determines what a society produces, how it produces it, and to whom it allocates it. Given the set of possible goods to produce, the potential production methods, and the people to assign them to, the number of potential answers to those questions is enormous. How can all those decisions possibly be coordinated? One idea is to gather the best-trained social scientists, give them the best available data about production costs and the needs of the population, give them the best computers available to crunch the data, and let them coordinate the decisions through centralized command and control.

A very different approach is to use free markets to coordinate those decisions in a decentralized fashion. As Friedrich Hayek famously argued over a half century ago, markets have the ability to process diffuse information and feed it back to participants making decisions in the economy. (1) Consider, for example, the market for men's running shoes and suppose in one year that demand is strong for some unanticipated reason. In that case, given supplies, retailers may raise their prices or, alternatively, decline to put men's running shoes on sale. Seeing the higher prices, manufacturers will want to make more of those types of shoes. Conversely, if there are too many, prices will fall and suppliers will stop producing shoes for a time until inventories fall and prices rise again. Producers and retailers, as entrepreneurs, smell out the opportunity to make profits and both set their prices and react to prices accordingly. In this way, markets can provide a self-regulating order coordinating an economy's production and allocative decisions.

There is a consensus among economists that such forces work well in most circumstances. The debates center on the exceptions--about where and when the exceptions occur and how significant they are when they do. One such contested area is a set of goods known as "public goods"--goods that are shared by groups. Some public goods, like national defense, must be provided by national governments. Other public goods like police, fire safety, city streets, and schools can be, and typically are, provided by local jurisdictions.

This Article will consider the case of such local public goods, emphasizing cases where local jurisdictions partially determine the quality of the local environment enjoyed by local residents. Consider, for example, the case of local green spaces, important environmental amenities. These can be influenced by zoning (such as minimum lot sizes), conservation easements, purchase of conservation lands or parks, urban forestry practices, and so forth.

The city's morphology and tree canopy, in turn, can affect local air pollution and urban heat island effects. Other local policies affect air quality more directly. Rules allowing or prohibiting industrial activities are one obvious example. Another is the area's transportation policies, from individually small engineering projects that improve the flow of traffic on a city street to walkable neighborhoods to county- or regional-level mass transit systems. By the same token, the city's morphology and tree canopy can affect storm water runoff, stream quality, and the water table. Local water conservation ordinances and practices can affect water levels in lakes and streams. Treatment of municipal wastewater and/or regulations on septic tanks affect water quality. And so forth. In practice in the United States today, many of these policies are influenced by federal as well as local policies. But this does not diminish the important role for local jurisdictions or, more to the point, the potential for them to be largely or even solely delegated to local jurisdictions.

It is not the purpose of this Article to survey this entire field or discuss all the proposed--and contested--limitations to markets. (2) However, I will argue that for locally provided public goods, a market--or, at least, a market-like process--coordinates the level and allocation of local public goods provided by local jurisdictions such as counties and municipalities. Accordingly, when these public goods are provided by local governments out of local tax revenues or with local codes and regulations, market-like forces help ensure better outcomes. The same cannot be said when these goods are provided by state or federal governments. For this reason, I suggest that public decisions should be made at the local level whenever possible, as is consonant with the principle of subsidiarity. (3)

The idea that cities compete in a market-like environment was first and most famously articulated by Charles Tiebout in 1956. (4) In this Article, I will introduce Tiebout's original argument, discuss its implications, and discuss the potential weakness in the argument. In particular, important questions surround the extent to which local property taxes and zoning ordinances interfere with markets. In this Article, I will argue that zoning, far from interfering with local property markets, actually plays a crucial role in facilitating those markets. I also present empirical findings consistent with the notion that zoning has been sufficient to price entry into local jurisdictions.

In Part I, I first overview some basic principles of public goods generally, before moving on to discuss the case of local public goods and local jurisdictions in Part II.

  1. PUBLIC GOODS: MARKET FAILURE OR MARKET PROVISION?

    1. Non-Excludability and Non-Rivalry

      Public goods are characterized by two features, non-excludability and non-rivalry. (5) Markets sometimes are said to "fail" under such circumstances because the price mechanism either seemingly cannot work or would not make sense even if it could. (6)

      Consider first the excludability problem. With private goods, people can be excluded from enjoying the good if they do not pay for them: no cash, no shoes. This does not necessarily hold for public goods. Even if people do not pay for them, they cannot feasibly be excluded from enjoying public goods like clean air or a sound national defense. It is, after all, pretty hard to ask somebody not to breathe or to let slip through only those terrorists targeting people who fail to contribute to the national defense. So the argument goes that if those goods were provided by a market, people would under-provide these goods and try to free ride off others who pay for them.

      The interpretation, or evaluation, of the excludability problem depends on the extent to which the second feature, non-rivalry, is also present. Rivalry centers on the question of whether one person's enjoyment of a good detracts from another person's ability to enjoy it. Private goods are rivalrous: if I wear a pair of shoes, then you cannot wear them too. Public goods are not: if I breathe the clean air in a city, it will not detract from your enjoyment of the same air at all. Thus, non-rivalry raises the question of whether it would be desirable to exclude people from enjoying a good, even if it were feasible. Even if I were a free rider in the contribution to air quality, and even if it were possible to exclude me from such air, would it make sense to do so, given my enjoyment does not detract from others'? (7) Goods like these, where non-rivalry is present as well as non-excludability, are known as pure public good.

      When non-excludability is present but not non-rivalry, the good is known as a commons good. A classic example is a fishery, in which the fish are rivalrous (if I catch one--or eat one!--you cannot) but in which there is open access to the sea. (8) Unless institutions are developed to overcome the problem, the resulting economic incentives drive overfishing, with individuals considering their own catch without considering how it diminishes the catch of others. This is known as the "tragedy of the commons." (9)

    2. Overcoming the Excludability Problem: Closing the Commons

      The excludability problem, though sometimes a challenge, can often be...

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