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Thursday, May 20, 2010

The Private Provision of Public Goods

Nobel laureate economist Elinor Ostrom’s important work shows that people are very good at using voluntary action to solve problems that economics textbooks insist require the forceful hand of government. Producing “public goods” (such as irrigation systems for a community of farmers) often promises large enough gains to stir the creative juices of people—who, given enough freedom of action and security of rights, then figure out how to cooperate to provide them. This cooperation often takes different forms from what we witness in markets for typical private goods (such as shoes).

Along similar lines other scholars over the years have discovered countless historical examples of the successful private provision of public goods. Sometimes it is achieved by firms seeking monetary profit, while other times it is achieved by people cooperating for gains that are real but not monetized or exchanged in conventional markets.

The discovery of any such instance always surprises the typical economist, whose thinking is stymied by too many wrongheaded models of economic interaction.

Perhaps the most surprising of these discoveries is the issue of private currencies (or “free banking”). F. A. Hayek, George Selgin, and my George Mason University colleague Larry White led the way in showing not only that sound money can be supplied privately but that it has been supplied privately—most notably in Scotland from 1716 until 1844.

What about roads?

Limited-access highways are no problem. Private highway builders can erect tollbooths at entrances and exits and charge for use of their roads. No free riders will thwart builders’ efforts to collect payment from willing customers.

Local city streets are different. Having tolls at each intersection seems awfully inconvenient.

One way of solving the problem of privately supplying local city streets was seen in St. Louis. As reported by historian David Beito:

In 1867, property on Benton Place, the first private street in St. Louis, went on the market. The street had been subdivided a year earlier by Montgomery Blair, who had been Postmaster General under Abraham Lincoln. Blair entrusted design of the street to Julius Pitzman. By the 1870s, at least four other private streets ringed Lafayette Park. Pitzman laid a park median on the street, a feature emulated by later private places. Every lot extended to the center of the median. Following the pattern of Lucas Place [a St. Louis street with some private characteristics], each deed carried restrictions, including a setback from the street of twenty-five feet. Business use and multifamily housing were not prohibited, however. The restrictions provided for the annual election of three commissioners by the lot owners. The commissioners had authority to maintain the street, street lighting, the park median, sewers, and the alley by levying an annual assessment of fifty cents per front foot on each property. Armed with private-street ownership, Benton Place’s residents enjoyed a range of powers not possessed [by residents of nonprivate streets]. The commissioners, exercising their proprietary rights, erected a gate at one end of the street and a retaining wall at the other. They could deny access to the alley or park median to residents delinquent in their assessments to the street association.

Note that the private payments for this private street were simultaneously also payments for several other public goods that people value: sewerage, a park, and street-cleaning services, among others. By bundling these public amenities into a single package—namely, title to property on Benton Place—the developer was paid for providing this range of public goods. Persons who didn’t buy property on Benton Place and live up to their express agreement to pay annual assessments got no residential rights to live there.

Note, too, that Beito does not call the assessments “taxes.” He’s right not to do so. Everyone who bought property on Benton Place expressly agreed to pay the assessments according to the contractual agreements they signed with the developer. These payments, therefore, were made voluntarily.

Modern Examples

Columbia, Maryland, and Reston, Virginia, provide more recent examples of cities whose infrastructures were built and supplied privately. In both cases, private developers—James Rouse in Columbia and Robert Simon in Reston—planned and constructed the streets, sewer lines, and parks. They then sold real estate that included a prorated portion of the infrastructure’s cost.

Obviously these developers also had incentives to provide high-quality infrastructure. Were the streets too few, the park too small, the sewer lines too narrow, the maximum prices that buyers would pay for homes in these towns would have been lower.

Interestingly, not only was physical infrastructure provided privately in Reston and Columbia, so, too, was perhaps the most important public good of all: law. By buying real estate in Reston or Columbia, a buyer also expressly agreed to abide by the town’s bylaws, which serve as constitutions. They specify limits on property use (for example, no old cars on cinder blocks in front yards) as well as procedures for making future collective decisions that affect all residents. Unlike constitutions and statutes chosen by majoritarian voting, these rules have the actual unanimous consent of the people they govern.

In our 2002 paper, “Contractual Governments in Theory and Practice,” Randy Holcombe and I called the rule-making procedures and agencies formed by such constitutions “contractual governments.” We explained:

A single owner who intends to subdivide property and sell individual parcels forms the typical contractual government. The owner’s motivation is to increase the value of the parcels. As such, the creator of the contractual government has an incentive to create constitutional rules with the highest value. . . . The entrepreneur who forms a contractual government is a residual claimant whose income depends on the production of efficient constitutional rules. In municipal government, in contrast, there is no residual claimant. Mayors, city managers, and town-council members may have some incentive for making efficient decisions, but not the direct incentive that they would have if they were able to capture the profit from efficient decisions directly, as is the case with contractual governments. Thus, a direct incentive exists to produce efficient constitutional rules under which a contractual government will operate, unlike the situation that exists with municipal governments.

Sounds like a pretty good system.

Find a Portuguese translation of this article here.

  • Donald J. Boudreaux is a senior fellow with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University, a Mercatus Center Board Member, and a professor of economics and former economics-department chair at George Mason University.