The private life of public economics.

• Author: Clotfelter, Charles T.
• Position: Transcript

16. Hansmann, Henry B., "The Role of Nonprofit Enterprise." Yale Law Journal, April 1980, 835-98.

17. Hanushek, Eric, "The Economics of Schooling: Production and Efficiency in the Public Schools." Journal of Economic Literature, September 1986, 1141-77.

18. -----. "The Trade-off between Child Quantity and Quality." Journal of Political Economy 1992, 84-117.

19. Hill, Martha S. and Greg J. Duncan, "Parental Family Income I would like to speak today about the significance of private behavior for the area known as public economics, or public finance. As a leading text puts it, this area is concerned with "the taxing and spending activities of government |32, 5~." Today I will be concerned primarily with the "expenditure side" of public economics, for it is clear that research on the tax side has long recognized the importance of private behavior, given the attention that has been devoted to the effects of taxation on such things as labor supply, saving, portfolio composition, consumption decisions, and charitable contributions. I will define as private behavior those actions that are taken by individuals or households not in their roles as voters, political operatives or public officials. The examples I use all refer to households, but I believe that many of the same arguments apply to firms as well.

    The thesis I wish to put forward this morning is this: many forms of behavior that we normally think of as private in fact have important implications for the public sector, especially the local public sector. I do not mean simply that some actions have externalities; it's more than that. The interactions that take place--between government and households, and among households--go to the heart of how public services are produced and consumed. To me, this perspective implies the need for a broader view of public economics than that contained in the typical public finance textbook.

    I will begin by giving a simplified rendition of the conventional public finance treatment of one of the field's central problems--the provision of public services--and then propose a somewhat different approach to looking at this question, one that emphasizes the use of non-governmental alternatives. Next I will give a bit of evidence to suggest the importance of such alternatives. Finally, I will note some of the implications of this approach for public economics.

    1. The Public Economics Problem

       In establishing the normative foundation for the public sector, the typical public finance textbook looks first to the concept of "market failure," the most important form of which being the existence of public goods. These are goods, such as a lighthouse or national defense, the consumption of which is said to be nonrival--my consumption does not diminish yours. Although an omniscient planner could determine the efficient amount of such a good (assuming he's taken calculus), an unfettered market would fail to provide this amount because individuals have an incentive not to reveal their preferences for public goods, and thus to act as free riders. Much of the fundamental theoretical work in public finance--including work by Wicksell, Lindahl, Samuelson, Musgrave, and Buchanan--is motivated by this basic problem.(1) It is also the motivating spirit behind a good part of the area known as public choice, a body of research that has examined how the institutions of government affect the allocation that comes about.

       Of the several "solutions" to the free-rider problem that have been suggested over time, one that has assumed a prominent place in local public finance is contained in a 1956 article by Charles Tiebout |41~. In it he argues that the process of residential location within a metropolitan area has the effect of forcing people to express a preference for public goods. This "voting with feet" assures the revelation of preferences for local public goods. This is a model that has launched a thousand articles, and the quasi-market mechanism that it suggests is a firmly established piece of the orthodoxy of local public finance. As I will argue shortly, I believe that the general applicability of this model has probably been overstated.

       I would like to highlight one thing that characterizes most of the literature on the demand for public services. In general, households are viewed as valuing public services in much the same way they value commodities that they purchase in the market, only the public services typically present a demand-revelation problem. Whether this problem is solved through this Tiebout voting-with-feet mechanism or through the institutions of collective decision-making, the public services themselves typically enter directly into the utility functions of individuals, just like private goods and services. A notable exception to this approach is a model proposed by David Bradford, R. A. Malt and Wallace Oates in 1967 |6~. There they distinguish between the "direct output" of public services, such as the number of police patrols, (which they call D, for direct) and the output that is relevant to the household, say personal security, (which they call C). The level of C that is enjoyed on the household level is a function of the D-output and environmental factors (E). Although their original motivation in putting forward this model was to explain the high cost of public services, their approach is quite general. In what follows, I attempt to extend the distinction they make between the direct output of government and the attributes that are valued by households.

    2. A Household Production Model of Public Services

       Today I wish to suggest a way of viewing the provision of public services that focuses on the household as a unit of production. As the labor economists among us would readily attest, the notion of production within the household is not a new one.(2) However, it has not been customary to apply the concept in public economics.(3) I will argue that such a perspective offers several advantages, including a more integrated view of the nonprofit sector and Tiebout residential sorting.

       My approach begins with two propositions. First, the public sector is only one of several alternatives by which households satisfy demands for services. Second, one household's production function may be influenced by who its neighbors are and how those neighbors are going about satisfying their demands.

       The first proposition, that there exist alternatives to the public sector, is of course not a brand new idea. For example, Albert Hirschmann |20~ examines in general terms the option of "exit" from public services, and Burton Weisbrod |44~ notes the importance of private nonprofit organizations as alternatives to government, in addition to privately-purchased goods and services.(4) But there are also important informal alternatives to public services, such as time and effort provided by the household itself, or services provided communally outside formal tax-exempt entities, such as by neighbors. As an illustration of the variety of household responses, consider some of the alternatives to police and the criminal justice system for enhancing security: I can purchase dead-bolt locks, lights, or alarm systems; I can join my neighbors in a formal or informal association to keep watch of each other's property; or I can change my own behavior, by locking doors, turning on lights, or simply staying inside at certain times. Or I can pick up and move--either to another jurisdiction or to a different neighborhood within the same jurisdiction.

       Other examples are equally familiar: backyard swingsets, club memberships, private automobiles, and private schools may substitute for publicly provided services, while tennis rackets, smoke detectors, and reading to children at bedtime augment them. Notice that residential relocation--the defining act of the Tiebout model--constitutes one important form of household behavior affecting its production of services, but it is only one of several alternatives open to households. In this sense, the Tiebout model is a special case of the more general model of household production.

       According to this perspective, directly-provided government services can best be viewed as intermediate goods that may be used as inputs in the household's own production, or alternatively, not used at all. In the same way, the household also uses services of nonprofit organizations and privately-purchased goods and services as inputs. Production thus takes place at two levels: the level of what we might call the agency (the government, the nonprofit organization, or the for-profit supplier of the service that constitutes the intermediate good) and the level of the household. Household utility in this model is then a function of the goods and services they consume "directly" and whatever they produce through this kind of household production. Obviously there is a certain indeterminacy here as to what things end up as arguments in the utility function, since virtually any article of consumption down to parkas and potato chips, can be thought of as "inputs." Regardless of exactly where one decides to draw the line between household production and consumption in general, the point here is that a real and significant element of production stands between the provision of public services and the ultimate satisfaction of wants.

       The microeconomics of this household production is fairly ordinary: the mix of inputs is chosen on the basis of what works (their marginal products) and how much the alternatives cost. If the household could choose the desired amount of public and private inputs, the optimal combination of inputs would be described in general by the familiar condition that the ratios of the marginal products equal the ratios of the prices of the inputs. In practice, the amount provided by government to a household is more or less fixed.(5) How this lumpiness affects the household's choice of inputs depends on the nature of the private...