Advancing Public Goods (The Cournot Centre for Economic Studies Series)

Advancing Public Goods The Cournot Centre for Economic Studies (formerly the Saint-Gobain Centre for Economic Studies...

Author: Jean-Philippe Touffut

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Advancing Public Goods

The Cournot Centre for Economic Studies (formerly the Saint-Gobain Centre for Economic Studies)

Series Editor: Robert Solow, Emeritus Professor of Economics, Massachusetts Institute of Technology; President of the Cournot Centre for Economic Studies. Conference Editor: Jean-Philippe Touffut, Director of the Cournot Centre for Economic Studies.

Advancing Public Goods Edited by

Jean-Philippe Touffut Director of the Cournot Centre for Economic Studies, Paris, France

THE COURNOT CENTRE FOR ECONOMIC STUDIES SERIES

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© The Cournot Centre for Economic Studies 2006 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library

ISBN-13: 978 1 84542 718 4 (cased) ISBN-10: 1 84542 718 1 (cased) ISBN-13: 978 1 84542 719 1 (paperback) ISBN-10: 1 84542 719 X (paperback) Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Contents List of figures and tables List of contributors Preface Acknowledgements About the Series: Professor Robert Solow Introduction: public goods, social enactions Bernard Gazier and Jean-Philippe Touffut 1 2

3 4

5 6

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Public goods: a positive analysis Inge Kaul For-profit, state and non-profit: how to cut the pie among the three sectors Avner Ben-Ner Services of general interest in a competitive multinational space Philippe Herzog Funding public services in Europe: state banks or public–private partnerships (PPPs)? Patrick Artus New public institutional design Xavier Greffe Knowledge as global public good: production conditions and preconditions Claude Henry Global public goods and global finance: does global governance ensure that the global public interest is served? Joseph E. Stiglitz

vi viii x xi xii 1

13

40 68

104 117

137

149

165

Index

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Figures and tables FIGURES 1.1 1.2 1.3 1.4 1.5 4.1 4.2a–c 4.3 4.4a 4.4b 4.5 4.6a 4.6b 4.6c 4.7

The basic properties of goods: a conventional approach to public goods The socially determined status of goods: an expanded concept of public goods Building blocks of food safety The de facto mix of national goods and global public goods Schematic description of the provision of transnational (global or regional) public goods Euro zone: yield curve ROE of the large banks Euro zone: non-financial corporate debt (as % of GDP) Bank loans to non-financial companies (% GA) Euro zone: bank loans to non-financial companies (% GA) Credit institution opinion poll on overall corporate treasury requirements Balance and gross issuance of Pfandbriefe (billions of euros) Balance and gross issuance of Cédulas (billions of euros) Balance and gross issuance of mortgage bonds (billions of euros) PPP structure

16 17 24 30 31 107 109 109 110 110 111 112 112 113 114

TABLES 2.1 2.2

2.3

The extent of violation by for-profit firms of the optimality conditions for consumer well-being in selected industries How government and non-profit organizations perform in comparison with for-profit firms that violate optimality conditions Governance, agency and access to capital in government and non-profit organizations relative to for-profit firms vi

48

55 59

Figures and tables

2.4 4.1

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Proposed allocation of economic activities among the three sectors, in various industries 60 Liability structure of commercial banks (%, 2002) 106

Contributors Patrick Artus is the chief economist at IXIS Corporate and Investment bank of the Caisse d’Epargne Group. He is a professor of economics at Ecole Polytechnique and at the University of Paris I Panthéon-Sorbonne. He is a member of the Conseil d’analyse économique reporting to the French Prime Minister. Avner Ben-Ner is a professor at the Carlson School of Management, University of Minnesota, USA. His research specialities are the theory of organization, non-profit organizations, and economics and psychology. Bernard Gazier is a professor of economics at the University of Paris I Panthéon-Sorbonne and a researcher at the laboratory MATISSE-CES (Modélisation Appliquée, Trajectoires Institutionnelles, Stratégies SocioÉconomiques – Centre d’Economie de la Sorbonne). His main research fields are labour economics and labour market policies in Europe. Xavier Greffe is a professor of economics at the University of Paris I Panthéon-Sorbonne. His main research area is the economic aspects of cultural heritage and its management. Claude Henry is a director of research at the CNRS (Centre National de la Recherche Scientifique) and a professor at the Ecole Polytechnique. His main research fields are competition and regulation of public services in the European Union, and economic growth and the environment. Philippe Herzog is president of Confrontations-Europe and a member of the Conseil d’analyse économique reporting to the French Prime Minister. He is a former European deputy and a professor at the University of Paris X Nanterre. Inge Kaul is director of the Office of Development Studies at the United Nations Development Program. Her research focuses on development financing and aid. Joseph E. Stiglitz is a professor at Columbia University and a Nobel laureate. His research explores information asymmetries, adverse selection and moral hazard in the economics of information. He has contributed to macroeconomics and monetary theory, development economics and trade viii

Contributors

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theory, public and corporate finance, the theories of industrial organization and rural organization, welfare economics, income and wealth distribution. Jean-Philippe Touffut is co-founder and director of the Cournot Centre for Economic Studies.

Preface This volume is one of a series arising from the conferences organized by the Cournot Centre for Economic Studies, Paris. These conferences explore contemporary issues, with particular focus on Europe. Speakers, along with other participants and members of the audience, are drawn from backgrounds in academia, business, finance, labour unions, the media and national or multinational governmental and non-governmental agencies. The specific texts presented here are the fruits of the sixth conference of the Cournot Centre for Economic Studies held on 2–3 October 2003. The title of the conference was ‘Public Sector, Private Sector: New National and International Frontiers’.

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Acknowledgements This book owes a great deal to Therrese Goodlett and Timothy Slind. My warmest thanks go to both of them.

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About the Series Professor Robert Solow The Cournot Centre for Economic Studies is an independent, Frenchbased research institute. It takes its name from the pioneering economist, mathematician and philosopher Antoine Augustin Cournot (1801–77). Neither a think-tank nor a research bureau, the Centre enjoys the special independence of a catalyst. My old student dictionary (dated 1936) says that catalysis is the ‘acceleration of a reaction produced by a substance, called the catalyst, which may be recovered practically unchanged at the end of the reaction’. The reaction we have in mind results from bringing together (a) an issue of economic policy that is currently being discussed and debated in Europe and (b) the relevant theoretical and empirical findings of serious economic research in universities, think-tanks and research bureaux. Acceleration is desirable because it is better that reaction occurs before minds are made up and decisions taken, not after. We hope that the Cournot Centre can be recovered practically unchanged and used again and again. Notice that ‘policy debate’ is not exactly what we are trying to promote. To have a policy debate, you need not only knowledge and understanding, but also preferences, desires, values and goals. The trouble is that, in practice, the debaters often have only those things, and they invent or adopt only those ‘findings’ that are convenient. The Cournot Centre hopes to inject the findings of serious research at an early stage. It is important to realize that this is not easy or straightforward. The analytical issues that underlie economic policy choices are usually complex. Economics is not an experimental science. The available data are scarce, and may not be exactly the relevant ones. Interpretations are therefore uncertain. Different studies, by uncommitted economists, may give different results. When those controversies exist, it is our hope that the Centre’s conferences will discuss them. Live debate at that fundamental level is exactly what we are after. There is also a problem of timing. Conferences have to be planned well in advance, so that authors can prepare careful and up-to-date texts. Then a publication lag is inevitable. The implication is that the Cournot Centre’s

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About the series

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conferences cannot take up very short-term issues of policy. Instead, a balancing act is required: we need issues that are short-term enough so that they are directly concerned with current policy, but long-term enough so that they remain directly relevant for a few years. I used the words ‘serious research’ a moment ago. That sort of phrase is sometimes used to exclude unwelcome ideas, especially unfashionable ones. The Cournot Centre does not intend to impose narrow requirements of orthodoxy, but it does hope to impose high standards of attention to logic and respect for facts. It is because those standards are not always observed in debates about policy that an institution like the Cournot Centre has a role to play.

Introduction: public goods, social enactions Bernard Gazier and Jean-Philippe Touffut The definition that economists offer of a ‘public good’ restricts the commonsense meaning of the expression. In general, the adjective ‘public’ suggests universal accessibility and some level of state involvement. For economists, the public characteristic of a good results from its availability and allocation. In the work of Paul Samuelson in the 1950s, this broader traditional concept was formalized, so that membership in the category of public goods came to be determined by two properties.1 The first property is called ‘non-rivalrousness’: consumption of the good or service by one individual does not reduce the quantity available to others.2 The second property is ‘non-excludability’: if it is difficult or impossible to exclude from the enjoyment of a good or service any user who refuses to pay, then the good or service is termed ‘non-excludable’. With his canonical definition, Samuelson sought to answer two questions. How should one define collective-consumption goods, that is to say, goods for which there is no distinction between individual consumption and total consumption? How should one characterize the optimal allocation of the resources necessary for the production of these goods? The answers were derived from a model designed to determine the optimal allocation in an economy in which there are two kinds of goods.3 The Samuelsonian formalization of public goods forms part of the wider extension and application of theoretical economic thinking to the public domain: the economic sphere is defined in terms of a specific goods-directed relation between agents. Economic agents are characterized purely through the operations that they carry out on physical goods.4 Public goods are constructed axiomatically, without any reference to their socialization. As a result, seemingly unimpeachably public goods, however pure, manifest ambiguities of construction. Recent debate has led to radical contestation of the identification of existing public goods with the formalized and strictly incomparable class of Samuelsonian public goods.5 In the case of the lighthouse, it is almost impossible to prevent a ship from determining its position using the lighthouse signal, and that ship’s access to 1

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Advancing public goods

this signal does not deprive any other maritime vessel. On the other hand, as Coase suggests, it is often possible to associate a lighthouse with the nearest port whose facilities are used by each individual ship.6 In the case of national defence, a frequently cited example of a fundamental public good, different levels of protection afforded to various populated zones and conflicting defence priorities for certain population groups reveal rivalries among the beneficiaries. Similarly, highway tolls, while making it possible to charge motorists according to use, can result in the exclusion of some users from the highway network, another public good. Thus the existence of a public good depends on the space relative to which it is defined and relative to the authority on which it is based. The necessity for the state to assume direct production of the good is therefore consubstantial with that good. It can set out provision specifications and organize regular tenders for private operators. The public aspect of certain goods can also be transnational: for example, the international postal service possesses the characteristics of a global public good. Of course, there may be weak national links that do not distribute letters correctly. However, Article 1 of the Universal Postal Union’s Convention states that ‘all member countries shall ensure that users/ customers enjoy the right to a Universal Postal Service involving the permanent provision of quality basic postal services at all points in their territory, at affordable prices’. The intangible operational rule of the Universal Postal Union is that each postal administration retains the taxes that it levies.7 The tax retention (or non-distribution) rule, observed throughout the 90-year history of the existence of the UPU, rests on the assumption that letters sent from one country to another match the replies. Despite contrary statistical evidence, the principle of reciprocity won out in justifying the cooperative construction of this global public service. In the case of the postal service, as in the other cases discussed above, the public good involved is not a mirror image of a private good. It originates in a different rationale grounded in a philosophy of ‘public service’. Samuelson’s account of public goods, in its refined and problematized variants, still constitutes the benchmark reference in the field, and remains the cornerstone of public economics. Public goods must be produced in sufficient quantities, yet the traditional mechanisms of private enterprise do not work. However, arguments for the traditionally acknowledged role of state intervention can equally be derived from the other social sciences. The contributions in this volume of proceedings from a conference entitled ‘Public Sector, Private Sector: New National and International Frontiers’, held in October 2003, are evidence of the immense current relevance of the economic concept of public goods. The papers describe recent advances that have transformed and strengthened the concept, yielding a series of concrete applications, in particular in the framework of Europe. Public

Introduction: public goods, social enactions

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goods, public sector? The assimilation of the two is far from obvious. In any event, it does not result as by default from the processes of market extension and protean liberalization currently affecting economies globally. This does not mean that the contributors to the volume judge the pressures in favour of privatization unimportant; nor does it imply that the latter are decreasing. However, it does involve moving to a timeframe appropriate to conceptual analysis and development, in order to present and discuss the lessons of lengthy apprenticeship and the fruits of international debates in a field that captures the interest of everyone. In the past 50 years, the concept of public goods has experienced four major transformations. First, public goods have come to be recognized as social constructs, and not simply natural objects, or matters of fact, of which general cognizance is sufficient for their existence. The identification and management of a public good are contingent on a series of choices. That does not mean that any private good whatsoever can be turned into a public good by communal decree; it means that some goods which may fall within the definition of a public good can be placed on one side or the other of the dividing line. In the case of roads and tolls, while it is unthinkable to install tollbooths everywhere in order to control all access to the road network, it is possible to build a separate system of motorways, and then to decide whether to leave it public (as in Belgium) or to privatize it (as in France). Global public goods, such as financial stability or the preservation of the ozone layer, are only clearly identifiable at the end of complex processes of discovery, and are very often revealed through negative experiences due to knowledge gaps or ignorance. The second transformation is recognition of the global dimension of public goods. Knowledge, the diffusion of which enables individual enrichment without detriment to other users, cannot easily be contained within national borders. However, consciousness of the global repercussion of the existence of certain public goods is a recent development. In the case of knowledge, the worldwide management of patents is a dazzling illustration of this state of affairs. The new perception of the global dimension is intensified when one draws up a list of the global interdependences that include for example climate degradation and financial instability, and that can upset individual lives, even those apparently best protected initially. Terrorism thus appears as a negative global public good, and the broad imperatives of development, such as growth in the level of education and knowledge, constitute positive public goods. The big question concerns the consequences of these identifications. The third transformation is the foregrounding of the multi-agency nature of public goods production. It has long been acknowledged that the production of public goods involves multiple interactions, including the

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potentially monopolistic behaviour of the state towards consumers or the interactions due to networks (for example, roads, postal services, railways). The novel element in the third transformation is an emphasis on the multiple cooperation and partnerships necessary for the efficient development and production of public goods. The fourth transformation, which follows from the previous three, concerns the intrinsically dynamic nature of public goods, in both their recognition and management. Consciousness of the interdependences and interactions is slowly but continuously reconfiguring the extension of the domain of public responsibility. The different levels and modes of this responsibility are then themselves subject to evolution. The example of Europe is a test case, as it engages in the redistribution of monopolies and regulation in response to the deepening imperatives of European construction. These four transformations are relative innovations. None breaks with the conceptual frame of the existing structure. However, taken together, the texts in the volume have important practical and theoretical consequences. Each contribution starts from a partial or total renewal of the foundations of public goods, leading to conclusions in political economy. They sketch the features of a mixed economy, for which a comprehensive theory and account of the conditions of its implementation have yet to be developed. Fifty years ago, the activities and roles of private and public sectors could be contrasted in a straightforward way, and it was appropriate to look for equilibrium conditions and their complementarity. Since then, the erection of a boundary between public and private, whether in favour of one or the other (nationalization or privatization), is insufficient grounds on which to base a project, much less a guarantee of credibility or an operational specification. The options are not interchangeable. They must be evaluated in the broader and more complex context of social logic, without which they collapse into ideological electives. At the core of the questions about a mixed economy lies a variety of private sector motivations and behaviour. Should the shareholder image be set against that of not-for-profit organizations? Both types of organization continue to evolve. The roles ascribed to each and the respective areas of engagement may change over time. For example, 50 years ago, networks of low-cost sales cooperatives (groceries) developed in France. In the main, the clients of these ‘co-ops’ were the low-income elderly, formerly termed ‘economically vulnerable’, now renamed the ‘senior poor’. The co-ops offered a relatively small number of inexpensive products purchasable as single items. The service was provided by a not-for-profit network. The arrival of supermarkets endowed with wide power over the prices and supply of a vast range of products rendered the service provided by the


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co-ops redundant and obsolete. The local small grocer became more expensive, and catered to a new clientele, and the senior citizen entitlement softened without solving the poverty problem. In other words, the challenge had shifted elsewhere. Not-for-profit organizations are massively present, in other forms and with other beneficiaries, in the fight against poverty. One of the not-for-profit sector’s roles is to work at margins that move slowly: the unmet needs of people outside the classical distribution networks, emerging general needs. Home care for the dependent and immigrant literacy are two current examples. A further matter for reflection is that of the stacking up and coherence of state interventions. The existence of global public goods is clear evidence in support of the emergence of structures of control and decision making at the planetary or at least continental level. The construction of Europe is a daily reminder of this fact: the nation state, if it still has a central role to play, must redefine its functions, caught as it is between a local–regional echelon of increasing importance and a federal entity emergent at the continental level. The question of who should do what is obviously tied to an appreciation of the area of interdependence and solidarity that every public good involves: supranational and global for the diffusion of knowledge, financial stability, global warming and ozone layer preservation; federal for the management of a currency such as the euro, macroeconomic stimulation delivered through a budget and for a policy of scientific research; national for social security transfers; regional and local for large planks of education and training policies. Beyond these relatively consensual examples, the divisions are not self-evident, and the overall architecture requires periodic redefinition. Beyond the multiplicity of actors and their levels of intervention, the conditions of joint action necessitate more exact specification than in the past. Under what condition is a partnership balanced? Does such and such a pricing policy open up over- or under-investment in the long term? How can the simultaneous presence of transnational firms and supranational organizations be balanced, and what rules of the game should be adopted? When two domains of intervention overlap, for example in internal trade and labour rights, who should take control of potential conflicts and reciprocal dependences? Questions such as these show that subtle argument involving at least two levels is necessary. At the first level are arguments in terms of comparative advantages enjoyed by particular classes of participants by virtue of their orientation, financing or control structure, and at the second level are arguments in terms of interactions and complementarities (or rivalries) between different groups of actors. The principal issue is then evaluation, not limited to the single discrete instantaneous action of a participant, but within a perspective of interaction and learning.

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These questions are all the thornier because they bear on the modes of collective control. Democracy presupposes freedom of access to information, a plurality of critical sources and assessments, but also the periodic interrogation if not suspension of advantage at every level. No longer is it sufficient to vote for or against a government, nor can one rely or trust lobbies or pressure groups. The title of Inge Kaul’s contribution hints at her position. She proposes a positive analysis of public goods in non-normative terms. Her argument does not seek to define the contours of an ideal or utopian collective intervention. It aims to delimit and deepen the direct implications of a class of public goods that is still poorly understood. The reader is invited first to follow a conceptual analysis. The pluralization and mobilization of agents, and the extension and multilateralization of viewpoints are immediate consequences of the pragmatic attitude she adopts to cope with a wide variety of contiguous problematics. It rapidly becomes clear that the two attributes of public goods, non-rivalrousness and non-excludability, are neither immovable nor given for all eternity. They are predicated implicitly on a social construction and collective decisions. Hence there is room for manoeuvre in the understanding and enactment of these goods. The determination of a good as public or other depends on the characterization of the context and an enriched family of new determinants. Public and private sectors are endowed with evolving boundaries and promote evolutionary interactions. Inge Kaul thus shows that the recent extension of the field and the variety of public goods is fuelled by several processes: on the one hand, processes that foster increasing interdependences and their practical consequences, and, on the other hand, initiatives based on voluntarist direct universalization. For example, the discovery of transmission routes of an epidemic and the appropriate preventive and therapeutic actions goes hand-in-hand with discussions of the necessity of universal basic education. One and the same agent, operating at different levels, may represent the legitimate management of a public good and hence of the general interest, or on the contrary may be found to represent a narrow coterie of vested interests. This is the case, for example, when nation states, in creating redistribution networks for social security, negotiate without an appropriate supranational structure in order to protect their interests in international trade. Derogation from the higher interest of the ‘global public goods’ that are described in Inge Kaul’s text may lead nation states to exhibit predatory or even delinquent behaviour. The final perspectives to which Inge Kaul’s analysis lead are both encouraging and uncomfortable. The issue of global economic and financial interaction is thoroughly expounded, and the necessity of coordination and


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control associating the multiple agents at the supranational level is advocated in detail. The perspectives are uncomfortable because the pivotal role played by the nation state, endowed with its monopoly on legal constraint, is reaffirmed at the same time as are the opportunistic temptations to which it is subject in the absence of global government. The role of nongovernmental organizations (NGOs) is also simultaneously brought into the spotlight and called into question. Is the ‘global civil society’ that they endorse simply an aberration? The inconsistencies of control at the planetary level and the existence of transversal conflicts (delegitimating several categories of agents and domains) run the risk of partial or sectarian actions on the part of NGOs. In the end, ‘conflict management’ is also a public good, the production and management of which remain to be envisaged and organized. Avner Ben-Ner’s contribution provides a directly complementary perspective, pursuing the same conceptual strategy of pluralization and contextualization from a different angle. It explores a micro-organizational viewpoint in an implicitly national framework, thereby foregrounding and generalizing the famous argument about ‘market failures’. The existence of a public good is a cause of market failure, since it is not produced at all, or at best in insufficient quantities, if one is reliant on the free initiatives of solvent, willing agents. The standard example is private security forces that rich individuals can afford: they do not fulfil the same role as the army and the police, and the latter are necessary. The flipside of market failure is ‘state failure’, where bureaucrats rule, and a large literature of varied provenance exists on the subject. Should one therefore lump together the institutions of state and market? This facile response has long been discarded, with the arrival of the non-profit private sector, in turn tasting successes and failures. Whether the failures are of the market, the state or the non-profit private sector, there is no room for dogmatism on the question concerning who is best positioned to produce a specific good in a specific context. This is the issue underlying Ben-Ner’s text. His responses are detailed and situational. Ben-Ner begins by enriching the list of criteria for the classification of goods before comparing the conditions of control and production in each case. This leads to a fine-grained analysis of the operational aptitudes of various candidate agents for the production of specific goods and services. It is noteworthy that the author’s concrete examples, drawn from North America, are not always transposable into the European context. This observation serves to reinforce the view that no fixed agent type or organization is the intrinsically ideal producer for any given category of needs. Two consequences are immediate. The first is that diversity of actual and potential producers is desirable in itself, and hence constitutes a supplementary public good, the availability of which should be monitored.

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The second consequence is that in many cases non-market private organizations, combining the advantages of free initiative with the concerns of public interest, appear relevant. The text concludes that the slow growth of these organizations is based on a series of comparative advantages, without precluding potential disadvantages and handicaps. The final criterion, here as in the preceding text, remains one of the amplitude and effectiveness of the control that the ultimate owners, in their resource allocation and investment decisions, can exercise. At the conclusion of Ben-Ner’s argument, the question surfaces concerning the increasing importance of the explicit customer ‘personalization’ of certain services, which induces their exit from the strictly market domain in order to thrive in receptive networks having a non-market perspective. Home care for dependent people is a case in point. Should competition be organized or should voluntary care be preferred? Arbitration here rests on the appreciation and organization of the role of family cohesion, and in the end involves carers’ career paths and lifestyles. To argue, as the text does, in favour of diversity of producers of goods that are more or less public both outlines and conceals this vast question. The diversity of public goods development is at the heart of Philippe Herzog’s paper. The author describes the difficulty in constructing European public goods. Heterogeneous conceptions of these goods from one country to another make the work of the European legislator very complicated. In the construction of the single market, Europe sought to avoid extinguishing national prerogatives. It established a principle of separation bearing not on the goods themselves, but on the ways these goods are developed. Essential services of a social non-market character are distinguished from other services, and fall outside the scope of the rules of competition and the single market. As Patrick Artus explains in his paper, these are services for which a demand requiring public provision is necessary, such as a public supervisory authority. This principle is insufficient when activities are mixed or hybrid, combining social and economic features, market and non-market elements. Philippe Herzog believes that criteria of social effectiveness should be put in place in order to describe the implementation of services of general interest: the idea is to measure real costs and external effects and to measure these relative to satisfaction indices. A properly funded European statutory monitor compiling these indices would facilitate transnational comparisons of services of general interest. Patrick Artus’s text tackles the question of paying for public services in Europe. The funding principles are completely different, depending on whether services of general interest are provided by private operators subject to specific regulations or on whether strong network effects or natural monopolies prevent the development of those services by the


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market. Consideration of the infrastructures associated with delivery of public services also modifies the service funding conditions: in the cases of water distribution, telecommunications and transport, should project financing be preferred to public–private partnerships between EU members? Xavier Greffe suggests that these specific questions be raised within a more general theoretical framework, the elements of which require future elaboration. This theory will include an account of the implementation of public intervention, in other words, a description of the microeconomy of the ‘public provider’. The fundamental question of the organization, production and financing of public goods remains a live issue for the state. While the user hopes to enjoy the quality expected of public service combined with the efficiency attributed to the market, these two properties have long seemed incompatible. Between the neoliberal position and the institutionalist tradition, Xavier Greffe argues that a pragmatic approach to public goods production will allow the articulation of global, national and local mechanisms, avoiding arguments couched in terms of isolated unconnected levels taken as ends in themselves. Strategies of decentralization and the construction of networks, markets and hierarchies require holistic consideration and will open the way to increasing dialogue and participation in democratic processes. Stepping up from the European plane, Claude Henry moves the debate to the planetary scale in his treatment of knowledge as a good, the public character of which is difficult to guarantee. In an issues-driven analysis, he discusses the conditions and consequences of the production of knowledge. First, he notes that knowledge is a public good in itself, but that it is also a precondition of other public goods. It is in some sense a ‘super public good’. The text invites the reader to a double pragmatism: upstream, in the organization of research, and downstream, in the use of the results of research for the benefit of all. Open science must therefore be encouraged. Researchers may be relatively indifferent to remuneration. However, if large budgetary resources are required, as is the case in the majority of scientific fields, then money must be found to guarantee the development and free circulation of knowledge. This involves a double incentive: researchers motivated by the desire for peer recognition, and capital commitments for research operations and infrastructure. In the collective interest, it is therefore necessary to introduce the incentive of market ownership if public funding is inadequate. The incentive is all the stronger where the boundary is fuzzy between ‘discoveries’ and ‘inventions’, the former relating to the diffusion of scientific knowledge, the latter to industrial applications. The solution described in the text appeals to temporary patent-based monopolies. Knowledge slips temporarily from

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public good to ‘club good’. Claude Henry presents different ways to calibrate, moderate and manage this lesser evil. The pragmatism of Henry’s text returns in his discussion of the links between knowledge and the public goods of climate and health. The connection between greenhouse gas emissions and global climate degradation is widely conceded, although unproven and unquantified; the links between antibiotic absorption and the resistance of certain bacteria families are amply documented, although in some cases remain conjectural. In these two cases, the uncertain nature of knowledge imposes specific management outcomes. In both cases, the convergence of independent expert opinion and the existence of a fragmented but pertinent scientific basis make possible and legitimate decisions informed by the precautionary principle applied with proper discernment. In both cases, the diversity of national interests has the result that while certain countries endorsed the legitimate scientific results, other countries, subjected to special interests, found ways to avoid endorsement. Hence coordinated and legitimate coalitions of agents are necessary to enforce correct management of these situations. Claude Henry’s analyses bring out the multiple tensions between knowledge as public good and knowledge restricted to a designated group, between the gains and losses associated with application of the precautionary principle and its suspension on grounds of uncertainty. The painstaking exploration of the collisions of short- and long-term horizons, between special interests and the general interest, leads nevertheless to a message similar to that of Inge Kaul: where no global arbitration authority exists, it is necessary to construct intermediate solutions, whether temporary monopolies or blocs of agents and experts, in order to reconcile opinions. In his decisive contribution, Joseph Stiglitz marshals a particularly rich set of arguments in defence of global public goods. The author sees in the light of market failures the obligation to construct, at the global level, public goods that repair the weaknesses of the structures originally designed to guarantee those goods: international organizations. Too frequently, the international arena is used to remedy public ills that cannot be handled locally. The question of the administration of international organizations and the possible subversion of the actions of these bodies in the pursuit of private aims must be resolved before any construction of global public goods is possible. Joseph Stiglitz examines minutely the roles of the International Monetary Fund and the global reserve system in the international financial system. The creation of special drawing rights emerges as the only specific form of intervention that can bestow on international organizations the legitimacy that governs the construction of global public goods.


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In concluding this introduction, it is useful to emphasize the expansionary dynamics that mark current developments in public goods. The conference ‘Public Sector, Private Sector: New National and International Frontiers’ demonstrated the increasing relevance of research on these goods and the power of the political argument based on the idea of public goods. This relevance may be understood first as directly induced by the diverse and protean processes loosely summarized under the term ‘globalization’. Progressive consciousness of the interdependences of the world economy, whether in matters of finance or pollution, and the creation of arenas and regulatory sites on a planetary scale are as much opportunities as impulses in favour of the list of public goods and of better collective control over their production and distribution. One sort of globalization breeds another. However, this simple response or assessment, likely to excite more unease than enthusiasm, is inadequate if it is interpreted in a simplistic manner as an idealistic or rhetorical proposition. The era of global administration based on the Western world appears ended. In diverse ways, the papers that we have reviewed escape this pitfall. They develop a project of multi-tiered collective deliberation, according to consensual transversal norms.

NOTES 1. Samuelson, P. (1954), ‘The Pure Theory of Public Expenditure’, The Review of Economics and Statistics, 36, 387–9, and ‘Diagrammatic Exposition of a Theory of Public Expenditure’, The Review of Economics and Statistics, 37, 350–56. Before Samuelson’s work, economists understood the term ‘public good’ in a broader sense in which state intervention in the production of the goods was an intrinsic part of their definition. See Holcombe, R. (1997), ‘The theory of the theory of public goods’, Review of Austrian Economics, 10, 1–20; 3. In his ‘Idea of a Perfect Commonwealth’ of 1754, the philosopher David Hume remarked that society might find advantages in the collective production of goods that are entirely unprofitable for an individual to produce. He looked to mathematicians for methods of justifying items of collective production. 2. In the economics literature, non-rivalrousness is sometimes identified with indivisibility. The non-rivalrousness of a good or service implies that others enjoy the same quantity and quality of the good, whatever the level of use or consumption by an individual. Indivisibility means that it is impossible (either in nature or through a political division) to separate off a single part of the good or service to render possible partial individual consumption. This does not prevent possible individual attribution: one can draw lots for the individual enjoyment of an indivisible good. One example is a family home that members do not wish to carve into allotments, and which is used by one of the legatees. In this sense, non-rivalrousness belongs to the field of politics: it rests on situations of natural or artificial indivisibility, in which pricing on the basis of observed individual consumption is abandoned. It brings to light or constructs a non-market interdependence. 3. Sandmo, A. (1987), ‘Public Goods’, in J. Eatwell, M. Milgate and, P. Newman (eds), The New Palgrave: A Dictionary of Economics, Volume 4: Q to Z, London: The Macmillan Press Limited.

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4. The principle of ophelimity is based on the idea that goods are separable, physical entities, characterized by their material features. For this reason, their objective definition is independent of any action involving them. 5. For example, Holcombe, ‘The theory of the theory of public goods’. 6. Coase, R. (1974), ‘The Lighthouse in Economics’, Journal of Law and Economics, 17(2), 357–76. 7. Article 1 of the Universal Postal Service Convention (http://www.upu.int/).

1.

Public goods: a positive analysis* Inge Kaul

INTRODUCTION Although the literature on public goods is extensive and diverse, it shares a standard definition of public goods. According to that definition, public goods have two main properties: non-rivalrousness in consumption and non-excludability of benefits. These properties, it is commonly argued, entail that the goods are public in consumption, that is, available for all. However, markets do not provide efficiently goods with such characteristics. The fact that markets fail is seen to justify state intervention. Consequently, mainstream theory often refers to public goods also as state-provided goods. This chapter takes a somewhat different approach to conceptualizing public goods. It presents a positive analysis aimed at clarifying three main questions. The first question concerns the properties of goods that are de facto public in consumption, that is, actually in the public domain and available for all to consume. How can they be characterized? What are the factors contributing to their publicness? Put differently, the issue is whether and to what extent non-rivalrousness and non-excludability are indeed predictors of a good’s publicness in consumption. This issue will be discussed in the first section of this chapter. The second question asks whether and to what extent publicness in consumption is a predictor of state provision. To clarify this aspect of the standard definition, the second section describes how public goods emerge, notably the actors involved in this process and the coordination mechanisms, policy tools or other instruments employed. Considering the importance of global risks such as financial crises and international terrorism, the final section focuses on the special class of global public goods. It seeks to determine the factors that contribute to goods being global and public, and how they are provided, in particular how their provision differs from that of national public goods. As pointed out by Desai (2003), the concept of public goods has changed over time, and the concept prevalent during any one era has tended to reflect the realities and policy experiences of its time. The basic elements of the present standard definition were formulated in the 1950s.1 13

14


Thus it is not surprising that, coming some 50 years later, the analysis below shows that present-day realities have outpaced the current mainstream definition of public goods in a number of respects. Therefore, besides summarizing the main findings, the concluding section of the chapter also offers suggestions on how to expand and advance the concept of public goods. Curiously, the notion of public goods does not figure very prominently in today’s policy debates. By implication, the same applies to its opposite, the notion of private goods. However, the increasing number of contested global issues has, in recent years, drawn some renewed attention to the concept of public goods (see, for example, Sandler, 1997; Stiglitz, 1995). Perhaps the concepts of public goods and private goods do not figure on the political centre stage because they have become identified, respectively, with the state and with the market. The current mainstream definition of public goods certainly suggests such a reading. Where to draw the boundaries between markets and states is a frequently and hotly discussed topic. The analysis in this chapter, however, shows that it is no longer correct (if ever it was) to define public goods simply as state-provided goods. In most instances they are multi-actor products. Thus the challenge is to understand the role of different actors and the comparative advantage each brings to the provision of public goods. Moreover, publicness in consumption does not depend only on non-rivalrousness or non-excludability. It is often a social construct, that is, human-induced. This raises the question of the forces and factors that make goods shift between the public and private domains. Is a good’s publicness in consumption a deliberate policy choice? Or does it reflect neglect and oversight? People’s well-being ultimately depends on the balance between private and public goods. Private income and the consumption of private goods are both essential. Nevertheless, neither the best private goods nor any amount of them are worth much when the public domain is denuded, or worse, filled with public ‘bads’ – war, crime, collapsing stock markets, communicable diseases, or natural disasters. Even markets need public goods, such as the rule of law, norms and standards, or information, to operate efficiently. Thus, understanding the nature and provisioning of public goods is not just an academic exercise; it has practical political relevance. Several of the points set forth in this chapter have been made in earlier studies. In fact, many were made in the contributions that emerged in the 1950s in direct response to Samuelson’s 1954 paper. Other points have been made by public choice and political economy scholars in their responses to market failure theories of government intervention.2 Yet while some of the issues have been stated before, the present mainstream concept of public goods has not yet been recast. The purpose of this chapter is to suggest, for

Public goods: a positive analysis

15

further research and debate, some possible modifications to allow public goods to advance conceptually as well as politically.

PUBLICNESS IN CONSUMPTION: A SOCIAL CONSTRUCT3 The conventional approach to defining private and public goods is to identify a good’s (non-)rivalrous and (non-)excludable properties (Figure 1.1), and then to define the good as private or public based on these properties.4 Rivalrous benefits mean that one person’s consumption of a good diminishes its availability for others. For example, if one person drinks a glass of milk, it is no longer there for someone else to enjoy. Moreover, those who have milk need not necessarily share it with others, or they may let others have just some of it. Milk can easily be made excludable; and since it is both rivalrous and excludable, it figures in quadrant 1 of Figure 1.1 as a pure private good. Goods That Are Not What One Expects Them to Be Land is another example from quadrant 1 of Figure 1.1. Yet, as is well known, the repartition of the world’s landmass into private parcels, including the demarcation of national borders, has been a highly contested process, giving rise to conflict and strife within and between families, local communities and countries. Many such struggles and disputes continue. By now, however, states have, individually and collectively, introduced property rights regimes that define land ownership, minimize uncertainty, and reduce the need for constant vigilance to defend territories against potential rival claimants. Nevertheless, land also continues to exist in various public forms. For example, some local communities still follow practices of communal ownership and management of land (see, for example, Barzel, 1997; and Ostrom, 1990). Sometimes governments acquire land so that everyone can enjoy it, for example, in the form of a public park.5 Thus, in Figure 1.2, which lists goods as they de facto exist rather than based on their ‘innate properties’, land is listed several times. It now appears in quadrant 1 as the pure private good that, in effect, it often is, and in quadrant 4b as a rivalrous good that has been deliberately kept non-exclusive. The main difference between the classification in Figure 1.1 and that in Figure 1.2 lies in where goods fall when assessed according to their basic properties and their socially determined status. Comparing the two figures reveals that in many instances there is no automatic link between

EXCLUDABLE

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Advancing public goods RIVALROUS

NON-RIVALROUS

QUADRANT 1a

QUADRANT 2

Examples: • Milk • Land • Education

NON-EXCLUDABLE

QUADRANT 4

Examples: • Atmosphere • Wildlife

Examples: • Research and development • Non-commercial knowledge (such as the Pythagorean theorem) • Norms and standards • Respect for human rights • Television signals QUADRANT 3b

Examples: • Moonlight • Peace and security/conflict • Law and order/anarchy • Financial stability/excessive financial volatility • Economic stability/flagging growth • Growth and development potential (such as educated workforce) • Efficient/inefficient markets • Communicable diseases spreading/controlled or eradicated

Notes: These properties are basic in that they have not been altered by public policies or other human actions. a: In the literature, goods that fall into this quadrant – those with rivalrous and excludable benefits – are often automatically deemed private goods. But, as argued in this chapter, the properties of (non-)rivalrousness and (non-)excludability only signal a good’s potential for being (public) private – not its de facto provision status. b: Goods that fall into this quadrant are often called pure public goods – non-rivalrous and non-excludable in consumption. Most of these can exist in variable quantities, ranging from adequately supplied (as with peace) to inadequately supplied (as with open conflict). But the available ‘amount’ of the good is the same for all consumers. Source: Kaul and Mendoza (2003).

Figure 1.1 The basic properties of goods: a conventional approach to public goods rivalrousness/excludability and privateness or between non-rivalrousness/ non-excludability and publicness. Exceptions to date include, for example, the moonlight or the warming rays of the sun; they are, therefore, listed in quadrant 3 of both Figures 1.1 and 1.2. The other goods that fall into this category of ‘technically infeasible to exclude’ are mostly intangibles: policy outcomes or conditions, such

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Public goods: a positive analysis RIVALROUS

NON-RIVALROUS QUADRANT 2

QUADRANT 1

2a NON-RIVALROUS GOODS MADE EXCLUSIVE • Patented knowledge of manufacturing processes • Cable and satellite television

PRIVATE DOMAIN

4b RIVALROUS GOODS KEPT OR MADE NON-EXCLUSIVEa • Atmosphere • Wildlife such as fish stocks • Public parks and nature reserves • Basic education and health care for all

2b NON-RIVALROUS GOODS KEPT OR MADE NON-EXCLUSIVE • Public television • Property rights regimes • Norms and standards • Non-commercial knowledge (such as the Pythagorean theorem) • Respect for human rights • As yet unknown ‘bads’ (such as undiscovered pollutants) QUADRANT 3

PURE PUBLIC GOODS • Moonlight • Peace and security/conflict • Law and order/anarchy • Financial stability/excessive financial volatility • Economic stability/flagging growth • Growth and development potential (such as educated workforce) • Efficient/inefficient markets • Communicable diseases spreading/controlled or eradicated • Knowledge embodied in pharmaceutical drugs

NON-EXCLUSIVE

QUADRANT 4

4a RIVALROUS GOODS MADE (PARTIALLY) EXCLUSIVE • Atmosphere: air pollution permits • Fish stocks: fishing quotas • Toll roads

PUBLIC DOMAIN

EXCLUSIVE

PRIVATE GOODS • Milk • Land • Education

Notes: a: There are two main types of goods in this category. The first are rivalrous and non-exclusive, often referred to as common pool resources. Because these goods are innately rivalrous, intensive use can threaten their sustainability. The solution is often to make such goods more exclusive, though not entirely so. New counterpart private goods such as pollution permits (see quadrant 4a) are often invented to manage the use of these resources. In countries with air pollution controls, for example, the atmosphere is still available for the general public to enjoy. But it can no longer be used excessively as a pollution sink by firms, which must now buy privately held and tradable pollution permits. The second type of goods in this category includes basic education and health care – public goods that can be made fully private, but that are often made non-exclusive by policy choice. Source: Kaul and Mendoza (2003).

Figure 1.2 The socially determined status of goods: an expanded concept of public goods

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as financial stability, law and order, or communicable disease control. They can be seen as final public goods: the public things that people ultimately consume. Many other public goods are of a more intermediate character, feeding into the production of final public goods. Intermediate public goods are mainly found in quadrants 2b and 4b. Property rights are an illustrative example: whether and to what extent markets (listed in quadrant 3) operate efficiently is often a matter of welldefined and enforceable property rights (listed in quadrant 2b). To give another example, the growth and development potential of a country (listed in quadrant 3) may depend on the existence of an educated workforce, which, in turn, might be promoted by respect for human rights, including people’s right to basic education (listed in quadrant 2b), and the realization of this right through making basic education universally available (as indicated in quadrant 4b). Quadrant 2b lists non-rivalrous goods, which are kept or made non-exclusive; and quadrant 4b contains goods that, like education, can be private goods as well as public by design. What does ‘public by design’ mean? How does it come about? Two main patterns of publicness by design can be distinguished. The first pattern can be termed ‘rollout’. It aims at promoting broad-based consumption of such intangibles as norms and rights. It is thus associated with the sort of goods listed in quadrant 2b: non-rivalrous goods made or kept public in consumption. The more people consume these goods, the more useful they are to their existing consumers. For example, the more people accept, that is, consume, a certain norm, the more established and reliable it becomes. As a result, those who already apply the norm (that is, the existing consumers) can feel reassured that what they do – let us say, exercising the right to freedom of speech – is indeed a socially and politically acceptable form of behaviour. Credit cards are an example of a technical norm. Credit cards can be used worldwide today thanks, in part, to the standardization of their size. Rolling out norms and standards and making them as public in consumption as possible facilitates networking and the reaping of network externalities. Rollout, however, is not always an easy process. Just think of the many obstacles that stood – and still stand – in the way of de facto respect for human rights such as ethnic, racial or gender equality. Consider the military battles and legal disputes that form part of the history of property rights. Many rollouts have been top–down, but some, such as the struggle for democracy, have also been bottom–up. Note also that the label for the goods in quadrant 2b is ‘kept or made non-exclusive’. Hence free-roaming public goods are also among the goods in this quadrant, such as perhaps undetected viruses or technology and capacity-building spillovers associated with foreign direct investment.


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The second pattern of publicness by design is ‘universalization’. It aims at making particular private goods available for all. Some of the goods in quadrant 4b, for example, ‘poverty reduction’ and ‘basic education’, illustrate this case. For example, schools have a limited intake capacity: a seat occupied by one student is a seat that is no longer available to other students. Tuition fees can make education even more exclusive. Yet limited intake capacity and tuition fees are human-made: they are social constructs, not immutable properties. Where the requisite political will and the necessary resources exist, exclusiveness can be turned into inclusiveness, and education can be made available universally, that is, on a non-exclusive basis. The same holds true for basic health care and some forms of insurance, such as basic old-age or disability insurance.6,7 Besides listing public goods, which are, against the backdrop of the standard definition of public goods, ‘unexpectedly public’, Figure 1.2 also reminds us of ‘unexpectedly private’ goods. Quadrant 2a, for example, mentions commercial knowledge. Some public good theorists refer to knowledge as a public good par excellence. Being non-rivalrous in consumption, it could be made available to additional users at zero cost. Yet intellectual property rights often grant knowledge producers a temporary exclusive right to control the use of the knowledge they have generated. Such protection creates a positive incentive to invest in research, encourages innovation and promotes dynamic efficiency. Dynamic efficiency, however, comes at the expense of static efficiency: restricting the utilization of knowledge implies its under-consumption. Therefore, ideally, patented pharmaceutical knowledge (the first example listed in quadrant 2a) should be complemented by public good measures that offset the static efficiency loss resulting from respect for patent rights. These public goods can come from quadrant 2b (such as consensus on a flexible interpretation of TRIPS – the Word Trade Organization Agreement on the Trade-Related Aspects of Intellectual Property Rights – should public health conditions so require) or from quadrant 4b (such as the Global Fund to Fight Malaria, Tuberculosis and HIV/AIDS), which, among other things, facilitates access to medicines for those who cannot afford market prices. Quadrant 4a lists goods that are basically rivalrous and non-excludable, but have, in a quasi way, been moved out of the public domain. But why ‘quasi’? The reason is that the basic properties of these goods have actually not been changed. For example, fish stocks and the atmosphere remain rivalrous and non-excludable. However, with the help of policy engineering, intangible barriers have been placed in front of them: quotas regulate fish harvesting, and pollution allowances limit the greenhouse gas emissions of individual agents. These quotas and allowances are a form of property rights, and if transferable, private goods.8

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A deliberate decision or public policy choice can also underlie the goods listed in quadrant 3 of both Figures 1.1 and 1.2. These goods are largely unchangeable in terms of their publicness in consumption, at least within the national context.9 Nevertheless, there is ample scope for public debate and choice over how much of the goods to provide – to what extent to tolerate them as ‘bads’ (for example, to allow markets to be inefficient) or to promote them as ‘positive utility’ goods (for example, to have peace instead of war). An Expanded Definition of Public Goods The challenge is thus to define public goods in a way that is both theoretically and empirically relevant as well as useful to policy making. The conventional definition of public goods has no doubt illuminated many important issues in the provision of public goods, notably the problem of the free rider associated with non-excludability and that of simultaneity of consumption associated with non-rivalrousness. It has also lent itself to mathematical formulation. As the previous discussion demonstrates, however, these properties alone are poor predictors of a good’s de facto publicness in consumption, that is, of whether and to what extent it is really there for all to consume, or conversely whether a good that is excludable is actually exclusive. Thus, it could be useful to expand the current definition of public goods into a two-tier definition. The current standard definition could be used in order to indicate a good’s potential of being public. It could be restated as: Definition, part 1: Goods have a special potential for being public if they have, in their original state, non-rivalrous benefits, non-excludable benefits, or both. This definition differs from the present, mainstream one in the sense that it does not assume an automatic link between non-rivalrousness and/or nonexcludability, on the one hand, and publicness in consumption, on the other hand. By introducing the word ‘potential’, it recognizes that a good’s properties are malleable: they may be subject to change and, as the comparison between Figures 1.1 and 1.2 has shown, they move across private–public boundaries.10 The complementary definition, referring to the actual properties of a good, would read as follows: Definition, part 2: Goods are public if they are de facto non-exclusive and available for all to consume. If it is not – or not alone – non-rivalrousness and/or non-excludability that determine a good’s publicness in consumption, the question is then: what


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else does a good’s publicness depend upon? Judging from the various cases examined above, it seems that publicness in consumption is attributable to at least three main factors: ● ●

●

infeasibility of exclusion – which simply rules out the option of modifying a good’s basic property of non-excludability; public policy choice – which may be the result of political processes, such as elections, decisions taken in various branches of government, or the construction of social and cultural norms; neglect and oversight – which could stem from a diverse set of factors, including various types of government failure as well as informational problems.

History has shown that goods that are public today can be private tomorrow. Much of television has undergone such a transformation, turning from public provision – provided free of charge – to private provision – cable television, requiring subscription and payment. The suggested twotier definition reminds us to be aware of this fact and not to assume, based on a good’s basic properties, that it actually is private or public in consumption. Moreover, the set of goods in question is not constant. New things and new conditions are likely to emerge. Computer viruses and Internet-based crime are examples of public ‘bads’ that until recently did not exist. SARS (Severe Acute Respiratory Syndrome) is a further case in point. The distinction between potential and actual publicness stresses the need for society to be vigilant and to scan the public domain continuously, assessing whether the things and conditions that are public in consumption are in line with current policy preferences and institutional arrangements. Looking at the ensemble of the goods that are public in consumption – that is, the size and composition of the public domain – is critical for analysing how public goods impact the well-being of various population groups. It is also important to see how both the contents and structure of the public domain vary with such factors as level of national income, stage of development, political regime, emergence of new technology, or major policy experiences such as the Great Depression, the Second World War, decolonization, Bhopal, or 11 September 2001.11,12 In sum, it is suggested that the term ‘public good’ denotes those goods that are actually in the public domain and available for all to consume. Some of these goods will certainly have non-rivalrous and non-excludable characteristics. This fact alone does not, however, indicate why they are public: are they kept or left public, or is it technically impossible to make them excludable? Perhaps even more intriguing is the question: why do some of the goods with significant public properties end up being private?

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THE ROLE OF THE STATE IN PUBLIC GOODS PROVISION: IMPERFECT, LIMITED, BUT PIVOTAL The definition of public goods is usually focused on the consumption properties of goods. Yet, as noted, the present standard concept tends to go a step further. It argues that publicness in consumption leads to market failure, and that market failure constitutes a justification for state intervention. Therefore, when looked at from the provisioning side, public goods are defined as state-provided goods. It is to this second dimension of the mainstream definition that the discussion now turns. The key question to be clarified is whether and to what extent a good’s publicness in consumption predicts state provision.13 Even a cursory look at the production path of various public goods reveals that this process can vary widely, depending on the good’s original properties, the social mantle it carries, and the conditions under which it is to be provided. Although highly good specific, provision processes also exhibit common features. First, they typically involve contributions from all actor groups: private individual actors and firms, civil society, philanthropists and state agencies. Second, adequate provision tends to require a collective-action component. The state’s role in providing this component is pivotal, but not unique: other actors also contribute to it. Multiple Actors: Multiple Strengths and Failures No doubt there are a few public goods that are solely the result of private initiatives. Free open-source software is a case in point. There are also a few public goods that are exclusively state-provided. Naturalization services and the management of citizenship is perhaps one of those goods. In most other instances, however, public goods emerge as a result of a complex interplay between not only numerous agents, but also many types of actors and coordination mechanisms, including markets. For example, the state may pass a law to ban cigarette smoking in public places, such as in restaurants. Achieving a smoke-free environment, however, depends very much on restaurant owners helping to ensure compliance with this law and on a myriad of customers actually changing their behaviour. Similarly, a traffic light can only serve its purpose if the general public – pedestrians, as well as drivers of cars, bicycles and other means of conveyance – know and respect traffic rules and regulations. Another example is the production path of the public good ‘malaria control’. Besides governmental public health measures, a major input into this good is the private purchase of insecticide-impregnated bed nets. Individual persons or households could conceivably buy these nets for the


23

sole purpose of sleeping more comfortably at night, that is, without any concern for malaria control. Their action nevertheless contributes to achieving this goal. Given this social effect, or externality, some countries aim at making bed nets affordable for everyone by offering public policy incentives (for example, tax credits) to private producers. Thus state intervention does not replace markets; it enables markets to enhance their contribution to malaria control. Furthermore, since effective control of the disease calls for the development of new medicines, the current provision process also involves public support (subsidies) for relevant R&D and product development, largely carried out in private pharmaceutical companies. Various state and non-state actors (including also private foundations) provide the financing for this purpose. The resources are made available to organizations such as the Medicines for Malaria Venture (www.mmv.org), which are global public–private partnerships.14 Figure 1.3 graphically depicts some of the building blocks entering the production of another public good: ‘food safety’. The message is, once again, one of complexity and multiple private–public linkages. The figure also highlights that different actor groups can play quite similar roles. In the case of food safety, for example, governments as well as firms are shown as being involved in standard setting; governments, firms and civil society organizations are listed as contributing to certification and inspection. Clearly, public goods provision today transcends the role of the state. It is of a hybrid nature: partly private – involving markets and firms; partly state – giving careful consideration to the principle of subsidiarity and assigning issues to the ‘right’ level of government; and partly voluntary – relying on philanthropy, civil society, social norms and culture, and leadership of different types. Private and voluntary involvement in this process has no doubt grown in recent decades with the re-engineering of the role of the state that has occurred in many parts of the world since the mid-1970s (see Anheier and List, 2000; Foundation Center, 2003; Glaeser and Shleifer, 2002). Even in earlier decades, it was perhaps somewhat of an oversimplification to refer to public goods as state-provided. Although back then the state was more directly involved in the provision of a number of essentially private goods, such as steel and cars, it also financed and produced such public utilities as water, sanitation, electricity or communication services. Nowadays, many of these goods have been privatized, either in full or in part (see Megginson and Netter, 2001). The state’s role has been reoriented, emphasizing more provision of incentives and supporting individual actors in aligning their private interests and activities with society’s overall policy goals and objectives. Even in cases such as defence, for which the state has usually retained primary political responsibility, earlier forms of market– state dualism are breaking down. Subcontracting and public–private

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Advancing public goods FINAL GLOBAL PUBLIC GOOD

INTERNATIONAL BUILDING BLOCKS

Food safety

International regime – implemented and enforced by institutions and organizations – of codes and standards for certifications, risk assessment and product liability

Regimes to prevent contamination when trading hazardous food products

NATIONAL AND REGIONAL BUILDING BLOCKS

Regimes to prevent contamination when cultivating and storing food products

Systems to promote food hygiene

Systems to promote harmonized national standards and certification

Testing foods and identifying food poisoning Promoting individual and collective good hygiene behaviours

Identifying food hazards Defining adequate standards

• Public health services

• Organizations in charge of coordinating interests and facilitating national decision making

• Information and public awareness programmes • Science and research facilities

Regimes to define norms and standards for food quality, safety, and suitability for consumption

Systems of inspection and control

Conducting regular inspections in a food industry

• Private self-inspection procedures

• Government inspection and control procedures

Notes: Role of major actors • Households can encourage labelling, demand information and certification, and adopt good hygiene behaviours. • Governments can develop standards, certification and inspection procedures (national institutes of health, veterinary services), and regulation on product liability. • Firms can adopt certification standards and develop self-regulation (internal inspection and control systems). • Civil society organizations can contribute to certifications and inspections (consumer associations). Source: Kaul and Le Goulven (2003b).

Figure 1.3

Building blocks of food safety


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partnerships are now a familiar production mode even in this sector (see Held et al., 2002; Foucault and Bellais, 2002; and Parker and Hartley, 2003). Despite all calls for privatization and public–private partnering, government agencies continue to finance and directly produce some goods. Examples are basic education, health care, justice, political norm and standard setting, as well as various forms of general administration, such as the registration of births and deaths and the provision of vital statistics. While all actor groups and coordination mechanisms play a role in the provision of public goods, each one is also known to fail. The case of market failure has been well established. Theoretical and empirical studies have shown that private provision of a non-rivalrous good, along with charging a price to make it available to additional consumers, violates the condition of equality of price and marginal cost required for optimal provision, and thus implies underconsumption. On the other hand, not charging a price will lead to underprovision. Non-excludability as well as non-exclusiveness of a good’s benefit presents the free-rider problem, that is, reluctance on the part of individual agents to reveal their true preferences. This causes public goods to be underprovided. Much, of course, depends on the exact nature of the good and its social composition function, in other words, whether its production follows a summation, weakest-link or bestshot aggregation technology (Hirshleifer, 1983; Sandler, 1997).15 Other elements such as group size also factor in (Olson, 1971 [1965]). As Sidgwick (1969 [1901]) and many other public choice and political economy scholars after him have noted, there is no easy solution to market failure: government failure also impedes the provision of public goods.16 Politicians and bureaucrats not only pursue the public mandates and tasks assigned to them, but also demonstrate self-seeking and personal-utilitymaximizing behaviour. Information problems are another important cause of government failure. Because governments may also fail, it is important to justify and design carefully their intervention in the economy. As Sandmo (2002) notes, however, economists and policy makers have often taken this task all too lightly. In recent decades, civil society has emerged as a powerful watchdog of consumers, private corporations and states. Men and women in fur coats are being frowned upon by the general public and pressured into not supporting the killing of animals for fashion purposes. Consumer groups boycott goods they consider to contain such public ‘bads’ as exploitation of child or prison labour, disrespect for workers’ rights and unfair wages, or chemicals harmful to the environment or human health. As a result, some private corporations have become more socially responsible, willing to internalize negative externalities lest their market share shrink. Similarly, civil society organizations are pressuring states into

26


being more public – that is, transparent and accountable – as well as more concerned about longer-term issues and problems that transcend their territorial boundaries, such as global warming. Civil society organizations are also involved in the delivery of some public goods, especially conflict management, where in-depth knowledge of local conditions may be critical (see, for example, Anheier, 2001; Ben-Ner and Hoomissen, 1993; and Edwards and Gaventa, 2001). Nevertheless, civil society, too, sometimes fails. Many non-governmental organizations are advocacy groups and issue leaders. To state their case successfully, they sometimes have to overstate it by being selective and particularistic in their approach. Finally, institutions can be slow to adjust to changing circumstances (North, 1990). This is one of many reasons for failures of the system of social and cultural norms. Beliefs and norms are often rooted in the past; what was perhaps a functional rule or permissible behaviour earlier may well be perceived as dysfunctional and as an impediment to public goods provision now. Many societies have, for example, encouraged a change in public attitudes towards borrowing and insurance in the interest of fostering overall economic growth and development (see Bernstein, 1996; and Shiller, 2003). Evidently, public goods are not always provided by the state, and certainly not always exclusively. A more fitting description is that they are multi-actor products, consisting of three main types of building blocks: ●

●

●

external effects of private actions – undertaken by individual actors based on self-interest alone, including possibly their self-interest in being compassionate; external effects of concerted private actions – reflecting some alignment of private and social interests brought about through collectiveaction components; collective-action components – put in place either by state or non-state actors, offering either a framework (for example, regulation) to nudge individual private actions into certain directions or to complement private and voluntary activities.17

The Specificity of the State’s Role The state’s role in providing public goods is primarily concerned with the provision of collective-action components. Since other actors are also involved in delivering these components, the question is whether it is possible to discern any specificity of the state’s role in public good provision. It seems that the state’s role differs from that of other actors in at least four important respects.


27

First, the state typically supports a diverse range of public goods. At least in democratic nations, the state is the institution expected to facilitate – through electoral and legislative processes – an aggregation of social preferences (in whatever imperfect way), including a bundling of the preferences of different population groups for various public goods. In contrast, other actors tend to intervene on a more issue-specific basis. This is not necessarily to make the government provide a private good that they prefer, but to ensure that the public goods to which they attach high priority also rank high on the government’s list of issues to be promoted. Second, it is rare that another actor can match the government’s financial allocations to public goods. Its special financial role is linked to its unique coercive powers, including its power to tax and to make, if deemed desirable, everyone contribute to its expenditure programmes. The state’s taxation authority implies that it can rely on a relatively predictable stream of income. This, in turn, means it can engage in activities requiring longer-term commitments (for example, pension systems) involving higher risks (for example, support for science or other ‘frontier’ issues), or offering very few, if any, benefits that lend themselves to private appropriation, except via some form of corruption. In comparison, private and voluntary actors tend to make limited, one-time allocations to ‘their’ issues; their interventions, therefore, are more of a special project type rather than a regular programme type. Third, promulgating and enforcing universal compliance with binding laws and obligatory rules is another aspect of the special coercive powers of states. Non-state actors can engage in self-regulation, or they can help promote consensus around certain norms (see Cutler et al., 1999). In order to make such norms compulsory and enforceable, however, they ultimately have to rely on the state and its regulatory powers. Fourth, state agencies may be the better-suited provider where the delivery of a good is difficult to observe (for example, the quality of education imparted to students) and, hence, difficult to monitor, verify and contract out. Government, as well as non-state, non-profit organizations, may also have an advantage over private, for-profit providers where opportunities for pecuniary rewards are limited, and where the provision of the good may depend more on workers being motivated by social concerns. On the other hand, where a task is unidimensional and calls for innovation and entrepreneurship, private provision may be preferable. These conclusions have emerged from a growing body of studies that examine the comparative advantages of various actor groups in public goods provision and how best to combine their respective strengths with the incentive structures underlying particular goods. The questions addressed in these studies include, for example: the pros and cons of public and private ownership; pecuniary and

28


non-pecuniary motivations of and incentives for workers in the private sector and in state bureaucracies; the different challenges of managing principal–agent relations in these two domains; and the experiences gained from various types of public–private partnerships.18 This juxtaposition of the possibilities of state and non-state actors injecting collective-action components into the provision of public goods suggests that the state is the core provider of these components, complemented at times by targeted interventions of non-state actors. Of course, there is always the issue of whether these interventions are designed to reduce government failure and move state action back on track, or whether these interventions distort what would otherwise have been a socially more desirable level or form of public goods provision. However, this question can only be answered empirically, on a case-by-case basis. In sum, a good’s publicness does not necessarily predict state provision. Rather, it suggests multi-actor provision. While all actor groups contribute in often important and critical ways, the role of the state, albeit limited and sometimes imperfectly executed, is a special and pivotal one. The state clearly is the core provider of collective-action components, which help bridge private interests and social interests and are thus an indispensable ingredient of adequate public goods provision.

THE CASE OF GLOBAL PUBLIC GOODS So far, public goods have been discussed without making reference to the scope of their benefits or costs. This section will examine the predictions of the standard definition in respect of global public goods. The focus will be on understanding the global dimension of these goods.19 Natural Global Commons and Globalized National Public Goods Public goods can be said to be of global scope if their benefits or costs extend to all countries, peoples and generations. Only very few goods meet these requirements. A less strict, but more useful definition is the following: a good is globally public in consumption if its benefits or costs extend to more than one group of countries and do not discriminate against any population group or generation (see Kaul et al., 1999). Global public goods are thus public in two senses: first, they are public as opposed to private; and second, they are public (global) as opposed to national. Global public goods are nothing new. Many, notably the natural global commons, pre-date human activity. They include the atmosphere, the geostationary orbit, the electromagnetic spectrum and the high seas.


29

Furthermore, externalities have always existed, travelling the world, often in a diffuse and not clearly traceable way, as with emissions of carbon dioxide and other greenhouse gases. Externalities alone, however, did not create links and interdependencies between different parts of the world. International cooperation also played a role, such as the seventeenthcentury debate on open access to the high seas for all nations (Mendez, 1992). It is this second class, the human-made global public goods, that has witnessed a rapid expansion in recent centuries, and especially in recent decades, being both a driving force and a result of globalization. Like Figure 1.2, Figure 1.4 classifies global public goods primarily according to their human-made (social) properties. As before, the goods in quadrants 2 and 4 involve policy harmonization. This time, however, it is policy harmonization behind national borders, based on agreements, such as the World Trade Organization’s multilateral trade regime, or on policy conditionality, such as the one implemented by the Bretton Woods Institutions, other multilateral and bilateral agencies (notably aid agencies) or private actors, such as ‘the market’. Such agreements stipulate or suggest both what to keep or make public nationally (for examples of goods, see quadrants 2b and 4b), and what to keep or make private nationally (for examples, see quadrants 1, 2a and 4a).20 The globalness of many public goods thus results from national public goods becoming embedded in and shaped by international regimes. An especially significant feature of these regimes in the present context is that many call for the removal of national border controls. In fact, increased openness of national borders has, in many instances, preceded policy harmonization behind borders. The two together, propelled also by technological advances, have encouraged a growing volume of cross-border economic activity and, with it, a growing volume of cross-border spillovers and spill-ins. Only some of these externalities are being addressed by international cooperation efforts; many others have so far gone unchecked or inadequately checked. A result of these and other related trends has been the interlocking of national public domains, illustrated by the goods in quadrant 3 of Figure 1.4. These goods now exist in an indivisible form throughout the world – for all to consume. Unfortunately, many are severely underprovided, presenting themselves as global public ‘bads’. Thus, only a few public goods are inherently and (so far at least) unchangeably global in scope. These are primarily the natural global commons. Most global public goods are globalized national public goods: they are either goods whose properties have been made indivisible by, say, the increasingly porous nature of national borders, or goods that have become embedded in international cooperation regimes. Like publicness in

30

Advancing public goods RIVALROUS

NON-RIVALROUS QUADRANT 2

QUADRANT 1 PRIVATE GOODS

NATIONAL DOMAIN

• Geographic territory: exclusive economic zones such as those established by the UN Convention on the Law of the Sea • Ozone layer: targets for reducing emissions of ozone-depleting substances • Atmosphere: targets or quotas for reducing emissions of carbon dioxide 4b RIVALROUS GOODS KEPT OR MADE NON-EXCLUSIVEa

2b NON-RIVALROUS GOODS KEPT OR MADE NON-EXCLUSIVE • International communication and transport networks • Norms and standards • Respect for human rights • Respect for national sovereignty • Multilateral trade agreements (such as the agreement on TRIPS) • Harmonization of language • Globalization of advertisement of lifestyles and other social norms and institutions

QUADRANT 3 PURE PUBLIC GOODS • Moonlight • Peace and security/conflict • Law and order/anarchy • Financial stability/excessive financial volatility • Economic stability/ global economic slowdown • Efficient/inefficient (integrated) markets • Environmental sustainability • Communicable diseases controlled or eradicated/spreading

NON-EXCLUSIVE

QUADRANT 4 4a RIVALROUS GOODS MADE (PARTIALLY) EXCLUSIVE

• Commercial knowledge

GLOBAL PUBLIC DOMAIN

EXCLUSIVE

• National biodiversity and wildlife • Languages and cultural traditions • National public education programmes • National water resources • National poverty eradication programmes

2a NON-RIVALROUS GOODS MADE EXCLUSIVE

• Atmosphere • Global gene pool to promote food securityb • High seas • Basic education and health care for all • Freedom from extreme povertyc

Notes: a: The goods in this quadrant are kept or made non-exclusive to current generations (as with education) and future generations (as with the atmosphere). b: Refers to the International Treaty on Plant Genetic Resources for Food and Agriculture (see http://www.fao.org/ag/cgrfa/). c: These goods are included in the Millennium Development Goals (to be achieved by 2015) adopted by the UN General Assembly (see http://www.un.org/millenniumgoals/). Source: Kaul and Mendoza (2003).

Figure 1.4

The de facto mix of national goods and global public goods

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general, globalness is in most instances human-induced and not – or not alone – a matter of a good’s original properties. International Cooperation for Global Public Goods Provision: Nation States as Private Actors Globalized national public goods face a double challenge: their adequate provision depends on successful cooperation nationally as well as internationally (see Figure 1.5). Since it was found earlier that despite all its limitations and shortcomings, the state plays a pivotal role in correcting market failures nationally, the question now concerns how collective-action initiatives can succeed, given that the institution of the state has no equivalent internationally. International relations theory (see, for example, Martin, 1999) argues that international cooperation in large measure functions on a voluntary basis. There are, of course, many reasons for which all or some governments may want to seek the cooperation of others. States themselves are interested in such issues as safeguarding territorial or policy-making sovereignty. There are also more transnational actors among national constituencies, both within civil society as well as among businesses. They may like to see their government promote cross-border cooperation of different types. However, government failure in international cooperation is perhaps more International collectiveaction components

Transnational (global or regional) public goods

• Financing and production of goods by intergovernmental agencies; • International agreements; • Financial side payments; • ...

Related national public goods

Externalities Generated by private actions based on self-interest alone

Externalities Generated by concerted private action, combining selfinterest with social concerns

National collective-action components • Financing and production of public goods; • Taxation; • Fiscal (dis)incentives; • Regulation; • Financing of pubic goods; • Social norms; • ...

Direct inputs Forces shaping private and collective action

Figure 1.5 Schematic description of the provision of transnational (global or regional) public goods

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pronounced than in national cooperation. Informational problems and the self-seeking behaviour of politicians and bureaucrats are not the only factors that contribute to the difficulties of international cooperation. An added source of government failure lies in the global publicness of goods, which can tempt individual states into free riding or other strategies aimed at not contributing their fair share to the provision costs of a good. More pronounced government failure, however, has its counterpart in more pronounced non-state-actor interventions in intergovernmental cooperation. In recent decades large numbers of civil society and business actors have accompanied various global conferences of the United Nations, World Trade Organization negotiations and Bretton Woods Institutions meetings – both in the hallways of the conference centres and out in the streets. Moreover, international cooperation among and between non-state actors is also on the rise. Global civil society networks are well established (see, again Anheier, 2001), and self-regulation of private business is a growing practice (see again Cutler et al., 1999). These facts suggest that at the international level too, collective-action initiatives are usually multi-actor-provided. It also seems that states are again the core provider. International cooperation is still predominantly an intergovernmental process. Yet an important difference exists between the provision of public goods nationally and internationally: states intervene internationally, not as the State but as individual nation states. This explains why international cooperation tends to function quite successfully where all nation states see clear, significant national net benefits, for example, in the global physical infrastructure area, such as civil aviation. International cooperation also happens where the interests of more powerful countries come into play, and where these countries offer side payments to bring other nations ‘on board’. The Montreal Protocol is such a case (see Barrett, 2003). International cooperation drags, however, wherever these two sets of conditions are not met, unless a major crisis occurs or non-state actors succeed in providing a decisive impetus as they did, for example, in the case of land mines. It thus is not surprising that many global public goods today are severely underprovided or ill provided (see Conceição, 2003). One global crisis after the other claims the political spotlight. Often the reason for these crises can be traced back to the same facts: ●

●

inadequate bundling of diverse preferences – linked to the current pattern of global decision making, and contributing to what many perceive as the unfair and overly intrusive character of the global public domain (see, for example, Nye and Donahue, 2000); lack of resources and of resource predictability – resulting from the


●

●

33

fact that the financing of international cooperation is primarily of a voluntary nature (see Kaul and Le Goulven, 2003a); lack of legitimate and credible coercive power – leading to mostly nonbinding international agreements, which are left to each country to implement or not; and an international bureaucracy with relatively high-powered incentives – reflecting the uncertainty of funding and resultant competition for scarce resources among international organizations, notably for operational cooperation purposes.21

Thus international cooperation for global public goods is a multi-actor process, in which nation states play a critical role in the provision of collective-action components. In this case, however, intergovernmental cooperation resembles more the institution of the market than the national institution of the state: it is largely voluntary and motivated by national (private) self-interest.

SUMMARY AND CONCLUSIONS This chapter has departed from the current mainstream concept of public goods to examine three questions. The first question was whether nonrivalrousness in consumption and non-excludability of benefits are useful predictors of a good’s publicness in consumption. The finding is that in many instances the prediction does not hold. It could, therefore, be useful to expand the current standard definition by distinguishing between a good’s potential to be public – based on its properties of non-rivalrousness and non-excludability – and its actual publicness in consumption, which is often a social construct. The second question concerned the role of the state in the provision of public goods. The discussion on this issue suggested that public goods provision is a multi-actor process in three respects: (1) decentralized private initiatives provide important contributions, in the form of externalities; (2) further important inputs are the external effects of concerted private actions, which reflect some alignment between private and social interests fostered through various collective-action components; and (3) both state and non-state actors are involved in the provision of these components, with the state being the core provider. The third question focused on global public goods. Like public goods in general, these goods often carry a social mantle. Many, if not most, constitute globalized national public goods, that is, public goods that, in the wake of increased openness of international borders and growth in international

34


regimes, have become placed or drawn into the global public domain. The provision of global public goods is also very much a multi-actor process; and again, nation states are key players in providing international collectiveaction components for these goods. In the case of international collectiveaction components, however, they do so, not like the state nationally, but like individual, private actors: largely with national self-interests in mind. Thus global public goods are perhaps the goods that least fit the prediction of the current mainstream definition of public goods as state-provided goods. Many of the controversial dimensions of globalization pertain to public, and especially global public goods issues: global warming; the design of the multilateral trade regime and of the financial architecture; the management, or rather non-management, of international migration; the control of global diseases; and international terrorism. It thus seems timely – even imperative – to assess how well current public goods theory captures these realities. Although many key policy issues today are global, the challenge is broader than just conceptualizing global public goods. The concept of public goods needs to be rethought as such in order to understand the special class of global public goods better and to manage globalization more efficiently and fairly.

NOTES * 1. 2. 3. 4. 5. 6. 7.

8. 9.

Balkissa Sidikou-Sow provided valuable research assistance. Thanks are also due to Pedro Conceição, Hana Haller, Ronald Mendoza and Sylvain Merlen for comments and observations on this draft. Samuelson’s 1954 paper is usually regarded as the foundation of modern public goods theory. For an overview of this theory, see, among others, Cornes and Sandler (1996); Oakland (1987); and Stiglitz (2002). A comprehensive overview of the literature is presented in Inman (1987) and Mueller (1989). This section draws on Kaul and Mendoza (2003). For reasons of simplicity, the term ‘public good’ in this chapter also refers to services and external effects or externalities. Governments, however, may also acquire land to close it off to the public. The motivation might be, for example, environmental protection or national security. For the main rationales underpinning decisions to roll out intangibles and universalize the availability of private goods universally available, see, for example, Stiglitz (2000). Evidently, there is a link between the goods in quadrant 2b and those in 4b. Rolling out a norm such as ‘basic education for all’ creates the social basis for policy action and actual development achievements. The Millennium Development Goals, set forth in the Millennium Declaration (www.un.org/millennium/declaration/ares 552e.htm), are a recent example of a roll-out initiative. They have spawned a large number of national and international policy initiatives designed to achieve – that is, universalize the actual attainment of – the MDGs by 2015. See United Nations (2003) for further details. An extensive body of literature exists on the theory of, and practical policy experiences with, employing these and other policy instruments of sustainable development. See, for example, Pearson (2000). The section below will show that the degree of their global publicness in consumption can in many instances be modified.

Public goods: a positive analysis 10.

11.

12.

13.

14.

15.

16. 17. 18.

19.

35

It would perhaps be more precise to say that goods move along a private–public continuum. For example, some goods become more easily non-rivalrous, that is, congested and rivalrous, than others. Just compare a swimming pool and the atmosphere in terms of (non-)rivalrousness. Similarly, it is easier to patent (make exclusive) commercial knowledge than non-commercial knowledge. It is often impossible to attribute the latter to any one agent. In order to determine the impact of the public domain and the sets of goods in it on people’s well-being, it is important to differentiate between publicness in consumption and publicness in the distribution of a good’s utility. The public goods literature often equates a good’s being public in consumption with it having positive net benefits for all. However, some goods, such as noise and pollution, force themselves on people, and few people, if any, derive benefits from this consumption. To the contrary, they may suffer loss of utility. Other public goods, such as the judicial system, may be ill designed, favouring some population groups, for example men over women, and so on. Examples of studies analysing determinants of public goods provision or assessing the impact of public goods on such dimensions as poverty include, among others: Besley and Ghatak (2003a); Cameron (1978); Itaya et al. (1997); Pottebaum and Kanbur (2001); Kaplow (2003); Persson et al. (1998; 2000); Pradhan and Ravallion (1998); and Rodrik (1996). The strengthening of civil aviation safety, immigration and other types of national border controls in response to 11 September 2001 can also be mentioned in this context. Some scholars, for example Musgrave and Musgrave (1989), distinguish between two sides of the provision process, namely politics and production. This distinction is analytically useful, although in reality many linkages exist between the two sides. The following discussion focuses on the production side of public goods, bringing in issues of politics only to the extent that they directly affect the production side. For a more detailed discussion of the production path of malaria control and other communicable diseases, including, among others, tuberculosis and HIV/AIDS, see Commission on Macroeconomics and Health (2001) and Arhin-Tenkorang and Conceição (2003). Hirshleifer (1983; 1985) introduced these three – in his terminology – social composition functions of public goods, which later also became known as aggregation technologies (see, for example, Vicary and Sandler, 2002). According to Vicary and Sandler (2002, p. 1502), the summation technology entails that ‘the level of the good is a function of the sum of the individual contributions’; the weakest-link technology implies that ‘the overall level of the public good equals the smallest of the individual provision amounts’; and the best-shot technology means that ‘the overall level of the public good equals the largest of the individual provision amounts’. For overview studies on these and related points, see, for example Inman (1987) and Mueller (1989). The interested reader may already want to turn to Figure 1.5, which presents a schematic description of the inputs to global public goods, including, among other things, the aforementioned three types of building blocks. To mention but a few of the theoretical and empirical contributions to this debate see Acemoglu et al. (2003); Besley and Ghatak (2001; 2003a; 2003b; 2003c); Blank (2000); Brooks (2003); Burgess and Metcalfe (1999); Diamond (2002); Dixit (1996; 2002); Feldstein (2002); Fitzgerald (1988); Francois (2000; 2003); Harris (2003); Hart (2003); Laffont (2002); Laffont and Tirole (1998); Osborne (2000); Prendergast (1999); Sandmo (2002); Shleifer (1998); Stiglitz (2002); and Stiglitz and Wallsten (1999). The term ‘transnational public good’ is sometimes used in the literature to refer to both regional and global public goods. There are many similarities between these two classes of goods. Much of the following discussion also applies to regional public goods. However, when regional public goods are provided within the context of a regional political union, such as the European Union, they perhaps resemble national more than global public goods. Therefore the discussion here considers only global public goods. For an examination of regional public goods, see, for example, Arce M. and Sandler (2002).

36 20. 21.

Advancing public goods The Convention on Biodiversity, for example, stipulates that biodiversity is a national (and hence a sort of ‘private’) good (see www.biodiv.org). Accordingly, national biodiversity has been placed here in quadrant 1. The tasks of many international organizations fall into two basic categories: (1) to serve as a forum for international negotiations; and (2) to assist in operational follow-up to international agreements. The financing of the former function tends to be a state obligation and amounts to some US$8 billion per annum. The latter, however, relies mainly on voluntary resources and currently amounts to some US$24 billion (Kaul and Le Goulven, 2003a).

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J. Brown (2002), Seeking Nontraditional Approaches to Collaborating and Partnering with Industry, Santa Monica: RAND. Hirshleifer, J. (1983), ‘From Weakest-Link to Best-Shot: The Voluntary Provision of Public Goods’, Public Choice, 3, 271–86. Hirshleifer, J. (1985), ‘From Weakest-Link to Best-Shot: Correction’, Public Choice, 46, 221–3. Inman, R.P. (1987), ‘Markets, Governments, and the “New” Political Economy’, in A.J. Auerbach and M. Feldstein (eds), Handbook of Public Economics, Vol. 2, Amsterdam: North Holland, pp. 647–777. Itaya, J., D. de Meza and G.D. Myles (1997), ‘In Praise of Inequality: Public Good Provision and Income Distribution’, Economics Letters, 57, 289–96. Kaplow, L. (2003), ‘Public Goods and the Distribution of Income’, Working Paper 9842, National Bureau of Economic Research, Cambridge, MA. Kaul, I., I. Grunberg and M.A. Stern (eds) (1999), Global Public Goods: International Cooperation in the 21st Century, New York: Oxford University Press. Kaul, I. and R.U. Mendoza (2003), ‘Advancing the Concept of Global Public Goods’, in I. Kaul, P. Conceição, K. Le Goulven and R.U. Mendoza (eds), Providing Global Public Goods: Managing Globalization, New York: Oxford University Press. Kaul, I. and K. Le Goulven (2003a), ‘Financing Global Public Goods: A New Frontier of Public Finance’, in I. Kaul, P. Conceição, K. Le Goulven and R.U. Mendoza (eds), Providing Global Public Goods: Managing Globalization, New York: Oxford University Press. Kaul, I. and K. Le Goulven (2003b), ‘Institutional Choices for Producing Global Public Goods’, in I. Kaul, P. Conceição, K. Le Goulven and R.U. Mendoza (eds), Providing Global Public Goods: Managing Globalization, New York: Oxford University Press. Laffont, J.-J. (2002), ‘Public Economics Yesterday, Today and Tomorrow’, Journal of Public Economics, 86, 327–34. Laffont, J.-J. and J. Tirole (1998), ‘The Dynamics of Incentive Contracts’, Econometrica, 56 (5), 1153–75. Martin, L. (1999), ‘The Political Economy of International Cooperation’, in I. Kaul, I. Grunberg and M.A. Stern (eds), Global Public Goods: International Cooperation in the 21st Century, New York: Oxford University Press. Megginson, W.L. and J.M. Netter (2001), ‘From State to Market: A Survey of Empirical Studies on Privatization’, Journal of Economic Literature, 39, 321–89. Mendez, R. (1992), International Public Finance: A New Perspective on Global Relations, New York: Oxford University Press. Mueller, D.C. (1989), Public Choice II, Cambridge: Cambridge University Press. Musgrave, R. and P. Musgrave (1989), Public Finance in Theory and Practice, 5th edn, New York: McGraw-Hill. North, D.C. (1990), Institutions, Institutional Changes and Economic Performance, Cambridge: Cambridge University Press. Nye, J.S. Jr and J. Donahue (eds) (2000), Governance in a Globalizing World, Washington, DC: Brookings Institution Press. Oakland, W.H. (1987), ‘Theory of Public Goods’, in A.J. Auerbach and M. Feldstein (eds), Handbook of Public Economics, Vol. 2, Amsterdam: North Holland, pp. 485–535. Olson, M. (1971) [1965], The Logic of Collective Action: Public Goods and the Theory of Groups, Cambridge: Cambridge University Press.


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Osborne, S.P. (2000), Managing Public–Private Partnerships for Public Services: an International Perspective. London: Routledge. Ostrom, E. (1990), Governing the Commons: The Evolution of Institutions for Collective Action, Cambridge: Cambridge University Press. Parker, D. and K. Hartley (2003), ‘Transaction Costs, Relational Contracting and Public Private Partnerships: a Case Study of UK Defence’, Journal of Purchasing & Supply Management, 9 (3), 97–108. Pearson, C.S. (2000), Economics and the Global Environment, Cambridge: Cambridge University Press. Persson, T., G. Roland and G. Tabellini (1998), ‘Towards Micropolitical Foundations of Public Finance’, European Economic Review, 42, 685–94. Persson, T., G. Roland and G. Tabellini (2000), ‘Comparative Politics and Public Finance’, Journal of Political Economy, 108 (6), 1121–61. Pottebaum, D. and R. Kanbur (2001), ‘Civil War, Public Goods and the Social Wealth of Nations’ (mimeo). Pradhan, M. and M. Ravallion (1998), ‘Demand for Public Safety’, Washington, DC: World Bank (mimeo). Prendergast, C. (1999), ‘The Provision of Incentives in Firms’, Journal of Economic Literature, 37 (1), 7–63. Rodrik, D. (1996), ‘Why do more Open Economies Have Bigger Governments?’, Working Paper 5537, National Bureau of Economic Research, Cambridge, MA. Samuelson, P.A. (1954), ‘The Pure Theory of Public Expenditure’, Review of Economics and Statistics, 36 (4), 387–9. Sandler, T. (1997), Global Challenges: An Approach to Environmental, Political, and Economic Problems, Ann Arbor, MI: University of Michigan Press. Sandmo, A. (2002), ‘Public Provision and Private Incentives’, Discussion Paper 18/02, Norwegian School of Economics and Business Administration, Bergen, Norway. Shiller, R.J. (2003), The New Financial Order: Risk in the 21st Century, Princeton: Princeton University Press. Shleifer, A. (1998), ‘State versus Private Ownership’, Journal of Economic Perspectives, 12 (4), 133–50. Sidgwick, H. (1969) [1901], The Principles of Political Economy, New York: Kraus Reprint Company [London: Macmillan]. Stiglitz, J.E. (1995), The Theory of International Public Goods and the Architecture of International Organizations, Helsinki: United Nations University and World Institute for Development Economics Research. Stiglitz, J.E. (2000), Economics of the Public Sector, 3rd edn, New York: W.W. Norton. Stiglitz, J.E. (2002), ‘New Perspectives on Public Finance: Recent Achievements and Future Challenges’, Journal of Public Economics, 86, 341–60. Stiglitz, J.E. and S.J. Wallsten (1999), ‘Public–Private Technology Partnerships’, American Behavioral Scientist, 43 (1), 52–73. United Nations (2003), Implementation of the United Nations Millennium Declaration. Report of the Secretary-General, Document A/58/323, New York: United Nations. Vicary, S. and T. Sandler (2002), ‘Weakest-Link Public Goods: Giving In-kind or Transferring Money’, European Economic Review, 46, 1501–20.

2.

For-profit, state, and non-profit: how to cut the pie among the three sectors1 Avner Ben-Ner

INTRODUCTION What is the best way to deliver various goods and services in the advanced complex economy? What is the appropriate division of labour among the state, the private for-profit, and the non-profit sectors? This chapter explores these questions relative to the well-being of consumers, and offers a set of broad answers grounded in the analysis of the relations between different types of organization and their consumers, and the internal organization of these types of organization. Around the turn of the twenty-first century, economic activity was divided among the for-profit, state and non-profit sectors in a few large advanced economies in the following ways: for-profit firms employed the vast majority of workers in the economy, from almost two-thirds in France to about three-quarters in Germany, the UK and the USA; government organizations (enterprises and agencies) at various levels employed as little as 15 per cent of workers in the USA to as much as almost one-third in France; and non-profit organizations employed as little as 5 per cent of workers in France and Germany to as many as 9 per cent in the USA. The shares of the three sectors changed during the previous two decades, with the state shrinking and the other two sectors growing.2 The experience of developed market economies such as France, Germany, the UK and the USA illustrates that both government organizations and for-profit firms can produce and deliver just about any good or service, including ammunition, airplanes, cars, building products, banking and other financial services, insurance, sports clubs, water, electricity, postal services, Internet, arts and culture, medical services, research, prisons, public toilets, public transportation, mail, military services, shelter for the homeless, and many others. The non-profit sector has been carrying out a narrower set of activities; yet, the non-profit form of organization is increasingly being enlisted to do more. 40

For-profit, state and non-profit: how to cut the pie

41

The past two decades were a time of great change, characterized by enormous technological advances and much economic, social, political, demographic and organizational change. In this chapter, I will examine the role of the three sectors in the complex, diverse and ever-changing economy. One question I will delve into is why multiple types of organization coexist in the same economy, sometimes side by side in the same industry. The answer I offer is that different types of organization have different advantages and disadvantages, and that the balance of advantages and disadvantages depends on factors that vary across industries and countries. Adam Smith’s famous statement that ‘[i]t is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest’ is central to neoclassical economics. A key theorem of economics is that in a competitive market, firms that seek to maximize profits will meet the interests of consumers as closely as economically feasible. This theorem holds in a perfectly competitive market because, in their search for profit, firms must attract customers with low prices, high quality and good customer service, not because they care about customers as such, but because customers will patronize firms that satisfy them best. Firms that seek to take advantage of consumers in a perfectly competitive market will lose customers and will go bankrupt. In such circumstances, a firm that seeks to maximize consumer well-being cannot do better for consumers than a for-profit firm. However, there are many departures from the conditions that make provision by for-profit firms optimal for consumers, including imperfect competition, asymmetric information, public goods, externalities, and situations where the identity of the interacting parties matters to them. This chapter examines the circumstances that lead to violations of the conditions for optimal provision by for-profit firms, relative to the criterion of maximum consumer well-being, and investigates key correctives in the form of government regulation and provision, as well as provision by nonprofit organizations.3 Such violations, small and large, are ubiquitous in the modern economy. The reason that correctives are not as pervasive as they should be is that they are not costless. The costs associated with establishing and running government and non-profit organizations stem from problems with governance, muted efficiency of operation and difficulties in raising capital, which frequently put them at a disadvantage relative to forprofit firms. Employing a cost–benefit analysis, I suggest a tentative allocation of economic activity across the three sectors for different goods and services. There are many issues connected to the question of distribution of economic activity, including income redistribution, social welfare and social

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insurance, the pursuit of macroeconomic policies through government employment and spending, the political power attendant on economic power, employment and work issues, and so on.4 However, the scope of this chapter is restricted to just one question: what is the optimal distribution of economic activity across the three sectors relative to the objective of maximizing consumer well-being?5 The chapter is organized as follows. The next section examines violations by for-profit firms of conditions for optimum provision relative to consumer well-being; this is a fairly rudimentary analysis of market failures. The sections that follow investigate government and non-profit correctives to for-profit failures and compare the efficiency of the three types of firms, focusing on issues of governance, agency problems and access to capital. The final section compares the advantages and disadvantages of the forprofit firms, government regulation and government organizations, and non-profit organizations, and proposes an allocation of economic activities across the three sectors for a number of industries.

WHEN DO FOR-PROFIT FIRMS FAIL TO OPERATE IN THE BEST INTEREST OF CONSUMERS? In a perfectly competitive market, for-profit firms operate in a manner that maximizes consumers’ well-being. Several related conditions must be met for perfect competition: 1.

2. 3. 4. 5. 6.

no market power: there is a sufficient number of sellers and buyers operating in the market, or ready to enter it, so that none of them has market power; information: sellers and buyers are fully informed about the relevant characteristics of the product; rivalry: consumption is rival; excludability: consumers can be easily charged for their consumption; anonymity: the identities of the transacting parties do not matter to them; no externalities: the actions of the seller or its products do not cause harm or benefit to those who do not use the product.

In this section, I examine the circumstances when each of these conditions for optimality is met or violated and the consequences for consumers of possible violations.


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No Market Power Firms may acquire power in the market and hinder competition in several ways. An important case is that of natural monopoly, which arises when there are large unrecoverable investments in capacity to serve a specific group of customers, leading to economies of scale, such as with the distribution of electricity and water. Monopolies or restricted competition may also stem from government restrictions or licensing, collusion among firms to prevent new entry, small market size, and aspects of products discussed later in this section. Cost and demand conditions may allow only a small number of firms to survive in a particular market, but if entry is easy, fast and relatively inexpensive, then the market may still be quite competitive.6 The consequences of violations of the ‘no market power’ condition include higher prices, lower quality, less reliable products, and generally more restricted and less dynamic markets – all adverse consequences for consumer well-being. Information Symmetry of information about a product exists when both seller and customers have free access to the same information about product characteristics. Frequently, sellers know more than their customers about the durability of a manufactured good, the curative value of a medical drug or treatment, the precise ingredients or the nutritional content of a food item, the growing method of crops, the way young children or aged parents are cared for in an institution, how funds donated for improving the living conditions of the poor are actually spent, precisely how donations to an art museum are used, and so on. Asymmetric information affords the seller the opportunity to take advantage of the relative ignorance of the consumer to enhance profits by misrepresenting the product as something better and more useful that it actually is. For example, some sellers hide the faults of used cars; some physicians and hospitals order unnecessary medical procedures;7 vegetable oil is sometimes surreptitiously added to chocolate and butter; elderly people may be treated poorly in nursing homes, and so on, all because consumers (or their sponsors in the case of the very young, the infirm, or the voiceless) cannot tell exactly what they are paying for.8 Whereas it is in the interest of every firm to take advantage of the privileged information it has about its product, it is also profitable for every firm to be recognized as an honest seller of reliable products. Therefore firms seek to establish a reputation for being sellers of products of reliable quality, so that when a product is advertised to have certain characteristics, customers’ post-purchase experience shows that indeed those characteristics

44


are present. The reputation mechanism works well in a stable environment, where firms are known and their past behaviour is public knowledge. Provision of product warranties is another strategy that firms pursue in order to earn consumer trust. However, residual mistrust often remains, especially in competitive markets where entry and exit of firms is easy, and, therefore, reputations and warranties are not that valuable.9 It is also in the collective interest of firms to ensure the viability of markets for products affected by significant asymmetric information, essentially to prevent a situation in which ‘bad money’ drives out ‘good money’. They establish voluntarily industry associations and lobby for governmental regulations that ensure standards and can impose various sanctions against violators. The provision of faulty products is a cause of private litigation. This mechanism – where courts impose penalties and reparations that make it less profitable to supply faulty products – undoubtedly reduces firms’ incentives to act on asymmetric information. On the other hand, private litigation is expensive; causal relationships are difficult to prove in courts; the court system and tort laws are not specialized enough in the numerous areas of potential litigation; and overall it seems that the threat of litigation does not contribute much towards eliminating asymmetric information’s adverse consequences for consumers.10 Rivalry Car repair, medicines, a can of soda, medical treatment, and a seat on an airplane are examples of rival products, because the use by one consumer excludes the simultaneous use by another consumer. In contrast, air, water, national defence and city parks are non-rival to a large degree. With rival goods, the seller receives a direct and clear signal about demand, and can react accordingly: if there is excess demand, increase production and/or price, and do the reverse if there is excess supply. At the equilibrium price, those who have greater demand than others will buy more, but the price will be uniform. Non-rivalry is a defining characteristic of public goods. The problem with non-rivalry is that everybody has to use the same product: everybody breathes the same air, and everybody enjoys the services of the same and only national military force, despite possible differences in demand. With rival goods, differences in demand are expressed through the purchase of different quantities: the total quantity of a rival good supplied on the market is the sum of individual demands. This cannot be done with non-rival goods, so instead of satisfying individual demands, supply is geared to the average consumer, but the price is uniform. As a result, at the prevailing price, those with low demand will regard it as too high, and those


45

with high demand will feel that there is insufficient provision in terms of either quantity or quality of the non-rival good.11 The problem can be solved by charging different prices and determining the quantity and quality of the product in view of the different demands. But how is the seller going to know what the different demands are, and how is it going to be able to charge different prices for the same good, that is, to institute price discrimination? Imagine the reaction to a for-profit firm’s plan to increase the quality of its product if only those who care about higher quality would pay a higher price – but of course will enjoy the same quality as those who pay a lower price. High demanders will prefer to free-ride – pay a lower price and get the higher quality – thwarting the voluntary price discrimination scheme. Suppose that high demanders find a way to overcome this free-rider problem, as it is in their interest to do, and are willing to pay higher prices in some form of donation to the for-profit firm. Without access to information on the firm’s detailed accounts and operations, however, highdemand consumers have no guarantees that the firm will devote the additional revenue generated by the voluntary contributions to quality improvements instead of bolstering its profit. Consequently, they will refuse to participate in this scheme.12 The alternative is to write contracts with individual consumers and donors, or with an organization that represents them, specifying the price, quality, quantity and other characteristics of the product. Individual customers will in general be unable to engage in complex contract writing and enforcement. Large or organized consumers and donors could engage in such contracting, as is often the case between suppliers and purchasers (typically for-profit firms themselves) when price discrimination of the sort discussed here is mutually beneficial. This is the problem with non-rivalry when it describes the entire product. A similar, less problematic, but far more pervasive, issue arises when non-rivalry characterizes only some aspects of the product, such as its design, quality or colour. The severity of violation of the rivalry condition increases with the importance of the non-rival aspect to the cost of production of the product and to consumers’ demand for it.13 The extent of the non-rivalry and the market failure associated with it vary inversely with the size of the market, and positively with the heterogeneity of demand. For automobiles, there is a very large market, so that the cost of the design is relatively small compared to the number of units and their individual cost, whereas a local theatre’s cost of production is relatively high in relation to the number of times the production is presented and the cost of each show; the severity of the non-rivalry problem is therefore greater for a local theatre than for automobiles. Parents of young children who have to use the same child-care centre and have strong and differing views about the

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centre’s educational philosophy and techniques will be dissatisfied. Such issues are unlikely to arise in the context of less important matters, such as the colour of the walls. Other examples of products with significant nonrivalry aspects include movies that are expensive to produce, medicinal drugs that require large R&D expenses, TV, museums and parks. The problem with non-rivalry increases with the heterogeneity of consumers’ demand: if all consumers were identical, there would be no problem with non-rivalry. But even with demand heterogeneity, the size of the market may eliminate potential problems, because for-profit firms can produce sufficient diversity and avoid a situation in which consumers are forced to buy the same model of car, watch the same movies, walk in the same park, have children in the same day-care centre, visit the same museum, and so on. Excludability The possibility of controlling access to a product and charging for its use is critical to the ability of a firm to cover its costs of production. There are few completely non-excludable products; air and national defence are perhaps the best examples. For the condition for optimal provision to consumers to hold, excludability should be costless. The problem with non-excludability is that products or aspects of products that are non-excludable will be provided at a suboptimal level. Examples include the non-rival aspects of products, since they cannot be unbundled and sold separately. Non-excludability is a matter of degree: even ordinary goods are not costlessly excludable, because they need to be kept under lock and guard. Products that were once non-excludable, such as TV signals, are now excludable through encryption. Just as non-excludable products can be made excludable, excludable products like library services may be made non-excludable in order to ensure free or inexpensive access. In principle, such access could be achieved through subsidies from government or private donors to for-profit firms, but as noted earlier, this is unlikely to happen because of the fear that for-profit firms would use the money to increase profit more than to increase service. Anonymity For a product to be traded competitively, different units must be considered equivalent and must bear the same price, irrespective of the identities of the transacting parties. The more important personal relationships are (on the basis of various sources of identity such as ethnicity, religion, culture, place of origin and so on), the greater the departure from competition.14 Furthermore, if continuity is the basis for the formation of social


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capital, a for-profit firm may be able to take advantage of the sunk costs made by the parties, because it would be costly to re-create them elsewhere (Hansmann, 1985). In a similar vein, when a service is valued for the degree of affect that is involved in its delivery, for-profit firms will not be fully trusted or valued, because consumers will think that the affect is motivated by financial gain (Gui, 2000). No Externalities The production and consumption of a product may have unintended effects on parties that are not direct consumers of the product. The problem is that externalities are not paid for: they are a special case of products with nonexcludable aspects. For example, a positive externality is produced when well-educated children behave well in public. A negative externality is generated when a factory pollutes the air, when stressful working conditions contribute to poor driving, or when physicians prescribe antibiotics excessively and strengthen bacteria’s resistance to drugs. This condition, albeit important, has fewer implications for the relationship between a seller and its consumers than the previous conditions. In conclusion, under certain circumstances the pursuit of profits conflicts with consumer interests and leads to the failure of for-profit firms to maximize consumer well-being. Table 2.1 describes generally the degree to which each of the optimality conditions is violated. The degree of violation depends primarily on the product, but other contingencies have an effect too. Some of these contingencies concern the ability of consumers to inform themselves about products (the information condition is violated less severely in the case of more informed and educated consumers), the size of the market (the no market power, rivalry and excludability conditions are more easily met in a large city than in a small town), the heterogeneity of a population (the more diverse the demand is, the more likely it is that the rivalry, excludability and anonymity conditions will be violated), the transparency of social relations (if for-profit firm owners are part of the community, the information condition will be violated less), the strength of ethnic and religious identity (contribution to violations of the identity condition), and much more. Therefore the degree of violation noted in Table 2.1 is not only a function of a product’s characteristics, but also of other contingencies. The entries in the table reflect an exercise in identifying issues that may arise in the production and delivery of various goods and services in common but unspecified circumstances. For instance, in the case of bottled water, there is a competitive market with many competitors selling close substitutes, and there is easy entry. There exists, however, considerable asymmetric information about the content and composition of

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Bottled water Tap water Electricity distribution Electricity production Automobile production Air transport Railroads Culture and arts Entertainment (mass) National defence Public safety Home security Prisons Telecom Post and delivery Social insurance Medical insurance Physician care Hospital care Medical drugs Garbage collection Research – basic

Product (examples)

* *** *** ** * ** *** ** ** *** *** * *** ** ** ** ** * ** ** * **

No market power Rivalry * * * * * ** ** ** ** *** ** * ** ** ** * * * ** * * **

Information *** ** ** * * ** * * * *** ** * *** ** * ** ** *** ** *** * ** * ** * * * * * ** ** *** ** * * * * *** * * ** * * **

Excludability

Conditions

* * * * * * * * * * * * * * * * * ** * * * *

Anonymity/identity

* ** ** *** ** ** * ** * ** ** ** ** * * * * ** ** ** *** **

No externalities

Table 2.1 The extent of violation by for-profit firms of the optimality conditions for consumer well-being in selected industries

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Note:

* * * * ** ** * * ** ** **

** *** * *** ** ** ** ** ** * * ** * ** ** ** ** * *** ** ** **

* Little or no violation; ** Moderate violation; *** Substantial violation.

Research – applied Financial services Libraries Child-care centres Elementary education Higher education Vocational training Advocacy and lobbying Ethnic clubs Professional sports clubs Professional sports clubs * * ** ** ** ** * *** ** ** **

* * * ** ** ** * * *** ** *

** * ** ** ** ** ** * * * *

50


the water, and there is a strong reputation effect due to the existence of a few well-known brands: bottled water is rival and excludable; the identity (as such) of the interacting parties does not matter much; and there are few externalities. Despite profound similarities, bottled and tap water are different with respect to the issue of the organizational form best suited for their delivery. The distribution system of tap water entails much more important economies of scale, hence monopolistic tendencies, than in the case of bottled water; asymmetric information is not too severe, because one test suffices for many distribution points; it is fully rival, and is nonexcludable only to the extent that society regards access to drinking water as a right; it is an impersonal product, and there are a few externalities (primarily those associated with water tables and such, but not much in consumption). Electricity distribution can be analysed in a similar fashion to tap water. Current technologies of electricity production permit relatively easy transmission from multiple points and alternative sources, so there is scope for some competition; there is no asymmetric information problem; electricity is fully rival and excludable, and externalities seem to be the main problem. Contemporary automobile production is carried out with technologies that permit the creation of relatively (to the size of the global market) inexpensive moulds, so the market is competitive and the non-rivalry problem minimal; the main problem is with externalities in production. For another example, consider prisons. The demand for the product comes from the public (or the authority in charge of prisons), not the incarcerated prisoners. From the public’s point of view there is no competition: it is very difficult to know what is going on inside a prison; the facility and treatment are the same for all prisoners in a particular prison, and, hence, there is considerable non-rivalry. The product is rival, and identity and externalities seem to play a limited role only. A more detailed justification of this table, including specification of the circumstances that bear on the degree to which each of the optimality conditions is violated for each example is beyond the scope of this chapter; the purpose of the table is to provide germinal ideas to stimulate the reader to evaluate the extent to which for-profit firms satisfy the demand of different consumers in diverse industries and circumstances.

GOVERNMENT AND NON-PROFIT CORRECTIVES AND SUBSTITUTES FOR FOR-PROFIT FAILURES The foregoing analysis has established that for-profit firms fail to maximize consumer well-being when circumstances allow them to take advantage of


51

their customers in order to maximize their own profit. The present section examines what, if anything, government and non-profit organizations can do to improve for-profit firms’ performance with respect to each of the optimality conditions, ignoring for now the special costs of operating these organizations. Government The state (government in the broad sense) has many roles that do not bear directly on the question addressed in this chapter. There are many kinds of government organizations, differing in their geographic scope, autonomy from higher levels of the state, and other dimensions. Regulation of economic activity and direct provision of goods and services are two governmental functions that are undertaken with at least a partial view towards improving consumer well-being, and I shall evaluate these functions only with respect to this question. I will reduce the complex and complicated institution of the state to an essential minimum, and will defer discussion of important issues, including the possibility of capture of government objectives by private interests, until later.15 The state’s regulatory role Governments can regulate the price, quantity and quality of products sold by for-profit firms, as well as the inputs required for production. In principle, regulators could affect all markets to operate optimally. The large number of violations and their geographical distribution would require that regulators be active throughout the economy, from the goods-producing industries to diverse services delivered in numerous establishments and localities. To a certain degree, this does take place in the complex contemporary economy. Regulators study, inspect, oversee, enforce, penalize and litigate firms in a vast swathe of the economy, from ensuring that the foundations of new buildings are sound, that trains are safe, that restaurants are clean, that child-care centre teachers are licensed, that cars are safe, that petrol pumps are accurate, that theatres have fire exits, that medicinal drugs do what their manufacturers claim, and so on. Regulation does not affect the for-profit firms’ objectives, and usually affects their incentives only through the threat of fines and penalties. Regulation works through the acquisition of information (continuously, periodically, or through random sampling, such as unscheduled inspections of meat-packing plants) to set price, quantity and quality standards. Regulators face a severe handicap of asymmetric information relative to the regulated firms. For example, to control market power, regulators need to know almost everything that concerns cost and production in the

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regulated firms. To deal with the information condition, regulators must not only know what firms actually do, but also why they do what they do, and how else they could operate. Regarding non-rivalry and nonexcludability, government regulators could facilitate donations by certifying their use, and so on. To carry out the regulatory function effectively requires a daunting amount of information, a large number of expert regulators to gather and analyse the information, as well as a cadre of regulators’ counterparts in for-profit firms. These heavy, and often unattainable, requirements limit considerably the effectiveness of the government’s regulatory function in many instances where it might be needed. Government provision In comparison, government organizations could provide directly products that for-profit firms fail to provide optimally, and could improve consumer well-being less expensively than through regulation – government organizations need only operate to maximize consumer well-being. This direct control mechanism works well in the case of some optimality conditions, but not in others. Government organizations should be able to refrain from using market power and be able to emulate the competitive outcome.16 Directives to avoid the exploitation of asymmetric information against the interests of consumers and to internalize externalities are conceptually easy to draft and to follow. The case of products affected by non-excludability offers a natural scope for government provision, with government organizations being funded by compulsory taxes. However, there is no market mechanism that can signal true demand when the effective price is set to zero. Of course, the public knows that national defence, for example, is not free, but the voting mechanism does not permit the selection of a tax price and a defence quantity-and-quality schedule according to which choices can be made. Voting for political candidates whose views bundle many issues is far from approximating such a schedule. Consequently, the outcome through the political mechanism is likely to leave many consumers (voters) unsatisfied, even though the outcome may improve upon lack of provision of the non-excludable product altogether.17 The closer the correlation among the various issues on different parties’ agendas and the closer the relationship between income and demand for non-excludable products, the more satisfying government provision is.18 Finally, the smaller the differences in demand, the easier it is to provide the products in response to the public’s demand. Government provision of non-rival products requires the ability to charge different prices for the same product, which can be accomplished


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with differential tax rates if the conditions just discussed hold, which is not very likely. Government organizations’ ability to obtain donations is quite restricted, not necessarily because of distrust on the part of consumers that government will appropriate profits instead of improving service, but because of the general reluctance to support government beyond compulsory taxation. Where the size of the market permits, government organizations could supply different products to different demand groups, as for-profit firms do with their products, such as cars, restaurants, and so on. However, this runs counter to a strong sense (that is sometimes anchored in law) that the government should provide universal-access services and be non-sectarian.19 Similar reasons lead to the suggestion that government organizations are not likely to be able to provide optimal levels of products that are linked to identity. However, the absence of the profit motive and the desire to assist the public may make government organizations better providers of products with a significant relational component than for-profit firms. Non-Profit Organizations The ability of non-profit organizations to minimize or avoid violations of the six optimality conditions and to improve for-profit provision depends on how they are constituted. Non-profit organizations seek to provide products for the benefit of at least some, if not all, of their customers rather than to generate maximum profits for their shareholders. Some nonprofit organizations serve a defined group of members; these members may be the owners of the organization – and thus entitled to profits generated by the organization – and formally govern the organization. These nonprofit organizations are called consumer cooperatives, membership organizations and clubs. In addition to members, cooperatives may serve customers who are not their members. Other non-profit organizations serve deserving people who often are not able to pay full price on the market, and are supported by individual donors or organizations (including the state). Such organizations, often termed charities, are run by donor representatives or by social entrepreneurs and boards of directors selected by them, and use all profit to enhance the product. A third type of nonprofit organization represents a hybrid of the previous two, and has a mix of revenues from sales and donations. Such organizations include many hospitals, theatres, universities and so on.20 In the USA, charities and hybrid non-profit organizations are prohibited from distributing profits and are required to invest all surplus; this restriction does not apply to cooperatives, and is less common in other countries, regardless of the specific type of non-profit organization.

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In general, non-profit organizations have little or no incentive to exercise market power against the interests of their customers. The primary reason is that they operate for the benefit of consumers: when they are formally prohibited from distributing profits, they reinvest profits in the organization.21 However, cooperatives and hybrid non-profit organizations may use market power against non-members or consumers who are not in their target group, in order to benefit their members and core consumers.22 Similar considerations apply to the information condition. Non-profit organizations have generally no incentive to exploit asymmetric information. They are expressly interested in the well-being of their customers and may elicit customer trust and patronage.23 However, in some non-profit organizations management may prefer to use profit generated by exploitation of some consumers’ insufficient information in order to support other activities or other consumers. This can be done with rival products, where different consumers can receive different qualities of the product (such as the reliability of car repair), but not with non-rival products (such as the curriculum in a school, care in a child-care centre, or produce available in a grocery store). Concerning non-rivalry and non-excludability, non-profit organizations may be able to provide a safe and trustworthy place where customers can reveal their desires (demand) for the product and make donations to ensure that the product (day care for their children, aid to the poor in distant locations, interesting theatre productions) is made available in the way they desire. Through their input in the decision making of their organizations, customers and donors can enforce proper use of their information and donations. Non-profit organizations enjoy a clear advantage in the provision of products that entail the affective involvement of the parties and whose value depends on the identity of those who participate in consumption. This is the case with many cooperatives, membership organizations, cultural groups and other settings where it matters who is participating in the organization, and where the product is partly the interaction itself. Non-profit organizations’ attitude towards externalities depends on how the externalities affect their customer or membership base. A regional electric power cooperative is more likely than a for-profit firm or a state enterprise to consider the consequences of pollution associated with the location of their plant and the equipment they use. Similarly, a local non-profit organization is more likely to consider the effects of its location on the neighbourhood than would a for-profit firm, or a non-profit organization with a national scope.

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GOVERNANCE, AGENCY AND ACCESS TO CAPITAL IN GOVERNMENT AND NON-PROFIT ORGANIZATIONS RELATIVE TO FOR-PROFIT FIRMS Table 2.2 summarizes the foregoing discussion of the comparative performance of government and non-profit organizations relative to for-profit firms that violate the consumer well-being optimality conditions. Nonprofits and government dominate the for-profit firm with regard to catering to the objectives of consumers. But simply put, the desire to do well for consumers is not worth much if the organization is inefficient and resources are wasted. In this section, I examine efficiency conditions that relate to governance, agency problems and access to capital. The first condition is that owners or controllers can agree among themselves what the organizational objectives should be, and are able to formulate and communicate their objectives to management. The second condition for efficiency is to bring management to comply with these objectives. Third, management has to enlist the efforts of employees towards the pursuit of these objectives. Fourth, owners must be able to marshal resources necessary for production, including financial capital. There are distinct differences among for-profit, government and non-profit organizations in the ways and the extent to which they can meet these conditions.24 For-profit firms’ owners are typically interested in profit, with only an instrumental concern for the products of their firms. (This is, of course, the source of the violations of the optimality conditions examined in the section on for-profit firms.) The objective of profit maximization is clear and easy to communicate to management, and there is a simple metric to Table 2.2 How government and non-profit organizations perform in comparison to for-profit firms that violate optimality conditions Violated condition

Government regulation

Government provision

Non-profit organizations

No market power Information Rivalry Excludability Anonymity/identity No externalities

0/ 0/ 0

0/ 0/

0/

Note: means improvement over provision by for-profit firms; 0 means comparable provision to for-profit firms.

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measure it. However, owners can rarely observe management’s efforts, and when they do, they often cannot judge the merits of these efforts, which are quite specialized. This gives rise to an agency problem, whereby management can pursue its financial and other objectives at the expense of owners. To reduce the problem, owners seek to align management’s interests with their own by offering them ownership shares, profit sharing, and other incentives linked to firm profit and share value. The difficulty in controlling management increases with the size of the company and the complexity of its operations, as well as with the number of owners, because they tend to free-ride on the supervision efforts of each other.25 Owners, however, are not alone in exercising control over management. Outsiders who believe that a company is not managed well may see an opportunity for gain by purchasing it and disciplining or replacing existing management: the threat alone has disciplining effects. Failed managers are likely to see their job opportunities curtailed. Additionally, in competitive markets, a firm will not be able to raise prices above the market, and if it provides poor returns to shareholders, they will abandon it and starve it of capital. A well-managed and profitable enterprise will be able to attract capital from investors. These various mechanisms tend to impose a considerable degree of discipline on management. Importantly, whether management pursues shareholders’ interests closely or its own, it will seek to run a firm efficiently, because efficient operation is consonant with both types of objectives. In contrast to for-profit firms, government organizations do not have clearly defined owners.26 Government organizations are owned by, or belong to, the citizens of the jurisdiction in which they are chartered. The meaning of citizen ownership of government organizations is, of course, different from that of ownership of for-profit firms. In particular, it does not accord individuals the right to returns generated by government organizations, the right to control them, or the right to transfer their ownership shares. In a democracy, these rights are exercised by elected officials who delegate them to management of individual organizations (enterprises, bureaus, agencies) through a long chain of agency relations. A government organization, whether regulator or provider of a product, is ordinarily not constituted to make profit but to attain other objectives, subject to a break-even constraint. A government organization has the difficult task of defining its concrete objectives as opposed to broad goals. It is rare that a government organization has a single quantifiable objective. A for-profit firm that runs a train service has to generate profit to its owners, whereas a government organization is charged to provide a train service that is accessible, continuous, affordable and safe (Héritier, 2002). The managerial problem is that there is no weighting scheme that will


57

aggregate these objectives the way prices allow aggregation of profits from different activities. Thus the first condition for organizational efficiency is generally very difficult to attain in government organizations. Meeting the second condition, of bringing management to pursue owners’ objectives, is a function of the difficulty with the first condition. Management has considerable leeway to pursue its own objectives, or those of parties that are not the recognized or authorized ‘owners’. The problem is not necessarily graft, but the bending of the organization’s mission, for example, towards the wishes of interest groups. The common remedy for agency problems in for-profit firms – connecting incentives to results – is difficult to institute when results are hard to pin down. Thus government organizations must be run without the powerful financial incentives that for-profit firms have at their disposal. The span of attention of both the ultimate owners, the citizenry, and of their agents – the elected officials – is limited by the fact that they have many additional concerns competing for their time and energy. The existence of numerous government organizations leads to a large span of control, which in turn leads to the long chain of delegation referred to earlier. The combination of limited attention span and large control span exacerbates the agency problem at lower levels of government organizations, including in the relationship between management and employees. There are two related problems at this level. First, managers have weaker incentives (as compared to their for-profit counterparts) to manage employees strictly. Second, managers are prevented from using certain types of incentives that are proffered to for-profit employees, such as profit sharing and other financial incentives tied to organizational performance. As a result, employee motivation will be weaker, and so will be performance.27 The alternative of using external criteria to judge performance, particularly through benchmarking against similar organizations, is not available, because government organizations often fill a specific niche by themselves. The competitive pressure of the market that forces discipline is unavailable for similar reasons. Finally, investment and access to capital are often determined outside the operating government organizations and are less directly connected to results than in for-profit firms. This factor reduces the operational efficiency of government organizations. On the other hand, the ability of the government to issue bonds and to tax makes entry of new organizations easier. Non-profit organizations face similar problems to government organizations on several levels, beginning with complex objectives and the absence of financially motivated owners. In non-profit organizations, as in many for-profit firms, a board of directors or trustees bears the

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authority to make key decisions. However, non-profit boards are rarely as active or as influential as for-profit firm boards; non-profit managers are probably less accountable to their boards than government managers are to their superiors. In cooperatives and member-controlled organizations, the situation is better, but even there, membership involvement, just like shareholder involvement, may not suffice to control management effectively. Unless an organization and its product are very important to its members, they are not likely to invest many resources in its control. Other mechanisms that control management in for-profit firms are not available in non-profit organizations. Hence management autonomy is probably greatest in non-profit organizations, leading to possible deflection of organizational goals, lax supervision of employees, and therefore suboptimal performance.28 Access to capital by non-profit organizations is limited to member subscriptions, donations and retained earnings. The mechanism on which forprofit firms rely, raising funds from investors, is not available to non-profit organizations, as it would contravene the consumer orientation by seeking profit to reward investors. Overall, non-profit organizations’ access to capital is less efficient than that of for-profit firms.29 The analysis presented in this section suggests that, in general, government and non-profit organizations encounter more hurdles to efficient operation than do for-profit firms. In other words, if all three types of organization were to produce the same product in the same environment, the for-profit form would be more productive than the other two forms and would, therefore, offer a lower price or higher quality. Various contingencies, including the size of communities, the educational attainment of consumers, the extent of the social capital, and more, affect the comparative degree of efficiency in government and non-profit organizations. For example, communities that are more cohesive will be able to exercise better control over management of government and non-profit organizations; the more diverse the population in a jurisdiction is, the less likely it is that government will provide separate services to all of them (leaving room for both for-profit and non-profit provision); ethnic groups interested in a set of services (including cultural activities, child care and elder care, and so on) will be able to control them better through a single control and oversight infrastructure than groups with disparate interests, and so on. Table 2.3 summarizes the comparative efficiency of government and non-profit organizations relative to for-profit firms without reference to various contingencies, implicitly assuming some ‘common’ levels for them.

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Table 2.3 Governance, agency and access to capital in government and non-profit organizations relative to for-profit firms Condition for efficient operation Clarity of objectives Management compliance Employee compliance Access to capital

Government regulation

Government provision

Non-profit organizations

0

/0

Note: means lower efficiency than in for-profit firms; 0 means efficiency comparable to for-profit firms.

BENEFITS VERSUS COSTS: COMPARING THE ADVANTAGES AND DISADVANTAGES OF FOR-PROFIT, GOVERNMENT AND NON-PROFIT ORGANIZATIONS No type of organization enjoys superiority in its relationship with consumers and its internal efficiency. As Table 2.3 illustrates, for-profit firms are generally more efficient, but as Table 2.2 has shown, government and nonprofit organizations tend to treat consumers better. An organization’s net comparative advantage or disadvantage relative to other organizations depends on the characteristics of its product and other factors that determine how it fares on the consumer well-being optimality conditions. It also depends on the attributes of its controllers and other factors that determine how it fares on the internal efficiency conditions. The answer to the question – which products should be provided, or regulated, by for-profit firms, government, and/or non-profit organizations – depends therefore on a number of factors. Table 2.4 contains my recommendations for the allocation of roles to the three types of organization in the provision and regulation of products in various industries. The table constitutes, in effect, a combination of the conclusions of the analyses summarized in Tables 2.1, 2.2 and 2.3. Table 2.4 suggests that there often may be room for more than one type of organization in the provision and regulation of a particular product, because the contingencies that affect their desirability vary across consumers and communities.30 To illustrate how the analysis underlying the entries in Table 2.4 may be carried out, consider the child-care and education industries. In many communities these industries and their products are characterized by significant elements of market power, asymmetric information, non-rivalry,

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Table 2.4 Proposed allocation of economic activities among the three sectors, in various industries Product (examples)

Bottled water Tap water Electricity distribution Electricity production Automobile production Air transport Railroads Culture and arts Entertainment (mass) National defence Public safety Home security Prisons Telecom Post and delivery Social insurance Medical insurance Physician care Hospital care Medical drugs Garbage collection Research – basic Research – applied Financial services Libraries Child-care centres Elementary education Higher education Vocational training Advocacy and lobbying Ethnic clubs Participant sports clubs Professional sports clubs

Sectors For-profit

Government

Non-profit

P1 P2 P3 P1 P1, R2 P1, R2 P1, R2 P3 P1 0 0 P1, R1 0 P1 P1 0 P2 P1 P1 P1, R3 P1 P3 P1 P1, R3 P3 P3 0 P3 P1 P3 P3 P3 P1, R1

R1 P1 P1 P2, R1 R1 R1 P2, R1 P2 0 P1 P1 R2 P1 R1 P2, R1 P1 P1, R1 P2, R2 P1, R1 R1 R1 P2 P2 R1 P1 R1, P2 P1, R1 P2 P3 0 0 P2 R2

R2 P3 P3 P3 0 0 0 P1 P2 0 P2 0 0 P3, R2 0 0 P3 P3 P1 R2 P2 P1 P3 P2, R2 P2 P1, R2 P2 P1 P2 P1 P1 P1 P3

Note: P Provision; R Regulation; 1 Primary role; 2 Secondary role; 3 Tertiary role; 0 No involvement.


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non-excludability and externalities, as well as the need for consideration of the identity of the children and teachers (Akerlof and Kranton, 2002). Provision by for-profit firms is therefore generally suboptimal relative to the well-being of consumers (students, their parents, or the organs of government sponsoring their care and education). Therefore government and non-profit organizations should be the providers of choice unless they suffer from large efficiency disadvantages relative to for-profit firms. Nonprofit educational organizations can be run efficiently when and where parents or other sponsors are involved in control over management, or if there is close supervision by an organization in which parents and community are involved. Government provision is often preferred to non-profit organizations because of the desire to ensure free access and to avoid difficulties associated with subsidization of students,31 as well as the desire to imbue students with common rather than sectarian values.32 In contrast, vocational training often lacks many of these elements, and is therefore appropriately provided by for-profit firms. As the table reveals, I do not find much reason for government provision of goods. The large size of the market for goods reduces problems with provision by for-profit firms associated with the first five conditions (in Table 2.2), and judicious regulation should suffice to deal with the sixth condition – externalities. Consequently, the cost of government organizations’ operational inefficiencies may outweigh the benefits of government provision. Why is there no need for non-profit organizations in the provision of goods? Generally, when consumers organize to protect or advance their selfinterest, they need to be close to the product. Because the market for goods is large, the organizing consumers will constitute only a small minority among all consumers, so the benefits of their actions will be dissipated over a large number of consumers, whereas they will have to bear all the costs. Some services, such as garbage collection, financial services and certain forms of training, are provided by for-profit firms in circumstances that are similar to goods, and with similar violations of optimality conditions. When the violations are more severe, government intervention or nonprofit provision is needed. Many services are provided in circumstances that vary greatly across communities; violations of optimality conditions vary with these circumstances, as does the ability to operate organizations more or less efficiently. Hence there will be organizational variation across communities in the provision of services like those listed in Table 2.4. The three types of organization examined in this chapter have advantages and disadvantages that are related to their very nature, and are bundled together. Nevertheless, neither advantages nor disadvantages are immutable, and policies can be developed to ameliorate weaknesses and enhance strengths in all three forms of organization. For example, partnerships

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across organizations from different sectors make it possible to build on the strengths of the partners (Hanss, 2001; Minow, 2003; and Sandmo, 2003); education of managers to understand the unique disadvantages faced by government and non-profit organizations improves management of these organizations and their ability to operate efficiently (Steinberg, 2004); development of institutions that support pro-social values limits violations of optimality in provision by for-profit firms (Ben-Ner and Putterman, 1998); establishment of support organizations that facilitate decision making in non-profit organizations improves their efficiency (Young, 2004); encouragement of access to information increases transparency and accountability, and strengthens the ability of all types of organization to provide their products efficiently; and enactment of legislation and regulations adapted to the needs of each type of organization has an important function in advancing their effectiveness and efficiency. Such policies can foster a more efficient distribution of economic activity across the three sectors, taking advantage of the sui generis strengths of each sector while improving their performance.

NOTES 1. 2.

3.

4.

5.

I am grateful to Bernard Gazier and participants at the Cournot Centre for Economic Studies Conference, ‘Public Sector, Private Sector: New National and International Frontiers’ (Paris, 2–3 October, 2003) for helpful comments. Sources: World Bank, World Development Indicators and OECD National Accounts. The role of the state in the allocation of resources is greater than these figures suggest because of the state’s ability to raise revenues from taxes rather than to allocate them for the production of goods and services in all three sectors, and because of the exercise of its regulatory functions. In the middle of the 1990s, government spending in France was about 46 per cent of GDP, in Germany 44 per cent, in the UK 36 per cent, and in the USA 20 per cent. The analysis and examples offered in this chapter concern the final consumer – primarily individuals. However, the analytical framework is applicable to buyers generally, including firms as purchasers of inputs from other firms, in which case the corrective measures also include contracting, vertical integration and outsourcing. A key difference between consumers and firms is the ability of the latter to enter into complex contractual arrangements that involve understanding, observation and enforcement of matters that are beyond the ability of an individual. The choices of such buyers also bear on the distribution of economic activity (for example, whether government and non-profit organizations carry out their own cleaning services or purchase them from for-profit firms, or government supplies its own needs or procures goods and services from for-profit firms). See Hart et al.(1997); Ben-Ner (2004); and Singer (2003) for examinations of such issues. The analytical framework applied to the examination of the relationship between firms and consumers is also applicable to the investigation of the relationship between firms and workers (see Ben-Ner, 1988; Ben-Ner and Jun, 1996). Dreze and Hagen (1978) establish the equivalence between the two types of analyses (firm–consumer and firm–worker relationships) in a general model. The chapter does not address the question of how economic activity came to be divided in different countries, except to observe that history has made big footprints and long shadows. To understand how things came to be the way they are, one would need an


6. 7.

8.

9. 10. 11. 12.

13.

14. 15. 16. 17.

18. 19. 20.

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analysis that combines de Tocqueville and Braudel. Weisbrod (1988) and Hansmann (1998) provide broad overviews of the mixed economy, emphasizing the role of the nonprofit sector. This is the essence of the theory of contestable markets (Baumol et al., 1982). See, for example, Kurt Eichenwald, ‘How One Hospital Benefited on Questionable Operations: Operating Profits – Surgery Needed or Not?’, The New York Times, p. 1, 12 August 2003. The article alleges that doctors at a for-profit hospital conducted unnecessary heart surgeries in order to boost profits (‘They were pushing for what I thought was ridiculous financial results’, said a former administrator). This is the condition that was studied under the rubric of asymmetric information by Stiglitz (1974), Akerlof (1970), and many other economists (predominantly in the context of principal–agent relations in the workplace and corporate finance). One of Akerlof’s examples concerns used cars, whose sellers have an incentive to hide defects and misrepresent the quality of their cars. Buyers know about such incentives and about bad experiences in purchases of used cars, and therefore suspect, although have no way of confirming or refuting all their suspicions, that cars offered to them are less good than how sellers represent them. As a result, buyers are willing to pay only lower prices, penalizing sellers of better cars as well as honest sellers, with the effect that such cars may be partially withdrawn from the used-car market. Blumberg (1989) relates numerous anecdotes about exploitation of asymmetric information by firms (including in the used-car market); the anecdotes were collected from hundreds of students who wrote about their personal experiences as employees in various industries. See also Holmstrom and Milgrom (1994) for an analysis of the distorting effects of strong profit incentives on quality. The issue of trust in for-profit firms is complex, and many factors are involved in developing it. See Ben-Ner and Putterman (2001; 2003). For reviews on the role of courts and litigation, see Glaeser and Shleifer (2003), and Polinsky and Shavell (2000). Of course, pure public goods such as national defence are supplied by the state; a tax rate that would fund defence would be equivalent to the price of a private good; and the average or median dominant voter is equivalent to the average consumer. In the USA, for-profit firms get practically no donations and very few volunteers as compared to non-profit organizations and government (511 000, 6 357 000 and 2 426 000, respectively, in 1998; see Table 1.6, The New Non-profit Almanac and Desk Reference, Independent Sector and Urban Institute, Jossey-Bass, 2002); nearly all volunteers in forprofit firms choose to work in hospitals and retirement homes. The relative importance is measured in terms of the cost of the design, the number of units produced on its basis, and their marginal cost (the smaller the number of units and the lower the unit cost relative to the cost of the mould, the greater the non-rivalry problem), and the importance of the design, quality, or colour to consumers’ demand for the product. Ben-Ner et al. (2005) show experimentally that various bases for identity have significant effects on economic behaviour. A detailed analysis of the role of government in the provision of non-excludable and non-rival goods can be found in Kaul (Chapter 1 in this volume). Montias et al. (1994) discuss this issue in connection with Oskar Lange’s principles for running government-owned firms. Non-excludable goods may have excludable partial substitutes: private militias may take the place of national armies, private guards may substitute for police, and private book collections may replace public libraries. A complete comparison should include these alternatives. This assumes that the income tax is progressive. For example, the government in the Netherlands supports financially the provision of products such as education, arts and media to diverse ethnic and cultural groups, not through its own organizations, but through non-profit organizations. This is a very coarse way of classifying non-profit organizations, but is sufficient for the purposes of this chapter. The legal classification of the universe of non-profit

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21. 22. 23.

24. 25.

26. 27.

28.

29. 30.

31. 32.

Advancing public goods organizations in the USA is described in Ben-Ner and Van Hoomissen (1993), Figures 1 and 2; for Europe, see Ehlermann (1992), and various papers in Borzaga and Defourny (2001). In fact, many consumer cooperatives, mutual financial institutions, agricultural purchasing cooperatives and the like were formed to fight the negative consequences of limited local competition in the provision of groceries, power generation and so on. For example, cooperative grocery stores may sell products to their members at lower prices, as well as distribute to members profits from non-members. Arrow (1963) was the first to suggest that asymmetric information may give rise to the non-profit form of organization, when he examined the trust patients need to have in their health-care givers, and concluded that the profit motive may get in the way of trustworthy care. Hansmann (1980) made the first comprehensive statement of the protection that the legal constraint against distribution of profit in non-profit organizations lends to consumers and how this earns their trust in these organizations. Ortmann and Schlesinger (2003), Bacchiega and Borzaga (2003) and others (myself included) consider this constraint to be a minor source of the trustworthiness that non-profit organizations may enjoy (consumer control being the main source). See Hansmann (2003) for a rebuttal. A discussion of these issues in the three types of organization can be found in Ben-Ner et al. (1993). There are differences across countries in the way large companies are managed; for example, in some countries boards of directors are dominated by representatives of banks, organized labour and other institutions, arrangements that reduce the free-rider problem, but introduce other issues. For a comprehensive analysis of the internal organization of government agencies, see Vickers and Yarrow (1988). Government organizations tend to compensate for these problems by instituting a myriad of rules and regulations aimed at controlling employees’ behaviour, leading to inflexibilities and other phenomena associated with bureaucracies. These tendencies are exacerbated by the need to protect government organizations from large swings in employment when politicians change, by granting employment protection to employees. See Ben-Ner (1994), Manne (1999), and Birchall (2002) for analyses of the role of members and boards of directors in effective control over management. The problem with management in non-profit organizations does not arise because ‘bad’ agents selfselect into non-profits; indeed, many authors consider non-profit managers at least as committed to their organizations’ goals as are for-profit managers; see Badelt (2003), Young (2003), Bilodeau and Slivinski (1996) and Glaeser and Shleifer (2001). The more severe agency problem arises because of more lax control over management. See Steinberg (2004) for a discussion of capital and investment in non-profit organizations, and for references to the literature. In the table, regulation by non-profit organizations refers to consumer organizations that evaluate goods and services (such as the Consumer Union in the USA), and to the very common associations of for-profit firms that provide various degrees of non-binding regulation (such as Better Business Bureaus, and industry-based associations). See Hart et al. (1997) for a discussion of vouchers in for-profit schools. James (1993) argues that the desire to inculcate religious values that are not imparted in public schools explains the size of the non-profit education sector in various countries.

REFERENCES Akerlof, G.A. (1970), ‘The Market for “Lemons”: Quality, Uncertainty and the Market Mechanism’, Quarterly Journal of Economics, vol. 84, 487–500. Akerlof, G.A. and R.E. Kranton (2002), ‘Identity and Schooling: Some Lessons for the Economics of Education’, Journal of Economic Literature, 40(4), 1167–1201.


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Arrow, K. (1963), ‘Uncertainty and the Welfare Economics of Medical Care’, American Economic Review, 80 (2), 941–73. Bacchiega, A. and C. Borzaga (2003), ‘The Economics of the Third Sector: Toward a more Comprehensive Approach’, in H.K. Anheier and A. Ben-Ner (eds), The Study of Non-profit Enterprise: Theories and Approaches, New York: Kluwer Academic/Plenum Publishers, pp. 27–48. Badelt, C. (2003), ‘Enterepreneurship in Nonprofit Organizations: Its Role in Theory and the Real World Nonprofit Sector’, in H.K. Anheier and A. Ben-Ner (eds), The Study of Non-profit Enterprise: Theories and Approaches, New York: Kluwer Academic/Plenum Publishers, pp. 139–56. Baumol, W., J. Panzar and R. Willig (1982), Contestable Markets and the Theory of Industry Structure, San Diego: Harcourt Brace Jovanovich. Ben-Ner, A. (1988), ‘The Life Cycle of Worker-Owned Firms in Market Economies: A Theoretical Analysis’, Journal of Economic Behavior and Organization, 10, October, 287–313. Reprinted in D. Prychitko and J. Vanek (eds) (1996), Producer Cooperatives and Labor-Managed Systems, Cheltenham, UK and Brookfield, VT: Edward Elgar. Ben-Ner, A., J.M. Montias and E. Neuberger (1993), ‘Basic Issues in Organizations: A Comparative Perspective’, Journal of Comparative Economics, 17 (2), 207–42. Ben-Ner, A. and T. Van Hoomissen (1993), ‘A Portrait of the Non-profit Sector in the Mixed Economy: New York, 1981–1987’, in A. Ben-Ner and B. Gui (eds), The Non-profit Sector in the Mixed Economy, Ann Arbor, MI: University of Michigan Press, 1993, 243–66. Ben-Ner, A. (1994), ‘Who Benefits from the Nonprofit Sector? Reforming Law and Public Policy Towards Nonprofit Organizations’, Yale Law Journal, 104 (3), 731–62. Ben-Ner, A. and B. Jun (1996), ‘Employee Buyout in a Bargaining Game with Asymmetric Information’, American Economic Review, 86 (3), 502–23. Ben-Ner, A. and L. Putterman (1998/2001), ‘Values and Institutions in Economic Analysis’, in A. Ben-Ner and L. Putterman (eds) (preface by A. Sen), Economics, Values, and Organization, Cambridge: Cambridge University Press, pp. 3–72. An abridged Spanish translation appeared as ‘Valores e instituciones en el analisis economico’, Revista de Economia Publica, Social y Cooperativa, December 1999, vol. 33, 43–78. Ben-Ner, A. and L. Putterman (2001), ‘Trusting and Trustworthiness’, Boston Law Review, 81 (3), 523–51. Ben-Ner, A. and L. Putterman (2003), ‘Trust in the New Economy’, in D.C. Jones (ed.), Handbook of Economics in the Electronic Age, Amsterdam: Academic Press. Ben-Ner, A. (2004),‘Outsourcing by Nonprofit Organizations’, in D. Young (ed.), Effective Economic Decision Making by Nonprofit Organizations, New York: The Foundation Center. Ben-Ner, A., B. McCall, M. Stephane and H. Wang (2005), ‘Identity and Self–Other Differentiation in Work and Giving Behaviours: Experimental Evidence’, Working Paper No. 08 05, Industrial Relations Center, University of Minnesota. Bilodeau, M. and A. Slivinski (1996), ‘Volunteering Nonprofit Entrepreneurial Services’, Journal of Economic Behavior and Organization, 31, 117–27. Birchall, J. (2002), ‘Mutual, Non-Profit or Public Interest Company? An Evaluation of Options for the Ownership and Control of Water Utilities’, Annals of Public and Cooperative Economics, 73 (2), 181–213.

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Blumberg, P. (1989), The Predatory Society: Deception in the American Marketplace, New York: Oxford University Press. Borzaga, C. and J. Defourny (2001), The Emergence of Social Enterprise, London: Routledge. Dreze, J. and K. Hagen (1978), ‘Choice of Product Quality: Equilibrium and Efficiency’, Econometrica, 46 (3), 493–513. Ehlermann, C.D. (1992), ‘European Community Competition Policy, Public Enterprise and the Cooperative, Mutual and Nonprofit Sector’, Annals of Public and Cooperative Economics, 63 (4), 555–71. Glaeser, E.L. and A. Shleifer (2001), ‘Not-For-Profit Entrepreneurs’, Journal of Public Economics, 81, 99–115. Glaeser, E.L. and A. Shleifer (2003), ‘The Rise of the Regulatory State’, Journal of Economic Literature, 61, 401–25. Gui, B. (2000), ‘Beyond Transactions: On the Interpersonal Dimension of Economic Reality’, Annals of Public and Cooperative Economics, 71 (2), 139–69. Hansmann, H. (1980), ‘The Role of Nonprofit Enterprise’, Yale Law Journal, 89 (3), 835–901. Hansmann, H. (1985), ‘The Organization of Insurance Companies: Mutual versus Stock’, Journal of Law, Economics and Organization, Spring, 125–53. Hansmann, H. (1998), The Ownership of Enterprise, Cambridge, MA: Harvard University Press. Hansmann, H. (2003), ‘The Role of Trust in Nonprofit Enterprise’, in H.K. Anheier and A. Ben-Ner (eds), The Study of Nonprofit Enterprise: Theories and Approaches, New York: Kluwer Academic/Plenum Publishers, pp. 115–22. Hanss, W.G. (2001), ‘Overcoming Competitive Disadvantages of Public Enterprises by Public–Private Partnerships and their Financing Models’, Annals of Public and Cooperative Economics, 72 (3), 393–411. Hart, O., A. Shleifer and R. Vishny (1997), ‘The Proper Scope of Government’, Quarterly Journal of Economics, 112 (4), 1127–61. Héritier, A. (2002), ‘Public Interest Services Revisited’, Max-Planck-Projektgruppe Recht der Gemeinschaftsgüter, Working Paper 2002/10. Holmstrom, B. and P. Milgrom (1994), ‘The Firm as an Incentive System’, American Economic Review, 84, 972–91. James, E. (1993), ‘Why Do Different Countries Choose a Different Public–Private Mix of Educational Services?’, Journal of Human Resources, 28 (3), 571–92. Manne, G. (1999), ‘Agency Costs and the Oversight of Charitable Organizations’, Wisconsin Law Review (2), 227–72. Minow, M. (2003), ‘Public and Private Partnerships: Accounting for the New Religion’, Harvard Law Review, 116 (5),1229–70. Montias, J.M., A. Ben-Ner and E. Neuberger (1994), Comparative Economics, in the ‘Fundamentals of Pure and Applied Economics’ series, Chur, Switzerland: Harwood Academic Publishers. Ortmann, A. and M. Schlesinger (2003), ‘Trust, Repute, and the Role of Nonprofit Enterprise’, in H.K. Anheier and A. Ben-Ner (eds), The Study of Nonprofit Enterprise: Theories and Approaches, New York: Kluwer Academic/Plenum Publishers, pp. 77–114. Polinsky, M.A. and S. Shavell (2000), ‘The Economic Theory of Public Enforcement of Law’, Journal of Economic Literature, 38 (1), 45–76. Sandmo, A. (2003), ‘Public Provision and Private Incentives’, Nordic Journal of Political Economy, 29 (2), 87–104.


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Singer, P.W. (2003), Corporate Warriors: The Rise of the Privatized Military Industry, Ithaca, NY: Cornell University Press. Steinberg, R. (2003), ‘Economic Theories of Nonprofit Organizations: An Evaluation’, in H.K. Anheier and A.Ben-Ner (eds), The Study of Nonprofit Enterprise: Theories and Approaches, New York: Kluwer Academic/Plenum Publishers, pp. 277–309. Steinberg, R. (ed.) (2004), The Economics of Nonprofit Enterprises, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Stiglitz, J. (1974), ‘Incentives and Risk Sharing in Sharecropping’, Review of Economic Studies, 41, 219–55. Vickers, J. and G. Yarrow (1988), Privatization: An Economic Analysis, Cambridge, MA: MIT Press. Weisbrod, B.A. (1988), The Nonprofit Economy, Cambridge, MA: Harvard University Press. Young, D.R. (2003), ‘Entrepreneurs, Managers and the Nonprofit Enterprise’, in H.K. Anheier and A. Ben-Ner (eds), The Study of Nonprofit Enterprise: Theories and Approaches, New York: Kluwer Academic/Plenum Publishers, pp. 161–68. Young, D.R. (2004), ‘Introduction’, in D. Young (ed.), Effective Economic Decision Making by Nonprofit Organizations, New York: The Foundation Center.

3.

Services of general interest in a competitive multinational space Philippe Herzog

INTRODUCTION There is broad universal consensus that Europe should develop and provide public goods. However, the context in which Europe must create and provide such goods is far from favourable. It is shaped by economic and financial globalization, the information technology revolution and a crisis within the political system. Indeed, the ability of the European political system to define and organize public goods has become very problematic. Consequently, the fundamental question of the creation and provision of public goods in a multinational, competitive space is as urgent as it is evident. A secular European politics adapted to its epoch must be able to show what the version of greatness is, as far as that politics is specifically concerned, that it has in mind. (Sloterdijk, 2003)

If a Europe of public goods is to come into being, this will require more than a series of pacts limited to competitiveness and fiscal and regulatory competition. Values of sharing and interactivity must become common projects. Fundamental rights must be acknowledged, which unite players in the field around multinational services of general interest (SGIs). European regulation of cross-border networks must be established. The role of information – revolutionized by technology – in developing interactively the capacities of Europe’s population must be grasped. Yet these imperatives are certainly incompatible with both the current capitalist and state hold on information systems and the closed nature of educational systems within the European Union. In this chapter, we explore the practical and philosophical implications of European public goods provision in a mixed economy within a multinational space.1

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Services of general interest in a competitive space

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DEFINITIONS AND OPTIONS SGIs as Essential Services at the Level of Public Goods Our societies consider certain services (human activities based on a person-to-person relation) as essential for individuals, communal life or development. Christianity elaborated a notion of the common good necessary for the flourishing of the person. Humanism in France led to a notion of public service, a doctrine and duty of the state (Duguit, 1921). In Germany, Daseinsvorsorge are based on a social philosophy. Amartya Sen (1984) renews this heritage in designating certain services (education, health and access to the labour market) as necessary in order for individuals to exercise their freedom in an inclusive society. The field of essential services is not frozen, but dynamic, a function of the structure of societies and technological change. There is no general definition of public goods that is universally accepted in the area of SGIs. In my opinion, however, the conception of a public good always appeals to the principles of non-market exchange (sharing, solidarity), whether intermixed or not with the principles of market exchange (quid pro quo). Economists have tried to offer objective definitions. They hold that a ‘pure public good’ possesses two features: the consumption of services excludes no one, and its users are not rivals. Public goods, however, are often built with modalities that do exclude (so-called club goods), or they may be subject to congestion, and therefore be the object of rivalry (Aloy and Levêque, 1997). In current debates, three dimensions of SGIs are often emphasized. ●

●

●

Economic: the activities involved have increasing returns. The more service is provided on the network (infrastructure), the more unit costs diminish. Ecological: these activities have extremely important effects on the environment, and must be managed according to principles of precaution and sustainable development. Social: equal access and universal inclusion necessitate rebalancing, from inexpensive zones to expensive zones.

Furthermore, it is critical to recognize that SGIs cannot be dissociated from the systems that contain them. These systems link infrastructures, communal services (information, operability, safety) and service provisions. Sometimes it is in the infrastructure that the principal costs and obligations reside, sometimes in the distribution and final provision.

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It is fundamental to emphasize that the definition and the organization of these services have always rested on a process of social and political action. Karl Polanyi (1983), in magisterial fashion, showed how work, land and money could be uprooted from the status of merchandise, where they had been swallowed up in the beginnings of capitalism, to become activities, resources and values, socially protected and involving a non-market link. According to Hannah Arendt (1994), in the nineteenth century, work was elevated to a public good2 with specific laws and an institutional system. At the same time, essential services began to be conceived as public goods (education, health, and so on). Today, Europe speaks more blandly about ‘services of general interest’ when a public authority (locality, region, state) has designed and organized them as such. These services are linked to national identity, of which they are an incarnation. All European countries have built them and are attached to them. In France, they are a dimension of the state. In Germany and the Scandinavian countries, they are at the heart of regional and local administration. The Anglo-American tradition borrowed more from common law. Thus a celebrated judgment of the Supreme Court of Justice of the United States in 1877 (Munn versus Illinois) ruled that companies owning grain silos, enjoying a de facto monopoly, were charging excessive tariffs. Their trade was then classified as a ‘public obligation’ and ‘subject to public regulation’. The first definition of universal service dates back to 1934 in the USA for telecommunications (Stoffaës, 2003). Essential services are not ‘social gains’. Redefining SGIs is nevertheless currently proving very difficult in France. Public service is often confused with public enterprise. Yet, what really are the public services provided by, for example, the SNCF (France’s national rail company)? Inter-regional and urban transport. However, rail freight, which should surely be a public service, is left abandoned, and private companies are the main road-haulage operators. On the other hand, another French tradition, rather misunderstood, entrusts essential services to private operators (for example, the treatment and distribution of water): they are organized as concessions by territorial collective bodies. Forcing a Rethink of the Purpose, Organization and Regulation of SGIs Important changes are taking place in the network sectors of economic services of general interest (communications, energy, transport). It would be false to attribute these solely to the impact of the European Union’s liberalization policy. There are in fact two concomitant processes. The first is technological and informational changes, which, with the evolution of the needs and demands of societies, necessitate, in any case, a reform of the


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national SGI systems. The other is the creation of the European single market on the lines of a liberalization that tolerates national rights, but does not assume the community choices of SGIs. Remember that in service network industries, public intervention was imposed when reality abundantly revealed the ‘deficiencies of the market’. Thus in the inter-war and post-Second-World-War periods, public organization of networks into natural monopolies was put in place within national frameworks, each according to its culture and the principles forged by economic theory. In France, an original theory was devised (M. Allais, M. Boiteux, and so on). It theorized the effectiveness of nationalization with franchised integrated monopolies. In other contexts, public regulation, entrusted to the state, provided a framework for private groups. In the recent context of the information technology revolution, all these systems have come under scrutiny and been judged heavy and inefficient, posing barriers to innovation by new operators. Sweeping reforms were undertaken in the USA and the UK in the 1980s (1984: unbundling of AT&T and the privatization of British Telecom). Privatization was only one dimension. The other was liberalization: unbundling of monopolies, creation of markets and entry of new players. Nevertheless, the notion of ‘deregulation’ is improper and deceptive (Henry et al., 2001). Public regulation was not suppressed; it simply changed. Of course, national monopolies built around a franchised, integrated, benchmark operator are exploding, but segments of natural monopolies remain (like the ‘local loop’ of fixed telephony). Even in the case of a plurality of networks, public regulation has been rethought. Debate on that subject is intense in Anglo-American countries (Hartley, 2001; Newbery, 2002; Helm, 2001). Despite this, Marcel Boiteux (1996) continues to contest the relevance of the private operator–public regulator ‘model’: he advocates preserving the operator–regulator interlinkage in the electricity sector. The European Union Confronting the Problem of Market–SGI Compatibility The Treaties instituting the Community and then the European Union, from Rome to Maastricht, fixed a framework: one big market should be shared, but the member states (MS) should maintain jurisdiction of services of general interest (SGIs). This was a reasonable choice, given the very great diversity of national choices. Coexistence was peaceful as long as we remained at the stage of the common market. Of course, the principles of free movement and the general rules of competition have been established since the Rome Treaty. However, at the time of the common market, national social and public order took priority for

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essential services, as jurisprudence reminded us whenever necessary. In contrast, the passage from the common market to the single market is a mutation. The Union requires that the national order be changed in order to establish effective competition; its aim is a single set of rules for a single market. However, for essential services, the Union has neither the mandate nor the desire to share and guarantee the missions of the SGIs. Moreover, these services always have a non-market dimension, with values of sharing, whose coexistence with the competitive market order is far from evident. There is therefore an outright contradiction that must be dealt with. Jurisprudence did an about-turn in favour of competition, while setting limits and specifying derogations (the Corbeau and d’Almelo rulings, European Court of Justice, 1994) (Pelkmans, 2001). The Union imposed a ‘controlled’ liberalization, but it did not take on the responsibility of guaranteeing access to essential services. Each member state protects ‘its’ SGIs, but it may attack the SGIs of other member states through competition. This, however, can lead to trench warfare. Conflicts of national interest are at the heart of disagreement about SGIs, and they gain strength from cultural misunderstandings. This is typical in France and Germany, although it should be possible to come to an understanding as each is extremely attached to these services. In Germany, the freedom of administration is constitutional; the ‘home’ operators have a local monopoly, but they may not compete on another territory. How then can Germans understand that EDF (Electricité de France – the French electricity company) – a public establishment enjoying until recently an internal monopoly that the state did everything to preserve – can act outside France as a private company buying networks and selling services? The electrical systems also appear opposed: in Germany, there are 700 operators and a strong local base, whereas in France, it is extremely centralized. Having said this, it is certainly not virtue that distinguishes one country from another, but comparative advantages. Germany favours European competition, but ultimately protects its internal base. For the moment, if French electricity is competitive, German electricity is not. Germany opposes access to its market in order to gain time to restructure, whereas France, which already exports 15 per cent, is highly active in the European electricity market. The same is true of water and urban services. Concessions are unknown in Germany; France is the champion, with three big private groups demanding ‘reciprocity’, that is, access to others’ markets. In principle, anyone can enter France, but no one can enter Germany. In deciding to create a single market, the Union wished to avoid killing off national prerogatives. Therefore it established a principle of separation: essential services of a social non-market character should remain outside


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the field of application of the rules of competition and the market. This principle is insufficient when activities become mixed, enlacing the social and the economic, the traded and the non-traded. It becomes just a convention, betraying a lack of will to elaborate the common good. Since 1992, European integration has visibly progressed. Yet, for SGIs, divergences of definition, politics and interests engender numerous conflicts. The impact of liberalization and competition has not yet been evaluated. They have perhaps allowed price reductions (provisionally) and technological innovations, but how can one ignore market failures (problems of network safety, lack of interconnections and investment)? Several Roads Leading to Community Recognition of SGIs Action aiming at positive community recognition of SGIs began in the mid1990s. Its first results came at the level of the Treaties (Amsterdam, Nice), and in the Charter of Fundamental Rights (Article 36). Above all, sector directives conceived for network industries (postal service, telecommunications, energy, transport) were developed. Their function was not only to create the market by breaking national monopolies, but also to harmonize and guarantee public service obligations and lay the groundwork for the creation of European networks. Nevertheless, contradictions, divergences in national rationales and the continuing bias in favour of the market led the member states to pose the following question at the Laeken Summit (2001): should one go further, and how? The Commission’s Green Paper (Commission Européenne, 2003) consulted the member states and civil society in order to try to answer this question. The Convention charged with Treaty reform remained blocked before accepting the creation of a new lever: it specifies that a European law could ‘define the principles and conditions’ necessary for the setting in operation of Services of General Economic Interest (SGEIs). In my report to the European Parliament, I attempt to extend and systematize these efforts. My approach3 rests on three axes: an appeal to a method of participatory democracy by engaging the action of carriers of cross-border SGIs; a conception of European modes of mixed and public regulation, transcending controlled liberalization; the development of the dynamics of fundamental rights. I am advocating here a new political strategy: the Community and the member states should assume co-responsibility and solidarity for the development of SGIs in Europe. Before developing this idea further, it must once again be underlined that it is not simply a question of protecting existing local, regional and national systems. These must first of all be reformed as a result of changes in technology and modes of consumption. ‘Internal’ reform of public services must absolutely make room for new offers and stimulate quality and

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efficiency. In this sense, the European Union acts as a positive stimulus when it imposes the transparency, clarification and redefinition of missions; when, in considering real costs, it requires justification of aid; and when it opposes monopolies. It goes too far, however, when it pushes for the unbundling of these systems, when it begins to discourage aid and generalize calls for tender. Thus reform must be articulated on two fronts: internally and at the level of the EU community framework.

THE LEGITIMACY OF COMMUNITY ACTION The Legal Framework of the European Union In the European Union, everything starts and finishes in law. A space of rules, Europe is not yet a multinational society made up of actors ‘sharing words and deeds’(to paraphrase Hannah Arendt’s definition of politics). The envelope of law translates substance, and this substance is principally that of the market; all the difficulty consists in going towards non-market relations. The judicial framework of the Union gives no substantial definition of SGIs.4 The Treaties mention neither public services (except for transport in Article 73) nor SGIs. They use the notion of an SGEI in Articles 86.2 and 16, and in the Charter of Fundamental Rights, Article 36. The EU considers that an SGEI exists when (1) a market exists, and when (2) a public authority defines a specific obligation. Yet, what is the relevant market: local, national, European, global? What sort of market: with or without public goods, with responsibilities shared by the operators? And which public authority? In fact, for the Commission and the Court of Justice, an SGEI is conceivable only when ‘the enterprise, considering its own commercial interest, would not assume the corresponding missions’. It is a subjective approach, and furthermore, arbitrary, since the motives of private operators are multiple. The famous Article 86.2 subjects enterprises charged with SGEIs to the rules of competition, within the limits compatible with the exercise of their mission. It specifies that ‘the development of exchanges must not be affected in a way contrary to the interest of the Community’. State aid is monitored by the Commission. It must neither ‘distort’ nor ‘threaten’ competition. The Commission, keeper of the Treaties, is itself the interpreter of these texts; the European Parliament is merely consulted, and the member states must conform to the rulings or decisions. They can, however, appeal to the Court of Justice. Thus European law does not include a common concept for SGIs. It also separates the ‘social’ from the ‘economic’ in an entirely contestable way.


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In its view, social activities are based on the non-profit principles of social justice and solidarity, for which the state is responsible, and which it defines within its internal order. Activities are dubbed economic when they can be exercised, at least in principle, by a private enterprise and with a profitseeking goal. The ‘economic’ is thus a priori confused with ‘mercantile’:5 the Union must then ensure that the rules of free provision of service and of competition are respected. Thus, whenever a national authority has recourse to the SGI conventions with a private operator, the Union demands obedience to the rules of competition, but it does not have to monitor whether the operator assumes its share of public responsibility well. Furthermore, ‘social’ activities always have an economic cost and dimension. Education and health are factors of sustainable development, required by the Lisbon objectives. ‘Economic’ activities, such as telecommunications and energy, also have essential societal dimensions. Operators within the ‘social economy’ contest precisely this separation, and they wish to see the elaboration of a hybridization.6 SGIs as Part of a Constitutional Treaty For many years, civic and social movements have militated for a reform of the Treaties and European law. This concerns putting an end to the disequilibrium between competition policy – the exclusive jurisdiction of the Union, the exercise of which it delegates to the Commission, the executive body – and SGI policy, left to the member states. The Community can take ‘pressure action’ and, as we have seen, establish sector directives when it wants to remove obstacles to the creation of a single market. Given the diversity of national definitions, civic movements have chosen to privilege the perspective of fundamental rights: both the common institutions and the member states would then have to recognize SGIs as such at the level of the Union. This combat has been partially successful, since the Charter of Fundamental Rights (which recognizes SGEIs, but not SGIs in general) was included in the Constitution. However, this is not enough: there is law, and there is the reality or truth of law. In practice, Articles 95 (the internal market), 86 and 87 continue to apply. Civic movements have wished to reform these as well. More precisely, they have sought: (1) to achieve the recognition of SGIs as fundamental objectives of the Union; (2) to consolidate Article 16 of the Treaty of Amsterdam, very ambiguous, but which recognizes the need to guarantee SGEIs; and (3) to modify Articles 86 and 87 in such a way as to ensure the financial and economic conditions necessary for the viability of SGEIs.

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The fight is not yet over on points (1) and (3). However, the Commission has accepted point (2); it is proposing to the European Legislator the clarification of the principles and conditions which guarantee the operation of SGEIs. Let us hope that the Intergovernmental Conference will not suspend the new drafting of Article 16 of the Treaties. The European Legislator will then be able to take up its responsibilities. A framework directive or a legal framework under the co-decision procedure might take as its ambition: the clarification of the definitions of SGIs and SGEIs; common principles for the obligations and for the conditions of operation and development of SGEIs; the putting into place of European regulation and of joint financing tools when this is necessary; and the organization of a democratic evaluation method in order to judge satisfactoriness and effectiveness. However, the concretization of community responsibility will take a long time. For the last ten years, civic action seeking an opening in European law has in fact privileged the perspective of the protection of local, regional and national SGIs. It has striven to increase their guarantees of existence in the face of competition. This is desirable, but the risks must be considered too: it must not be to the detriment of cross-border exchanges and of the ambition of a real Community. Furthermore, the explicit setting up of European public regulation under democratic control for cross-border networks has not yet been achieved. In reality the breakdowns and the serious problems for energy and transport call for policies; yet the current sector directives, whatever their quality and audacity given the political context, are way below future needs and lack operational levers. The major political problem is the co-responsibility to be achieved between member states and the Union. It is necessary to clarify, or get beyond, the sacrosanct principle of subsidiarity, according to which decisions must be made at the most relevant level; this leads to defending the level closest to citizens, but also to hindering the emergence of European public goods.

DIVERSITY AND UNITY The Problems of Range and Distinction The field of SGIs can be large, as a number of services are judged to be essential, and thus are made the subject of missions and/or public regulation. Nevertheless, concrete definitions of SGIs are national, and states do not necessarily agree on them. Additionally, to obtain community recognition, there first needs to be agreement on common principles. The European Legislator should state that the criteria that make up the base of a positive right in the member states are recognized by the European Union, and


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cite them: they concern universality and equality of access, quality and efficiency; they are calls to solidarity, inclusion and participation. In such a way, all SGIs are calls to non-market principles (sharing, universality); when they also call upon market principles, there is a political obligation to work towards rendering the market and the public good compatible. As has been seen, the Treaties mention only SGEIs, leading to an inevitable distinction between economic SGIs and all the others. This has important implications: SGEIs are subject to the rules of the internal market and competition; other SGIs are not. The problem is that in reality the situation is often (or at least becomes) mixed. All SGIs have a cost; all SGEIs must be the subjects of missions and public supervision. I propose keeping the principle that fundamental SGIs be excluded from the rules of the market and competition; whatever the case, however, the ‘others’ should not be subject to the general rules of the competitive market: the rules must be adjusted, specified, because they touch upon the domain of public goods. SGIs at the Heart of the State–Citizen Relationship The SGIs most fundamental for the human person and social inclusion (education, health, access to the labour market) have historically been organized by the nation state. The Union may only engage in complementary actions supporting those of member states.7 As long as the Constitution of the Union does not include the explicit sharing of values and non-market ends, this remains appropriate. However, one cannot stop there. If the aim is to make a European society and to build a competitive knowledge-based economy, it is necessary to have open education and mobility of training and employment capable of developing human capacities in the era of globalization. National educational systems must be opened up in order to multiply cross-border exchanges.8 In the domain of public health, national systems are already open and mixed, and this will become more marked with the development of private insurance. I formulate three principles: 1.

2.

primacy of the national social order should be reinforced: if the member state judges that an activity lying beyond the obligatory missions of public service should not be subject to the general rules of competition, it may do so (for example, continuing education, complementary protection); within the framework of cross-border exchanges, enterprises operating in these domains must assume explicit social responsibilities;

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3.


an action plan is indispensable for the development of European education, culture and lifelong learning, in order to lay the foundations for a European economy of knowledge and creation.

Local public services have been developed in activities as diverse as social work, culture, sport, urban transport, water supply, sewage and waste disposal. Associations of European communes are fighting for better judicial protection. These services involve two different judicial regimes in the Treaties: if they are described as SGEIs, they are subject to the rules of competition; on the other hand, systems of social security often involve national public order.9 I suggest, as above, strengthening the primacy of the national social order. One problem is the choice of operator. Territorial collective bodies can manage the service themselves (by administration, a mixed economy company, Stadtwerke, and so on). They can choose a private management, without the operator having any contractual tie to the local regulator. They can delegate the management (concession or farming out), but for a fixed term in a contractual relation. The private operator is charged with the maintenance of the public infrastructures that it uses to furnish the service, and sometimes with their construction. Attribution of the exercise right has a monopolistic character. The European Union intervenes, however, in the case of a change of choice, when the collective bodies invoke competition. Thus the rules of public markets apply in principle; the Commission allows concessions, however, on condition that the principles of publicness, non-discrimination and transparency are respected.10 Two problems arise. On the one hand, national local situations are very different, and there is no reciprocity in opening up to competition. On the other hand, there are enormous differences in the capacity and power of territorial collective bodies faced with market forces. The city of Helsinki has good mastery of its choices and partnerships with the private sector. French rural communes, on the other hand, find it difficult, given the lack of any decentralized organization of public economic authority. My propositions are the following. 1.

Recognition of the free regional and local administration, when it exists within the national constitutional order, must prevail at the community level. Nevertheless, the capacity of local collective bodies to regulate and monitor must be built when it does not exist. It is also desirable that the territorial collective bodies develop their cross-border relations. Delegation of SGIs is thus just one of the modalities of desirable exchanges.


2.

3.

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A right to auto-provision, that is to say, provision by local or regional enterprises, must be recognized by the EU, on condition that these enterprises do not compete on another territory (that is the German principle). However, one may request the periodic re-examination of these systems, even renegotiation, with the deliberation of the collective body. Judicial safeguards must be reinforced in the case of an appeal to competition. If a local authority chooses delegated management, the spreading of risks must be equitable. There is a need for a European law on concessions and public–private partnerships in order to frame the conditions of the awarding of contracts and of risk allocation, aiming at the quality of service rendered.

The Environment and Information Some SGIs (or SGEIs) handle and make available natural resources (the environment) and regenerate them. The organization of these SGIs is decentralized, and access is shared. Interconnection of these decentralized networks does not exist in Europe, and there are no specifically European networks. In contrast, European environmental law, which each member state is supposed to respect, has been highly developed. Let us take the case of water.11 Water is a natural resource, localized and required to be accessible to all (Courrier de la Planète, 2002). A non-market common good (drinking water is in the main outside the market), it is of course also an economic good, with a natural monopoly at the level of upand downstream infrastructures. In the EU, everywhere except in the UK, municipalities own the infrastructures and are responsible for their management. Management may be delegated to private operators (France, the UK). The EU has a mandate allowing it to develop environmental law (Article 174). It sets ambitious objectives for the state of water and the quality of drinking water. It preaches pricing equal to cost and the application of the principle that the polluter pays. Yet the EU has no mandate to make a single market. There is neither a European network, nor interoperability between basins, nor a principle of solidarity. The current management of water resources is a problem. There are big inequalities, great need of investment and lack of funding. Public–private partnerships (PPPs) are useful, but insufficient. They are characterized by weak participation, low profitability and deviation towards private management of a cross-border leasing type (with US penetration). Strong pressure is appearing for the application of competition policy in the water sector and for the extension of tenders to the private sector. This is not acceptable: the EU has not decided here to make a single market, and the fundamental role of public collective bodies must be preserved. On the

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contrary, to resolve the big problems mentioned above, one will need to work at a new mixed economy, with the will to mobilize investments and to organize infrastructure renovation. To this end, it will be necessary to put in place European taxation to feed a solidarity fund, to mutualize public guaranties, and to work out ‘good practice’ in the domain of PPPs with a view to creating a positive European framework. Similar issues arise when we consider the public good of information. Information is not a good that is destructible by its recipient; it is diffused and enriched by interactivity. For Thomas Jefferson, it constituted an archetypal public good. National public services in information exist, but the operators that handle and make information accessible are in the main market players. The Union regulates electronic communications networks, but, for content, it has only a complementary role administered by the Amsterdam protocol. Now it will be necessary to work at the creation of a basis of community action founded on cultural diversity and the pluralism of information. This is indispensable for the foundation of a European public space. As far as the economic dimension is concerned, freedom of funding by member states should be preserved. European competition policy should contribute to clear up the market and to favour cooperations of public interest. Active European Integration Networks SGEIs are furnished on the basis of big network infrastructures: energy, transport, telecommunications and the postal service. Often infrastructures are in a situation of ‘natural monopoly’. Non-market systems of security are necessary. Service provisions may be private or public, but they must be accessible to all. The EU undertook to build a single market of European scale. This is fully justified within the community perspective of economic efficiency, social cohesion and sustainable development. Since public goods are involved, however, specific regulation is indispensable; the competition rules must be adapted, and solidarities must be organized. The Union first took priority actions in the direction of competition: opening up of national networks to third-party service provision; separation of the operator and the regulator with the installation of national regulatory authorities. Then (at the end of the 1990s) sector directives wished to make competition effective, and they began to establish regulation. The sector directives want to ensure interconnection and mutual access to networks, whereas the national authorities and operators do not lend themselves to this without difficulty. They require the member states to supervise supply guarantees, urging them to invest if necessary. They require member states to establish obligations of universal service.


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However, neither the quality nor the viability of this regulation is well established. For many, it is a transitory phase, after which the market and competition will supply the rest. That would be to despise the lessons of economic history, including that of Anglo-American public utilities. To take up a notion already put forward by Augustin Cournot, network regulation should contribute to obtaining a surplus of collective utility: increasing the traffic and interactivity, integrating external effects, combating congestion, ensuring systemic security, and encouraging capacity development.12 We are far from having achieved this. Not only should the Union take on such regulation, but to build European networks (interconnections, rail and freight haulage, high-speed links, and so on) in order to achieve its development objectives, common policies will be equally necessary. They will target energy supply security and energy conservation, the flourishing of the telecommunications industries, the configuration of European transport space, and the modernization of the networks of Central and Eastern Europe, and so on. We shall later develop these issues of regulation and development. A network of financial services has been in the process of integration since it was decided to create a single financial market. Many countries enjoin on their banking and credit institutions the missions of SGIs and sometimes entrust them to public banks. Access of populations to tellers, without exclusion, and credit provision to SMEs, are de facto universal services. Specific financing arrangements for social housing, regional development and infrastructures are necessary given their weak profitability. Now, the EU wishes to mass-distribute financial services by including them in the commercial sphere. It requires the separation of SGI activities from competitive activities. It contests public guarantees. Germany and Austria have voiced their worries, and they are protecting their regional banks. The Union, however, has neither a concept nor a policy for recognizing the diversity of functions and the heterogeneity of organizations. I merely indicate the problem here, without developing it any further, but underline its strategic importance for the evolution of the European financial space. The approach that has just been proposed is one of diversity, in which the progress of notions and community interventions work according to different rhythms and outlines. Where is unity then to be found in such a plan? The answer: unity is not decreed; it is a social construct. Forming a society within Europe is the common motive; its expression must be different according to the area of public goods in order to respect local and national realities, and because opening up these areas demands that forms of sharing and solidarity be elaborated with prudence. The market is one of the dimensions of this opening, but it is certainly not the only one.

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THE PROBLEMS OF REGULATION AND FINANCING The central problem for SGIs is not only their compatibility with the market, but also that of quality and efficiency as regards their respective purposes. These dilemmas are the subject of ‘regulation’. The concept of regulation is borrowed from systems theory: it concerns the conditions of coherence and development of a system. Regulation should not be confused with specific rules or legislation: the management criteria of businesses and of funding, along with the nature of public incentives, are crucial. Defining Missions For the operation of SGIs, the national public authority defines Public Service Obligations (PSOs). ‘Universal service’ is one of them; it implies access for all categories of the population, including the ‘disadvantaged’, with the corresponding territorial coverage. Its definition is not a minor question, nor merely technical; it must invoke a broad civic and social dialogue, and its economic dimensions are ‘potentially explosive’ (Laffont and Tirole, 2000). This notion was first elaborated in the USA when Americans became aware of the bias of the classic liberal vision, according to which the function of redistribution should be handled directly and exclusively by the budgetary/fiscal route (see the old Atkinson–Stiglitz theorem, 1980). The notion of universal service answers social motivations, but also economic interests (augmenting traffic, yielding the scale effect) and financial interests (funding other than that from the general budget) (Laffont and Tirole, 2000). To work out the obligations, different criteria are required. ●

● ● ●

quality13 and continuity – one should attempt to found these on social dialogue, and to ensure over-capacity when necessary, to foresee guarantees in case of failures; equal access to networks and town and country planning; affordable pricing; adaptability,14 and so on.

The specification of obligations may be significantly influenced by economic considerations. Let us underline some of the problems in this area.


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Universal service and economic structure In the situation of a franchised integrated monopoly, universal service is provided by an entire system. When the structures are unbundled, it is defined on a segment. What value is universal service downstream, if upstream the system is disjointed (for example, British rail transport)? Universal service and its cost Today public enterprises must be competitive in the market and at the same time meet public service obligations (PSOs). They have great interest in seeing the charges associated with PSOs reduced. For example, the incumbent electricity provider wants to know why it should subsidize renewable energies. When public aid is provided, litigation proliferates: the market operators consider that the aid gives unfair advantage to public enterprise. In this context, the erosion of PSOs is a fundamental trend. The risk is the reduction of universal services to subsidies for the vulnerable and the targeting of difficult geographical zones. Should one allow the market to define the cost of SGEIs and limit oneself to the procedure of tenders? The public collective body thereby risks losing its powers of definition and control. It may be too weak to work out the expenses correctly, the elaboration of which will be costly, and which cannot be really configured for the long term. Nor can it anticipate the real costs and the consequences of public guarantees that it is called on to give. I would underline in particular the great difference between network maintenance costs and development costs. I am convinced that criteria of social effectiveness must be worked out for the implementation of SGIs. This would force an attempt to measure the real costs, external effects (and in particular the costs avoided), and to relate them to indicators of satisfaction (quality, access). ‘Affordable’ pricing The public authority should establish a price control mechanism. It might seek uniform pricing, allowing re-balancing over regions. It might wish that the tariff allow one or more benchmark operators to offer complementary services. At that point, however, the Union says, ‘Stop!’ The rules of competition intervene. A clarification is necessary for cross-subsidies. There ought not to be a general ban, but only in the case of dumping in favour of competitive activities.15 The monitoring should also not be done on a case-by-case basis, but within the framework of a price control mechanism. For affordable pricing, there are no common criteria yet. Postage stamps are the same tariff in Poland as in France (€0.46), whereas the Polish

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guaranteed minimum wage is one-third of that of the French. If the price is affordable in France, is it affordable in Poland, when it is relatively three times the amount? When the price of electricity increases by 40 per cent in six months in Finland, is it still affordable? In some cases, one is not far from complete price freedom, which the notion of accessibility claims nonetheless to combat. In order for a European notion of ‘accessible pricing’ to have meaning, each country must be able to measure and compare pricing not only in euros, but relative to purchasing power. A ‘benchmarking’ exercise on affordability would allow one to see that the costs differ widely according to the geography of member countries. To attempt to ensure an affordable common guarantee would involve a policy of territorial organization and solidarity among member states. The method of pricing Three formulae are possible: the ‘price cap’, re-balancing, or subsidy. When monopolies are suppressed, the price cap is no longer possible. When structures are unbundled, price volatility appears. In its Green Paper on SGIs (Commission Européenne, 2003), the Commission suggests that the Union define (for example in a framework directive) common principles for the definition of PSOs. This is partially the case in several sector directives (telecommunications, postal service, electricity), where it is said that member states ‘may’ impose PSOs, ‘take care to’ ensure universal service, and take appropriate measures for vulnerable populations. The operational scope of these texts has still to be tested. Their impact may be real (see, for example, the universal service required by the Electricity Directive). Directives may strengthen the judicial safeguards of the choices of member states, in particular, that of the funding allowed under a derogation from the rules of competition (back-taxes, protected sector, and so on). The elaboration of common principles must avoid two snares. ●

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Universal service should not be separated from other more or less vague and non-binding obligations. The PSOs for the activity of an SGEI form a totality which must be coherent. Universal service is provided on an (some) infrastructure(s); its quality depends on that of the network, interactivity, and especially the systems of security of supply and operation. The social, economic and ecological aspects should be meshed together, not dissociated. All the evidence is that the definition of PSOs is in no way independent of the pressures of competition and cost considerations: it is better to recognize this fact.


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On the other hand, care should be taken not to restrict the notion of PSO to individuals alone: the SGEIs are just as necessary to enterprises, in particular to SMEs and tradespeople. If common principles are legitimate, a centralized definition of PSOs, in general, is not. It is only acceptable in specific form to achieve cross-border exchanges and the development of interconnected networks. Thus the sector directives on energy require security of supply in general. A specific ruling also bears on the cross-border pricing of electricity (Merlin, 2002). In order for integration to develop genuinely and swiftly, the role of the Union in defining and monitoring obligations must be expanded. Member states are already being asked to establish a programme of investment in network industries. However, the constraints weighing on public finances play against this, and it is hard to see how these recommendations could take effect without real industrial policies. A comparison of the quality and efficiency of SGIs among member states would be useful. This implies creating a European observatory and giving it both a mandate and the financial means to carry out its work. A process intimately associating communes and regions, and largely open to civil society organizations (operators included), would make it possible to build mutual knowledge and understanding. ‘Consumer protection’ Our societies are victims of the excesses of consumer culture. When the obsession to buy at least cost, at guaranteed quality, takes over, one risks neglecting the essential pillars of life in society. In effect, one must first be able to work and produce in order to consume. In particular, this implies the development of human capacities, with access to essential services without exclusion. Public goods are crucial, not only for the ‘consumer– user’, but also for the collective conditions of development. They have a cost. It is also worrying to observe that powerful European consumer associations do not want European legislation for SGIs, because these associations promote competition. In terms of social cohesion and sustainable development, the effects of legislation are problematic. The external effects are not taken into account. It seems important to us, therefore, to underline the duties in the domain of SGIs and not just the rights of consumers. European Projects of General Interest Harmonizing the principles and missions of SGIs is all very well, but the Union should not stop there. It must open itself up to the prospect of creating specifically European public services. Projects of general interest are a first step.

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On the initiative of Jacques Delors (European Commission, 1993), 14 projects of transport infrastructure development of common interest were defined at the Essen Summit (December 1994). Almost nine years later, only three have been completed, and two have not yet been started (European Commission, 2005). For rail and cross-border links, the blockages are the clearest, despite the increasing congestion of heavy freight traffic and 20 per cent overloading of railways. ‘Intergovernmental cooperation’ is failing. A member state does not pay outside its territory, even if it benefits indirectly from the effects of the project. The trans-European network project cannot be built by the juxtaposition of national projects. This is why a work group presided over by Karel Van Miert has proposed the following alternative method. 1.

2.

3.

The European Union defines ‘community interest’ with precise criteria: increase in traffic, capacity, interoperability, re-balancing of modes, contribution to cohesion. It chooses projects which will receive the European label. A few examples include: Galileo, the Rhein– Main–Danube connection, main sea routes, the central crossing of the Pyrenees, and so on. Community funding for community projects – and no more superficial, haphazard allocations to projects which remain in fact national. Financial engineering will appeal to the EIB (European Investment Bank) and to guaranteed funds for public–private partnerships. Community guidance/piloting for community projects. Coordination is necessary to ensure that all the segments come into service simultaneously. A manager will be designated for each big axis. European project companies will be formed for cross-border projects. Public utility and environmental impact enquiries will be community-wide.

The method thus allies the participation of players in the field with the central community initiative. Apart from transport, one could imagine its application in many other sectors, and in particular non-market sectors (education, health). The Choice of Operator The Treaties include a principle of the Union’s neutrality regarding the domains and status of SGI operators (Article 295). This principle is justified, because it expresses respect for the freedom of choice of national and local public authorities. However, it is insufficient when liberalization and competition no longer allow for unilateral state choice. In fact, it also appears fairly hypocritical regarding current practices.


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Evidently, historic public operators are the targets of competitors, but also of the Commission. In particular, public aid policy reduces the possibilities of the state or territorial authority as shareholder (Article 87 is in contradiction with Article 295). The Commission extends the notion of aid to practically all the specificities of operators, when their domains or tutelary charges are public: guarantees, reputation, safeguards relative to bankruptcy risk, and so on. Moreover, the possibility of local collective bodies turning to ‘enterprises’ such as mixed-economy companies or not-forprofit organizations is called into question by the rules of public markets and requests for tenders. There are grounds, therefore, to question the damages to which public and hybrid operators are exposed and the threats to their future. In order to reconcile the choice of public authorities and the requirement of fair competition (‘level playing field’) among market operators, the Union invented the principle of the ‘informed investor’. When it finances or goes guarantor for an enterprise, the state–shareholder must act as do private shareholders. Otherwise, this ‘aid’ is judged as potentially impeding competition. Matthew Parish (2003) has torn this principle apart. It is subjective: which private investor (are they not all aiming for money?)? It is absurd: the motivation of the state is not that of the private investor. Parish suggests abandoning the principle of the private investor, considering public enterprises as not part of the state, and attributing to the state just those of their activities directly linked to PSOs. However, this judicial solution, which still separates the general interest activity from the commercial interest activity, seems insufficient faced with more complex realities. On the one hand, it is undeniable that the historic public operators used comparative advantages to dominate the competition: the case of EDF is known all over Europe. On the other hand, it is nevertheless abnormal for private operators not to contribute to functions of general interest in a sector of general interest. For example, why should express mail not contribute to the costs of the universal postal service? Funding requirements increasingly push states to turn public operators towards financial markets. Only enterprises with an open capital structure can avail themselves of this option. Is privatization then desirable and inevitable? One cannot remain indifferent to the failure of railway privatizations, nor to the fact that the market does not undertake the financing of missions of general interest. The Union must offer a new interpretation of ‘neutrality’, making way for diversity oriented towards social effectiveness. It should not leave states to manage for themselves. When an operator has to accept a subnormal profit rate, is subsidy the only possibility? Does an ethical operator, which pays its shareholders less, distort competition? How should one underwrite

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the activity of mutual societies and other enterprises in the social economy, which are in the market, but use different criteria and different modes of governance? The Union should favour the promotion of Europe-dedicated hybrid operators. Hybridization preserves the social motive, and demands at the same time an effort at efficiency. Hybrid financial institutions are needed to undertake functions of general interest – for example, specific funding for affordable housing, SMEs, territorial development – and which will enter into partnerships with the operators of SGIs. An economy of cooperation must emerge clearly against the unilateralism of competition: it is known how necessary it is to share resources and infrastructures between operators, in order to reduce the fixed unit costs of research and development, instead of prioritizing consolidating mergers designed to take control of assets developed by others. Public–private partnerships (PPPs) are one form of the desired hybridization and cooperation. Neither public markets nor privatizations, they express a stable relation of general interest between public authorities and private agents. This is not about a miraculous solution in the face of the lack of public resources, but about increasing social effectiveness and developing transnational links: in this sense, PPPs have a great future. The possible, and current, configurations are many, and an evaluation of the various experiments is still outstanding: both the successes and failures are spectacular. Three broad issues are distinguishable. ●

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The working out of the project and contract. There are large imbalances between the project managers: large towns can dialogue with big firms, but the rural milieu lacks the necessary tools. An intercommunality capable of consultation and negotiation is indispensable. The first generation of PPPs concerned the easiest projects: roads, with state project management. It is more difficult for railways, and still more difficult for the environment. The lack of human resources is also patent. Risk distribution. For example, Thessalonique guarantees a volume of traffic adequate to remunerate the metro operator. Transfers of risk to collective bodies can be very heavy. However, they are also familiar in the private sector (see the deficits and debts in Argentina). Financing. Rather than resources, the operator brings a financial service and an aptitude for cost reduction (notably for the operation of works that were over-sized). Given the difficulty of financial engineering, purely financial operators are even appearing. For funds, it is necessary to tap the financial and credit markets. Yet, who will bear


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the debt? The state does not want to increase the public debt; international accounting standards discourage leveraging the balance sheet. Securitization is a future avenue, which allows risk spreading at the international level (and if possible not suffocating countries wishing to catch up their developmental lag). Most often, subsidies and public guarantees are necessary. For example, the Figueras–Perpignan rail concession calls for a guarantee against loss of revenue if the Perpignan–Nimes section is not finished. National and community classical budgetary frameworks, however, are not designed to handle this. In particular, extra-territorial effects must be considered: member states finance internally, but the benefits may be external. For example, 80 per cent of Brenner heavy freight traffic merely transits through Austria. New community tools must be conceived in the knowledge that current funds can only be injected into programmes co-financed by states and with a limited time-horizon. The emergence and cooperation of the project carriers are the priority issues – something that underscores the challenge to decentralize European participatory democracy. There are not just two, but at least four, partners: civil society, public authorities, operators, and financial investors. Public–private separation is a general obstacle. The theory of effective and equitable risk distribution also remains to be worked out. Financing SGIs16 State aid is an essential form of funding for SGIs. To monitor the grant, the Commission uses a proportionality principle. The idea is that PSOs create supplementary costs relative to the market. They must therefore be compensated by financial assistance, but just ‘compensated’, otherwise competition is distorted. However, PSOs do not just create supplementary costs; they engender considerable cost savings for other activities! To insist on capacity reserves for electricity has a cost. Yet, if there is under-capacity at a peak point, the induced costs may be ten times higher. Of course, national aid can be ‘exaggerated’ when it serves a national champion in competition, whence the need for a common base so that aid financing is both sufficient and equitable. How should the attribution of special rights and state aid be framed? When and how should the Commission judge the rationale? The solution of Advocate General (AG) Tizzano (Ferring ruling) was: the state need not notify the financial aid up to the point where it corresponds to a (net) excess cost of the SGI relative to the market price. Problem: if there is litigation, the validity of the calculation has to be analysed (and with which model?).

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AG Léger refuted the arguments of the Ferring ruling, underlining that the state does not ‘buy’ an SGI, because it acts with motives proper to the public authority. According to him, notification is necessary – unless the Commission passes an exemption rule (based on Article 87). The Altmark ruling of July 2003 confirmed the Ferring ruling. The Commission immediately announced the elaboration of a rule. On this subject, in the current Treaty framework, the Legislator is merely consulted. The Legislator may wish to have its say: it can write in the proposed framework directive that aid for SGIs is not state aid in the sense of Article 87. This aid need not, therefore, be notified, but, since SGEIs are involved, should nevertheless remain proportionate. In any case, litigation concerning the aid/costs relation will continue. Europe should try therefore to adopt common positions on the ‘right’ models of cost calculation. It is not a simple matter. Currently, operators are obliged to produce cost accounts, and states can choose their calculation model freely. However, when there is interference with cross-border competition, how should one arbitrate? Uncertainty about the ‘right’ model is evident in the case of Deutsche Post: it was found guilty on 20 March 2001 of abuse of its dominant position, and on 19 June 2002 of illegal state aid; the judgments were based on two different cost calculation models. The problem should not of itself lie in the excess of aid relative to the ‘cost’ (remember that external effects are seldom properly evaluated), but in knowing whether it goes to finance an abnormally low price (or ‘eviction price’). A powerful operator combining a dominant position with competitive activities can practise low prices in order to eliminate its competitors. Having shown that tenders for an SGI are not a miraculous formula (‘no need to calculate costs anymore: the market is the benchmark’), Laffont and Tirole (2000) emphasize that the ‘proxy models’ aiming to estimate the cost of universal services must consider a mass of elements (among others: what is the relevant geographical area?). They produce ‘strongly divergent’ estimates. However, if the EU claims to examine the rationale of aid, then what is the legitimacy of its reasoning? Operators can themselves contribute to finance SGIs. Auto-financing is one option. This depends on the pricing policy of the public authority. When there is a public monopoly, the authority encourages it to lower costs while ensuring its functions. It has used systems of cost-plus and then price caps.17 These are not without their inconveniences, given the ‘asymmetry of information’ (Laffont and Tirole, 2000). Inasmuch as the firm benefits from profits, it incurs losses. In this way, the regulator possesses discretionary power over profitability. Overly strong incentives to reduce costs create problems for quality. In the UK, it was necessary to introduce quality


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requirements at British Telecom, faced with its deterioration; the same story unfolded at US West. With liberalization and unbundling, recourse to price caps has diminished, but it becomes necessary to establish network access charges. The stakes are raised because of their weight in the total cost, and the negotiations are bitter: how should access of competitors be encouraged without shafting the historic operator? The dominant paradigm is the price of access at marginal cost (average incremental cost). This raises two major problems: high fixed cost networks would never have been built if their owners had only been able to price access at marginal cost! The calculation of marginal cost also gives a discretionary power to the regulators. For networks with a monopoly (electricity, gas, railways), the EU nevertheless uses this benchmark of average incremental cost (cost of transport). For networks without monopoly, it uses the ‘stand-alone cost’, in order to encourage the construction of new networks (including the construction cost of an identical new network keeping the technology constant). The importance of the choice of model of calculation and the possible contradictions between ‘fair competition’ and industrial development are clearly visible. Litigation often bears on the cross-subsidies at the heart of an operator. Cross-subsidies should be allowed when they transfer resources from market activities towards SGI obligations. The future, however, lies in mutualizing resources among a plurality of operators. SGI funds supplemented by the operators are desirable for sharing costs and risks. That being the case, when it involves making competitors pay the specific charges of an operator, litigation leads to an erosion of funds (cf. the questioning by the Union of the funding costs of the universal services provided by France Telecom). For electricity, David Newbery (2002) proposes that one choose between two solutions: (1) one operator guarantees capacity, while its over-capacity is paid for by its competitors; (2) all operators must have over-capacity; otherwise, licences are revoked. A similar problem exists for mobile telephones, in respect of total geographical coverage. The Union has no policy for financing network development. In part, this is a consequence of the predominance of market ideologies which aim at the least price without concern for capacity development and cohesion; another factor is the lack of specific political and financial tools at the Union level. Nick Hartley has analysed the recent English experience and the problem of the lack of investors. Given the amplitude of the fixed costs and the

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uncertainties of profitability, the responsibility of investing cannot rest with operators alone. Hence regulators have sought to lessen the in situ rents and costs, even if it means lowering the incentive to invest. The takeover by privatized firms has worked in the same direction. The introduction of markets brought price volatility with perverse effects. An operator can increase its profits by congesting the network. It cannot respond to price signals, due to interconnection. Thus the precautionary principle has become a priority exigency, following the rail accidents in the UK. Regulation by output (results) has been replaced by regulation by input. That means regulators interfere with the management of a firm to push it to invest. Paradox: this meddling is stronger than in the past. The Blair government has even created a Strategic Regulatory Authority that has put Network Rail and the ORR (the railway regulator) under tutelage. The EU now recognizes that multi-annual programming of investments is necessary, for example, in energy. However, it does not have the necessary authority. What would be the political objective? Self-sufficiency? Export capacity? What would be the relevant spaces? Common policies are clearly necessary, for national solutions will be much more difficult: it is hard to imagine a second exclusively state-sponsored programme for French nuclear power! Some economists have wished to ‘remove’ from the rules of the stability pact the public investments necessary for the success of the objectives of the Lisbon strategy. The Council of Ministers has refused. This being the case, the problem is more complex for projects of general European interest. The group coordinated by K. Van Miert estimates at €235 billion the funding requirements for urgent and priority transport projects between now and 2020; it estimates €600 billion for the projects of the overall scheme. The chosen approach is to tap the financial market, via the EIB in particular. However, even concentrating public funds and taking account of their credit leverage, the resources currently planned are insufficient. The Directorate-General for Energy and Transport is asking for a doubling of community funds and the setting up of a mutual fund of guarantees. The EIB would be able to create a specific structure that would repurchase and guarantee loans of national financial institutions, and would issue bonds on the market. Beyond the EIB, the question of the roles of financial institutions should be re-examined. They are directly affected by SGIs, and they have a specific function in PPPs: as soon as long-term infrastructure financing is required, credit is necessary, and a lender of last resort will be necessary. The last communication of the EU on these questions dates back to 1998, following concerns expressed by the German and Austrian banks. Since


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then, nothing! However, the EIB and the EBRD (European Bank for Reconstruction and Development) will be unable to play their part if the financial institutions do not enter into public–private partnerships and, more generally, into the dynamics of general interest projects. European Regulation of Networks Since networks were involved, national public service enterprises in a monopolistic situation took on this regulation. This is no longer the case: to build a multinational competitive market space requires the separation of the functions of the operator from those of the regulator, and the creation of ‘independent’ regulatory authorities. Regulation, in this context, has several functions (Helm, 2001). ●

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It aims for effective competition at the levels of production and provision, by endorsing separation and mutual access to infrastructures. However, it must take care not to sever coordination and safety in the functioning of networks, and to encourage their development. It must guarantee territorial and social cohesion, and in particular re-balancing, by adequate pricing of natural monopolies and the installation of mutual funds. It must watch over the environment, particularly by taxation and incentives up- and downstream of the networks.

The concept of ‘regulation’ is only just in the process of formation. Its development and validity will require both input from recent economic theory and public endorsement. Current economic theory struggles to interpret concrete experiences, and the doctrine of ‘good’ regulation are far from stabilized. Pointing out the contradictions and dilemmas, the contributions of modern economic theory are nevertheless thought-provoking, and serve to alert the Commission and the Legislator faced with the risks of choices that are more opportunistic or ideological than founded on ethics and rationality. For example, the policy of competition imposes a functional separation within the networks of SGEIs. Certainly, the separation between infrastructure and operation is justified within the perspective of the broad market, on condition that safety is ensured. However, are the splitting of the functions of distribution, and the introduction of volatile markets at the level of commercialization, well founded? Should the EU go beyond separation of accounts? Should it ensure reciprocity of access? David Newbery, one of the best-qualified economists in this area, has asked: does an unbundled structure permit a stable equilibrium or not? The crises of

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the US electricity grids and British transport systems make this seem dubious. In the future one may be forced to return to more integrated systems. When security is at the level of systems, regulation cannot be confined to those segments in a natural monopoly, and sufficient incentives are necessary for investments in reserve capacity. Should guidelines not be worked out for the choice of structures? Newbery underlines two very difficult tasks: decentralizing the dimensions of a public good (security, adequate capacity); and channelling market forces (revising anti-trust laws in response to the rising power of oligopolies). Which method should be chosen for the European regulation of networks? Member states have begun to put in place independent regulatory authorities, not without great differences. For example, Germany wants to keep its informal methods of co-determination. Others, such as Sweden, wish to limit themselves to ‘transparency’, and so on. The British system, put in place since the mid-1980s with important successive adjustments, has tended progressively to become the benchmark in Europe. The public authority determines the PSOs and general rules; a regulator is put in place in each SGEI sector; it is consulted, and it applies the rules. Evaluation of the national ‘model’ has not yet been undertaken. Moreover, forms of cooperation exist at the European community level: between the operators in a sector, the regulators and national administrations.18 European agencies invested with specific functions (aviation safety, railway safety) have also been created. However, cooperative procedures have little operational effect, and the national regulators do not possess the competence to conclude binding agreements with their counterparts. This is why the usefulness and possible forms of European regulatory institutions are being debated today (Stoffaës, 1996). A European regulator will not replace national regulators, for national markets will endure. This is true even in telecommunications, where the local dimension gains in importance. However, a European regulator can, in a complementary way, lift obstacles to cross-border exchanges, and handle issues of territorial and social cohesion and development judged of general European interest. It should place the national actors in emulation with each other and in ‘strengthened’ cooperation. Remember that for competition policy, national authorities still exist, but are subject to federal rules and a federal authority (the Commission). By comparison, the national sector regulators have more latitude. The Commission has a vocation to become fully a European Regulator, but through respecting a legislative framework better founded than the one that exists today. The Commission has, as yet, neither the capacity (few forecasting and econometric tools) nor the legitimacy required for such a function.


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Progress might take place along the lines of the ‘Lamfalussy’ method implemented for financial services. A European Committee of national regulators could be formed in each sector, consulted by the Commission, and involved in the measures of application of the directives. The European Legislator would decide the rules on the basis of the propositions of the Commission. However, it would better control their implementation by having at its disposal power to ‘repeal’ (the capacity to go back on the rule and its application in light of experience). National parliaments would be consulted. In this way, the European Regulator would be constructed cooperatively. It could rely on specialized technical observatories and agencies. Numerous ‘market failures’ show the inadequacy of current community mechanisms (procedures for the attribution of UMTS licences, weakness of electricity interconnections and pricing problems, deficiencies of interoperability and safety). If the method of strengthened cooperation described above were not enough, then one would need to aim directly at the creation of European sector authorities. The telecommunications sector (for satellites, licences, frequencies, and so on) is one example. However, in my view, the ‘independent’-agency approach should be rejected, and we should strengthen democratic control. Evaluation: a Democratic Challenge The evaluation of the implementation of the obligations of SGIs cannot be reduced to consumer satisfaction polling (of the Eurobarometer type). It must possess indicators of quality, cost and effectiveness, and it must scrutinize the policies of the Union. It should set an example of participatory democracy, which in my view is one of the characteristics of public goods. Currently the Commission itself is handling the evaluation of the state of things, sector by sector. Judge and plaintiff, it considers that there is no problem of compatibility between competition and SGIs. It is unacceptable to leave to the Commission such a monopoly: evaluation must involve the member states, the Legislator and civil society. I propose that evaluation be placed under the responsibility of the European Parliament (cf. the Langen Report and the resolution of November 2001, European Parliament, 2001). It would organize the debate among the different existing and future observation sites. It would draw support from the elements furnished by each member state. Valuation is essential, particularly for calculating costs. As long as the Commission does not possess this capacity, it is making decisions with models that have not been validated publicly. The Court of Justice charged with legal determination is also ruling on scientific questions on which it is

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not qualified. I advocate the creation of an Office of Economic Calculation and Forecasting for SGIs and suggest that it be situated within the European Parliament. It would examine the relevance and the coherence of the criteria of competition policy and regulation for the working of SGIs. It would establish forecasts, currently lacking, for the funding and development of SGIs. Of course, evaluation should not be only transversal, but also sectoral. To this end, the creation of European observatories is indispensable. The Commission does not even have a permanent working group for SGIs. I propose setting up a management team for the legislative and financial programming of services of general interest.

THE COHERENCE OF INTERNAL AND EXTERNAL ACTION Is the WTO a Threat to European SGIs? In its internal policy, the EU must overcome the contradictions existing between the offensive interests of each member state (supporting nationally based firms in competition) and the general interest, which requires the guarantee and promotion of essential services. The same type of contradiction is to be found at the heart of trade and external economic policy: between the interests of the Union, be they offensive or defensive, and the values that underpin what it designates ‘non-trade concerns’. These contradictions are normal, but their resolution through a coherent policy is difficult. Since Seattle, the mandate for the trade policy of the EU has been to seek coherence between our interests and our social choices, for ourselves and also with respect for the choices of others. Nevertheless, the violent critique of liberal globalization and the WTO is accompanied by a profound mistrust of EU action. The GATS (General Agreement on Trade in Services) signed in 1994 opened negotiations which are still ongoing. Do they threaten ‘our’ SGIs? In principle, yes, since liberalization sweeps away any contradictions with the regulations in force – if not de jure, then in any case de facto. However, for Europe, these risks are still largely potential – except in the vast field of information – since external firms have few dominant positions within European networks. For the moment, liberalization is advancing, more quickly at the core of the EU than at the core of the WTO. The threat to public services in Europe is essentially of an internal nature, and that is why, as we have seen, it is necessary to make the effort to truly share values and objectives, abandoning formulaic incantations, and to build common


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guarantees and regulations. Then the EU – aware of its own social choices – would be able to go forth to negotiate elsewhere, stronger, more united and in a more fully coherent way. The mandate of the EU negotiators at the WTO is to develop trade in services where the EU’s ‘offensive interests’ are powerful, but respecting the PSOs decreed by the member states. The Commission is sticking to its ‘mandate’: after Doha, it made no offer of liberalization for the excluded sectors (education, health, culture), and it detailed precise restrictive clauses to protect the SGEIs of member states. Of course, it must next take account of the requirements of other countries. However, beyond that which the EU has abandoned under US pressure – telecommunications, financial services – these requirements are currently pressing neither for the classical SGEIs (where the fixed costs are considerable and where, at the WTO, one is still at the classification stage), nor for the predominantly non-market SGIs. In any case, the negotiations do not require reciprocity of commitments (one party can reject or restrict opening up, the other not), but in fine a principle of non-discrimination (whatever has been opened up should benefit all the members of the WTO). Let us remember that firms cannot take complaints to the Dispute Settlement Body (DSB): only states can do that. Certainly, market pressure is progressing, also in the ‘excluded’ sectors, via liberalized segments (such as the diffusion of films and television programmes, and in the future parts of higher education and life-long training); this is due not so much to the WTO, however, as to the EU’s deficiencies of internal regulation and industrial policy in the new domains of information, where, moreover, the EU admits its inability to work out its objectives. The Interests of the Countries of the South The coherence of EU international action concerns others too, especially the countries of the South. There, too, the mandate is right: link trade and development. In addition, the action of the EU at Doha, led by Pascal Lamy, has contributed greatly so that the roadmap for the negotiations should be a pro-development agenda. However, first of all, there is the South and there are the southern countries: differentiation is necessary. A mass of countries call themselves ‘developing countries’, but what do China, India and the African countries have in common? Certainly, the category of ‘least developed countries’ exists, and its number has increased over the last 15 years. Yet what should one say of other countries, vulnerable, or regressing, like Argentina? Special Differentiated Treatment (SDT), a priority in the demands of the

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South, stumbles on the eminently political problem of differentiation. One cannot say, however, that the EU is agog to pose it, and SDT is nothing more than a huge business of delays and derogations in the face of the rules of free trade, whereas we should be thinking more fundamentally of positive discrimination in order to deal properly with the inequalities (the EU has made a start as regards access to its markets). Many questions concern EU requests for liberalization in the direction of the countries of the South. Far from demonizing these countries, we must be attentive to the fact that a number of them do not possess public services, and not having the capacity to build them, appeal to foreign private investors. I was able to witness at Porto Alegre that the rallying cry of the social movements of the South is not ‘no to the dismantling of public services’ (happening in the North) but: ‘we want quality public services’. This leads them to accept foreign direct investments, on condition that these be viable and that the firms be committed over the long term and respect local obligations. I agree that investment should be partially integrated in multilateral trade negotiations, taking account of the intimate link frequent between investment and service; it is also because, otherwise, this link is treated within bilateral agreements, where the asymmetric pressure of Northern giants on weak Southern parties is strongest. However, it would be fair to support the vindication of the countries of the South, for which the construction of publicly regulated political space is a prerequisite to liberalization. They should be able to establish rules and restrictions before the establishment of the multinationals. Next, equitable rules are necessary for public–private partnerships involving civil society, financial companies and operators, and local authorities. Everyone acknowledges the difficulty of a stable relation between enterprises and these countries. Public guarantees are necessary, and the accountability of the financiers equally so, in particular for debt sharing. Let us take an example: EDF should remain in Latin America, otherwise there will be regression in an essential service, but who will pay for the deficits? If it is EDF, then it is taking a high risk for its competitiveness in Europe. Multilateral or regional public guarantees must be invented; and to this end it is necessary to mobilize and rethink public aid (for example, the mutualization of resources in re-balancing funds). Social accountability of firms, sharing of guarantees, aid to endow local authorities with regulatory and institutional capacity: that is the future. It is better to launch these processes before a weak state liberalizes, that is to say, opens up its space in order to avoid taking excessive risks. Further, liberalization, knowledge and technology transfers and poverty reduction programmes must be articulated. GATS negotiations must be


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tied to capacity building and essential services, involving the World Bank and the IMF. They are beginning to understand that the quality of public institutions is a key question for development. Despite this, they still favour free trade and the short slogan ‘aid for trade’. It must be admitted that the European Union has, to this day, neither the concepts nor the mandate to help the countries of the South to acquire public goods, neither within a regional framework (typical examples: south of the Mediterranean, the Middle East, Africa), nor at the world level (Kyoto and Johannesburg are just early sprouts). The WTO and International Public Goods The system of the WTO must itself be questioned as regards the issue of essential services. To emphasize that the WTO does not interfere with national or other regulations, the European Commission reminds us that it is not a place where regulation is negotiated, but a place where offers/requests are presented. Each member state specifies its commitments to the GATS (positive lists), and it can establish restrictive clauses: if a state wishes to protect its internal organization, it details how it limits or denies ‘national treatment’ accorded to foreign competitors. This being so, we should examine the difficulties further. The WTO defines public services narrowly (in terms of sovereign rights), which forces states to add defensive clauses. However, the most vulnerable do not necessarily have the strength to conceive and apply them. On the other hand, the WTO, in the name of the elimination of trade barriers, is necessarily led to question certain dimensions of the internal regulation of member states, such as public markets and subsidy regimes. Finally, the combined pressure of the USA, the EU and other heavyweight bearers of ‘offensive’ interests works in the direction of liberalization and not toward the protection of internal rules – except when it suits the heavy-weights. From that point of view, the agreement on Intellectual Property at the WTO is typically a protection of the strong and not one of free trade. Certainly, the principle of such protection is justified economically. However, one could at least imagine that a contradiction might be managed with a different principle, just as legitimate – that of free access to knowledge, considered as a public good. Recent studies emphasize that those systems of protection are not adapted to the new challenges of information technologies, software and biotechnologies (Tirole et al., 2003). They argue that the state should play its role of regulator, in order that patents on ‘essential facilities’ should not damage research and the diffusion of innovations useful to the whole of society – to developing countries in particular. The latter are asking for the reopening of the

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agreements negotiated in 1994 when they could measure neither their scope nor their impact correctly. Strengthening multilateralism, and therefore the WTO, is necessary, but it will require a revisiting of the strict separation between liberalization and regulation (referred to the member states) and a start on their articulation. This will accentuate even more strongly the necessity of democratizing the system. This exigency is first the responsibility of the European and national institutions, where the powers of those elected and of civil society in the matter of trade policy are particularly weak. The EU has ground to make up towards a united external trade and economic policy, under democratic control (Lamy, 2002). At the level of the WTO, which is more transparent than bilateral relations, what is manifestly missing is a permanent forum and a space for research and plural scientific debate (Ostry, 2002). The consultative authority of civil society and of elected representatives also remains to be built. Thus within the EU itself, as far as the public domain and participatory democracy go, the essential remains to be achieved.

CONCLUSION Throughout this chapter, I have avoided opposing one ideology against another, the market against the state. Experience has shown the extent to which market fundamentalism coexists with the obsolescence of statism and the weakness of democracy. I therefore sought a dynamic for reinventing the public good, which calls for the articulation of the role of public authorities, that of operators and the rules of the market. I do not want to trivialize the distinction between public and private; rather, I wish to give new meaning to the two spheres and facilitate their cooperation according to higher social conceptions of the common good. This new ‘mix’ poses an immense challenge for economic globalization that is inclusive, and thus accepted. As it has been in the past, Europe is being called upon to set an example.

NOTES 1.

And in particular on the current debate on my report to the European Parliament on Services of General Interest (SGIs) (Draft report Services of General Interest in Europe, PE 323.188/DEF; INI/2003/2152).


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2.

Let us recall that the Greeks distinguished private goods and public goods – at the heart of the city the latter concerned the political sphere, considered the most noble activity encompassing all others. 3. And that of the network of associations, Confrontations Europe. 4. The Commission’s Green Paper acknowledges ‘the impression of disequilibrium’. 5. See, for example, the ‘Non Paper’ of the Commission’s GD on Competition, November 2002. 6. This presupposes the sweeping away of the ill-conceived notion of a ‘third sector’. 7. See Articles 149 (education) and 152 (public health). 8. In the domain of distance education, the EU insists on the distinction between freely provided services, which are the object of national obligations of public service (alone capable of being subsidized), and those which involve the competitive sector. It does not establish common obligations for the private sector. 9. The case of social housing is particularly interesting. ‘The character of general interest of housing lies less in its patrimonial dimension than in the conditions of its use’ (Ghekière, 2003). The interpenetration of the social and the economic spheres is evident. Community law is not yet able to recognize this specificity. 10. A tender must be published, and in negotiation, candidates must be treated equally. The territorial assembly must endorse the candidate selected; the contract terms are limited. 11. There is an overlap in my typology between local public services and environmental services, and, moreover, between all categories, without my distinctions losing their relevance. 12. For example, to ensure the continuity of electricity supply, over-capacity is necessary. 13. Within the European Union, only the Post Office and Telecommunications directives are based on this. 14. This criterion appears in the 2nd Telecommunications Packet: a non-universal service can become universal if 60 per cent of people are connected and if externalities are strong. 15. Cross-investments in the inverse sense (from profitable towards non-profitable activities – interpreting Article 87) should be permitted. 16. Note that currently the EU only specifies financing for universal services, and only in three sectors (telecommunications, postal service, aviation). 17. Price caps: the regulator fixes the path of the price of the monopoly (rate of inflation X). If the monopoly reduces its costs by more than X, it keeps the earnings. X can also be the productivity growth rate. Cost-plus: the regulator fixes a fair and reasonable rate of profit. It guarantees the monopoly prices allowing it to earn a return on its investments at this rate of profit. The risk of a price cap is under-investment. The risk of cost-plus is overinvestment. 18. Networks link different protagonists. Clubs of national regulators have meetings. While useful for exchanging viewpoints, they go no further.

REFERENCES Aloy, E., and F. Levêque (1997), La définition, les outils d’évaluation et de financement du service public en situation de concurrence ouverte, Rapport pour la Direction des études, stratégies et investissements de la SNCF, CERNA, ENS Mines de Paris, July. Arendt, H. (1994), Condition de l’homme moderne, French translation of The Human Condition (1958), Paris: Calmann-Lévy. Atkinson, A.B. and J.E. Stiglitz (1980), Lectures on Public Economics, New York and London: McGraw-Hill.

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Boiteux, M. (1996), ‘Concurrence, régulation, service public. Variations autour du cas de l’électricité’, Futuribles, January. Commission Européenne (2003), Livre vert sur les services d’intérêt general, May. Courrier de la Planète (2002), Eau : inventer la coopération internationale, No. 70. Duguit, L. (1921–28), Traité de Droit Constitutionnel, Paris: Fontemoing, reprinted in 1972. European Commission (1993), White Paper on growth, competitiveness, and employment: the challenges and ways forward into the 21st century, COM (93) 700 final. European Commission (2005), Trans-European transport network. TEN-T priority axes and projects 2005, Directorate General for Energy and Transport. European Parliament (2001), Rapport sur la communication de la Commission sur les services d’intérêt général en Europe (Langen Report), 17 October and 13 November. Ghekière, L. (2003), SIG et cohésion sociale de l’UE: quels enjeux pour l’habitat social?, Bulletin Européen du Moniteur. Hartley, N. (2001), Regulation, risk and new investment or ‘Slack plans, busy regulators’, Oxera. Helm, D. (2001), ‘The Assessment: European Networks, Competition, Interconnection and Regulation’, Oxford Review of Economic Policy, 17 (3), 297–312. Henry, C., M. Matheu and A. Jeunemaître (eds) (2001), Regulation of Network Utilities, The European Experience, Oxford: Oxford University Press. ISUPE (under the direction of J. Vandamme and S. Rodrigues) (2003), L’accès aux services d’intérêt économique général. Laffont, J.-J. (2000), Incentives and political economy, Oxford: Oxford University Press. Laffont, J.-J. and J. Tirole (2000), Competition in telecommunications, CES, Cambridge, MA: MIT Press. Lamy, P. (2002), Politique commerciale commune : un exemple pour l’action extérieure de l’Union, Convention, Groupe Action Extérieure, 15 October. Merlin, A. (2002), ‘La sécurité de l’approvisionnement électrique en Europe’, in Pour une Communauté de l’énergie, L’Option de Confrontations, No.16, June. Newbery, D. (2002), ‘Regulating unbundled network utilities’, The Economic and Social Review, No.1. Ostry, S. (2002), The world trading system in dire need of reform, Canadians in Europe Conference, April. Parish, M. (2003), ‘On the private investor principle’, European Law Review, 8 (1), 70–89. Pelkmans, J. (2001), ‘Making EU network markets competitive’, Oxford Review of Economic Policy, 17 (3). Polanyi, K. (1983), La grande transformation, French translation of The Great Transformation (1944), Paris: Gallimard. Sen, A. (1984), Resources, Values and Development, Oxford: Blackwell; Cambridge, MA: Harvard University Press. Sloterdijk, P. (2003), Si l’Europe s’éveille, French translation of Falls Europa erwacht. Gedanken zum Programm einer Weltmacht am Ende des Zeitalters seiner politischen Absence, (1994), Paris: Mille et Une Nuits. Stoffaës, C. (1996), L’Europe à l’épreuve de l’intérêt général, under the direction of the ISUPE, ASPE Europe, Paris.


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Stoffaës, C. (2003), Vers une régulation européenne des réseaux, Report for the Minister of European Affairs, Paris. Tirole, J., C. Henry, M. Trommetter, L. Tubiana, and B. Caillaud (2003), Propriété Intellectuelle, Conseil d’Analyse Economique, Paris.

4.

Funding public services in Europe: state banks or public–private partnerships (PPPs)? Patrick Artus

INTRODUCTION: THE PROVISION OF SERVICES OF GENERAL INTEREST IN EUROPE Services of general interest (SGIs) (whether economic or otherwise) are services for which there exist markets, but for which there are also specific obligations of public service. There may be an obligation of universal service, for example, access for the entire population, quality, security, affordable pricing, and so on. These specific obligations require a supervisory public authority (a regulator). Examples include energy, transport, telecommunications, the postal service, but also education, training, health, waste management, among others. Two types of SGI can be distinguished: those that can be provided by private operators that are subject to regulation, rules and monitoring, and those that are more difficult to provide through markets, in particular when a situation of natural monopoly obtains: the cost of production is less when it is evaluated by a single firm because of significant fixed costs/network activities or because there are significant network effects (positive externalities). The problem is then that the pricing structure chosen by the monopoly is higher than effective marginal cost pricing. Thus, either marginal cost pricing can be imposed, and the monopoly subsidized, thereby running the risk that it will have no incentive to rationalize; or, a secondlevel optimum with average cost pricing can be chosen; or, a system of cross-subsidies can be put in place between those services that are the object of a public service obligation and the other services. In most network SGIs, the existence of a natural monopoly leads to the separation of the network activity from the management and use of networks that can be provided by competing private operators. The cost of this separation is the risk of bad coordination between the network manager and the service providers, the difficulty of defining network access pricing, 104

Funding public services in Europe

105

and arbitrating between insufficient competition among service providers (prices that are too high) and excessive competition (investments that are too low). We shall consider the financial problems linked to the provision of general interest services. These are essentially of two sorts. ●

●

Are there identifiable SGIs in the financial domain? Are some of these services of general interest better provided by state banks (normally in situations of natural monopoly) than by private financial institutions in competition? Network SGIs require considerable infrastructure investment (water, health, education, telecommunications, energy); progressively, these investments are increasingly financed through PPPs (public–private partnerships); is this a desirable development?

A ROLE FOR STATE BANKS? In most countries in the euro zone, there are state financial institutions. We are not interested here in their competitive activities, for which they will eventually lose the state guarantees that they currently enjoy (that is the case, in particular, for the Länderbanken in Germany). Our interest, however, is in their other activities. Let us give some examples (apart from the Caisse des dépôts et consignations in France). ●

●

In Germany, KfW (Kreditanstalt für Wiederaufbau) had a total balance sheet of €261 billion in 2002; it raises money on the financial markets, and it provides subsidized loans to small and medium-sized enterprises (SMEs), real-estate mortgages, and export credit loans. In Italy, the CDPP (Cassa dei Depositi e Prestiti) had a total balance sheet of €241 billion in 2003; its funds come essentially from post office savings deposits and post office bonds (30-year instruments with increasing returns). The CDPP uses its funds for the following purposes: – loans to the state, local authorities, and public organizations; – the financing of public investments (essentially infrastructure and large-scale projects).

●

In Spain, the ICO (Institut de Crédito Oficial) had a total balance sheet of €28 billion in 2003, and finances itself through borrowing in the market and subsidized funds. Loans contracted by the ICO are

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●


designed for SMEs (in part with state guarantees), the funding of infrastructure innovation (high-speed trains, water, energy), and Spanish firms expanding overseas. In Austria, the OeKB (Kontrollbank) is not properly speaking a state bank, since it is owned by the large Austrian banks. Nevertheless, it acts on the state’s account (credits and export loans), and its debt is guaranteed by the state (AAA rating). Its total balance sheet was €25 billion in 2003.

Other state banks exist: in the Netherlands, the BNG provides funds to local authorities and project finance; in Luxembourg, the BCEE (Banque et Caisse d’Epargne d’Etat du Luxembourg) grants loans to SMEs and local authorities, and has retail and investment banking activities; in Greece, the Savings and Loans Bank (Caisse des dépôts et de prêts) makes loans to local authorities; in Denmark, the Kommune-Kredit grants margin loans, restricted to county councils; in Sweden, the Postbank provides basic banking services. Is the existence of state banks justifiable, or are they historic legacies (results of postwar reconstruction, and so on)? We shall present four arguments in favour of keeping state banks. Argument 1: state banks are more efficient very long-term lenders Let us start from the liability structure of commercial banks in the four large countries in the euro zone (Table 4.1). From the table, it is clear that long-term resources (long-term securities – only those over two years – and capital resources), even in Germany, represent a very low percentage (15–35 per cent) of resources, which are for the most part short-term resources.

Table 4.1

Liability structure of commercial banks (%, 2002)

Sight deposits and short-term repayable deposits Fixed-term deposits Short-term and monetary securities Long-term securities ( 2 years) Capital resources Other

France

Germany

Italy

53

27

36

8 12

32 2

6 11

8 7 12

28 8 3

10 15 22

Spain 77

5 15 3

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Funding public services in Europe 30-year rate 10-year rate 5-year rate

8 7

3-month rate 30-to-5-year spread

8 7

6

6

5

5

4

4

3

3

2

2

1

1

0

0 96

97

98

99

00

01

02

03

Source: Datastream.

Figure 4.1

Euro zone: yield curve

This means that commercial banks must demand significant risk premia when lending over the long term. The 30-year to five-year spread on the sovereign loan rate curve is on average 150 basis points in the euro zone (Figure 4.1). To this should be added the spreads taken by the banks above the sovereign loan rate on corporate loans: from 50 to 200 basis points depending on the country. If state banks have very long-term or very stable resources, their ALM (asset and liability modelling) leads them normally not to demand such large risk premiums; this may reduce the cost of very long-term (30-year) financing by as much as 200–350 basis points). Argument 2: the profitability requirement of state banks is weaker Since the mid-1990s, the average profitability of European banks has increased greatly. Figures 4.2a–c give some examples of the return on equity (ROE) of the large banks. With the exception of the German banks, whose recent difficulties are well known, the ‘normal’ ROE lies between 15 and 20 per cent. This implies that many sorts of financing that are structurally less profitable can no longer be undertaken by private banks: public infrastructure projects, loans to ‘mid-range’ SMEs, and so on. State banks, since they are not listed on the stock market, can have more reasonable ROE targets, unencumbered by competitor comparisons. In a scenario where real long-term rates oscillate between 2 and 4 per cent, with an average equity risk premium, a real ROE of 7 to 9 per cent seems entirely appropriate. The spectrum of potentially acceptable financing is thereby enlarged.

108

Advancing public goods a Crédit Agricole (Ile de France) Crédit Lyonnais Société Générale

ABN AMRO AEGON

30

30

25

25

20

20

15

15

10

10

5

5

0

0 95

96

97

98

99

00

01

02

b BBV Argentaria

Commerzbank

SANTANDER CTL.HISPANO Bayerische Hypo- und Vereinsbank

Deutsche Bank

35

35

30

30

25

25

20

20

15

15

10

10

5

5

0

0 95

96

97

98

99

00

01

02

Argument 3: private banks cannot finance SMEs Small and medium-sized firms do not have access to financial markets; furthermore, within the euro zone overall, bond debt of non-financial firms represents only 7 per cent of GDP, whereas bank loans represent 50 per cent (Figure 4.3).

109

Funding public services in Europe c San Paolo Imi

Dexia

Fortis (Brussels)

25

25

20

20

15

15

10

10

5

5 0

0 95

96

97

98

99

00

01

02

Source: Datastream.

Figure 4.2a–c

ROE of the large banks

Bank and financial company loans (G) Total debt (G) Bond debt (D)

60

9

55

8

50

7

45

6

5

40 97

98

99

00

01

02

03

Source: BCE.

Figure 4.3

Euro zone: non-financial corporate debt (as % of GDP)

In addition, during economic slowdowns, European banks restrict loan distribution rapidly (Figures 4.4a–b), and this affects small firms more than large firms. This is clearly visible in Germany, where defaults involve SMEs in the main, and in France (Figure 4.5). It is easy to understand the banks’ position: in the current scenario, the interest rate spreads for SMEs do not cover the default risk during recession, and hence it is better to ration credit.

110


France Germany

20

Italy Spain (including financials)

20

15

15

10

10

5

5

0

0 ⫺5

⫺5 90

91

92

93

94

95

96

97

98

99

00

01

02

03

Source: Central Banks.

Figure 4.4a

Bank loans to non-financial companies (% GA)

Bank and financial company loans Bank loans

16

16

14

14

12

12

10

10

8

8

6

6

4

4 2

2 98

99

00

01

02

03

Source: BCE.

Figure 4.4b

Euro zone: bank loans to non-financial companies (% GA)

There are three avenues for financing SMEs more efficiently: ●

develop public institutions specializing in financing the SME segment, and playing a countercyclical role in providing financing even during recessions;

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All companies

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SMEs

75

75

50

50

25

25

0

0

⫺25

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* rise: favourable view

⫺100

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93

94

95

96

97

98

99

00

01

02

03

Source: BDF.

Figure 4.5 Credit institution opinion poll on overall corporate treasury requirements

● ●

strengthen the equity capital of SMEs, for example, through fiscal incentives; develop refinancing instruments reserved for SME loans.

It is rather strange to see that in Germany, France and Spain (Figures 4.6a–c), the market in securitized debt has developed in order to refinance loans to local authorities and mortgages. Would it not be at least as useful if loans to SMEs could be securitized using an instrument whose legal and financial structure would guarantee it a AAA rating? Argument 4: minimal banking service provision When banking services are provided solely through private banks, part of the population is in fact excluded from these services: the poorest, the rural elderly or those living in very small towns. In the UK, 9 per cent of the population does not have access to banking services. The problem cannot be resolved just by regulation, which could require private banks to provide a certain number of simple financial services at low cost. There is also a network effect, for example, in maintaining bank branches in very small towns. Thus the situation is one of natural monopoly: there is a single network, and the financial activity linked to it

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300

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Gross issuance (billions of euros, gross) Balance (billions of euros, D)

250

1,000

200

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150

600

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50

200 0

0 70 72

74 76 78 80 82

84 86 88

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00 02

Source: Bundesbank, CDC IXIS.

Figure 4.6a Balance and gross issuance of Pfandbriefe (billions of euros) 30

30 Gross issuance (billions of euros) Balance (billions of euros)

25

25

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20

15

15

10

10

5

5 0

0 99

00

01

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Source: CDC IXIS.

Figure 4.6b

Balance and gross issuance of Cédulas (billions of euros)

is loss-making. The service can be provided either through cross-subsidies (as is currently the case with the Post Office [La Poste] in France, with subsidies between the postal business and the financial business), or through subsidies (as would be the case if a postal bank were created).

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Funding public services in Europe Gross issuance (gross) Balance (D)

11

40

10

35

9

30

8

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7

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6

15

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5 99

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Source: CDC IXIS.

Figure 4.6c Balance and gross issuance of mortgage bonds (billions of euros) Synthesis: State Banks, even in a Liberal Economy? Visibly, therefore, financial markets and private banks cannot finance everything, because of the constraints and costs involved: instrument conversion risk, default risk and profitability targets. Nor can private banks maintain a network providing basic banking services. This might justify the continued existence of state banks to complement other financial institutions in the areas of very long-term financing, the financing of projects with significant externalities (infrastructures), SME financing, and the provision of banking services to the poorest and/or rural segments of the population. Problems of competition should not arise if the scope of these interventions is clearly delimited.

OPERATING SGI-RELATED INFRASTRUCTURES The relevant infrastructures are those involving utilities (water distribution, electricity), telecommunications, transport (motorways and railways), the petroleum industry, waste management, and also public services (health, education, prisons, and so on). There are two main kinds of financing.

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●


Project finance: lenders (investors) are remunerated by the revenues extracted from the project. After the delirious excesses of the Eurotunnel (massive overspending, debt restructuring, debt–equity conversion, repeated extensions of the concession period, and so on), this type of financing is now reserved for infrastructures relating to market services (water, petrol), for which the private consortium is granted an operating licence. In this type of financing, lenders run the risk of insufficient revenue generation. Public–private partnerships (PPPs): similar to the Project Finance Initiative (PFI), PPPs are of a very different nature from project financing. The private consortium (which groups together ‘technical’ firms – public works and financial institutions) is remunerated through rents paid by a public authority (state, local authorities); these rents are not related to the revenue extracted from the infrastructures. See Figure 4.7 for PPP structure.

Hence the problem involves financing and managing public infrastructures whose profitability may be weak or negative (transport) or even zero (hospitals, prisons, schools, and so on). In the UK, 15 per cent of public investments are made through PPPs. Clearly, these infrastructures can generate externalities that do not correspond to any monetary revenues. The ‘technical’ private firms at the origin of the proposition are involved in a number of ways. ●

They manage the infrastructure once it has been constructed (which may in certain cases, such as schools, prisons, and so on, be a very limited activity); they receive rents from the local authorities; these

Project companies (technical firms) Rents

Interest

Lenders (banks, markets, etc.)

Public authorities Interest (if project company defaults)

Figure 4.7

PPP structure


●

●

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rents remunerate management, skill and supervision, and are not related to revenues. They enter into association with banks in order to finance the infrastructures, the banks granting loans and issuing long-term paper (30year bonds). Frequently, the European Investment Bank (EIB) takes a stake, raising the rating. Loan interest is payable by the technical firms (‘project companies’). Gearing is high, as equity capital represents only 10 to 20 per cent of the total debt. In the event that the project companies default, the public authorities take up the relay for the interest payments.

Therefore, there is no revenue-related risk (turnover-related risk). However, the following risks exist: ●

● ● ● ●

investment cost overshoot risk, and/or the risk that delays may occur; the contract specifies how in either event the excess cost is shared between the public and private partners, depending on the cause of the overshoot; political risk, default risk, or the risk of bad faith on the part of the public authorities; management risk (performance risk); if the management of the PPP is inefficient, the cost is not covered by the rents; financial risk (interest rate fluctuations, inflation, and so on); legal risk (poor drafting of contracts, and so on).

How should one assess the choice of PPPs for financing public infrastructures? As has been seen, lenders and private managers bear no risk relating to project revenues, and, unlike in the case of project financing, the entire revenue-related risk is borne by the public authorities. Remuneration of the private lenders is high, at variable rates, 100 to 165 basis points over LIBOR (London Inter-Bank Borrowing Rate): the financing cost is significantly higher than if the funding were public; the funding lines generally have a BBB rating versus a AAA rating for governments; in part, this arises from set-up and legal costs. Contrary to what is commonly asserted, it is not certain that the ratings difference results from some putative financial constraint applying to public entities. Were this the case, however, there would be a simple replacement of an on-balance-sheet debt by an off-balance-sheet debt, resulting from the commitment to pay rents. PPPs are to be found only in the most developed countries, not in emerging countries; the British and French governments are easily able to raise supplementary debt in order to finance these projects. The financial

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constraint is probably more of an issue when local authorities are involved. The decision to use the PPP option is most often based on the efficiency of the private sector in regrouping and coordinating a wide range of skill sets: technical, legal, financial, administrative, managerial, and so on. The projects are often complex, both at the investment level and at the levels of management and funding. In reality, the development of PPPs reflects not so much the financial poverty of the state as its incapacity to bring about the efficient operation of multidisciplinary teams on complex projects. If this is not the case, then PPPs simply serve to transform on-balance-sheet liabilities (debts) into the more discrete off-balance-sheet debts of public entities. The public authorities must obviously supervise and monitor the project roll-out, which they often do correctly although there is a clear risk of informational asymmetry between the public and the private partners. However, they should not directly run the project. It has been shown that in several cases, the delivery of infrastructure projects (motorways, for example) has failed, not for financial reasons, but due to problems of coordination between public services. The conclusion is sobering: the development of PPPs will certainly increase the amount of public investment achieved; yet, this will happen, not through the loosening of the financial constraints of the state, but through the introduction of teams that are more efficient than state teams, thereby incurring a supplementary financial cost.

5.

New public institutional design Xavier Greffe

Reforms of the public sector and public management are among the most important projects that states have set in motion in the course of the last two decades. Marketing, the introduction of pricing, outsourcing, and management by objectives have become anchors of these reforms. Even if these phenomena are less spectacular or publicized than the big choices in political economy (monetary union, social protection policies, labour market reform), no country escapes them, whether its economy is developed, developing or in transition (OECD, 2000b). The reasons for this ineluctability are varied, even if the most frequently advanced is that of budgetary constraints, justified by the pressure of globalization, as well as the questioning of the relevance of deficits and public sector borrowing. There is, however, another equally important, competing reason, which renders the debates somewhat opaque: critical discussions over the quality of the services provided. Finally, certain international or intergovernmental organizations have defended the theme ‘less government, more governance’ in order to avoid damage by public interventions to the liberalization of markets and its expected effects (Reinecke, 1994; Wildavsky, 2001). In reality, the agenda is not so new, and the problems of budget management and public administration have never been absent in the history of the state. Still more surprising is the fact that the themes enunciated today are often themes already present in the experiences of more than 40 years ago. This leads to the question of why economic analysis has apparently contributed little to clarify the debate, even were it only through the integration of the successes and failures of past experience. An early clue – rather than an explanation – appears initially appealing, in my view. If there has always existed a public economy illuminating the reasons for and the limits of public intervention, there has hardly been any theory of the implementation of public intervention or any microeconomics of the public provider. Whereas the welfare economy saw the creation of management economics in its wake, no symmetric movement happened on the side of the public economy. Of course, significant contributions, for example the analyses of bureaucracy and of public choice, were made. Nevertheless, these contributions – limited to setting aside a Weberian perspective according to which 117

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functionaries carried out exactly the orders given to them, and grounded more or less explicitly in the idea that public intervention carried in itself something intrinsically bad and dangerous for its citizens – could do little more than fuel and re-deploy ideological debates. The argument that the only choice lies between a theory of private ills–public goods and a theory of public ills–private goods leads one as rapidly on to the path of anathema as on to the path of reform (Greffe, 1999). It is therefore important, profiting from the calm pervading certain debates about public intervention, to deepen the question of the modalities of public provision, whose performance reflects inevitably on the level of interest therein. The field of public institutional design, or the modes of organization and procedures capable of implementing public services, should be at the heart of economists’ reflection today, even if economic analysis should in this case ally itself with legal science and sociology (Alexander, 1995). An exploration of this approach will yield a coherent view of the full spectrum of current challenges relating to the provision of public goods.

THE THREE LEVELS OF PUBLIC INSTITUTIONAL DESIGN For many contemporary states, the principal challenge of the organization of the provision and financing of public goods is to marry the qualities expected of public provision with the efficiencies attributed to the market. This task involves two seemingly incompatible properties: (1) the qualities of public allocation, for some goods cannot be allocated in an appropriate way by the market, even if it is accepted that shielding them from the market will provoke other debates about the cost or means of provision; (2) the qualities of market allocation, since it is supposed to guarantee least cost (efficiency) and the matching of consumer needs (effectiveness), and thereby even the possibility of complementary financing. The public provider, however, must arbitrate continually between several utility functions, as pressure groups seek to obtain by direct dialogue with public services that which they could not validate by the process of political choice. The public provider must also arbitrate between different provision functions, since employment is considered by some as an end in itself and not as a means. Continuously subject to such pressures, the public provider is negatively opposed to the virtues of market efficiency.1 Many critiques rest therefore on the increasing difficulty of public provision to respond correctly to the needs of populations or target groups, and the cost overshoot associated with this mismatch. Into this breach are

New public institutional design

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thrust the analysis of bureaucracy originating with the Nyskanen model, the application of concepts of the economics of information (in particular, the asymmetry of information and moral hazard), the economics of profit seeking, and so on. Not content with showing the losses which accompany public provision, the resulting critiques have also shown that behind these losses, private profits are being amassed, adding the risk of unjust distribution to the risk of deficient allocation. At a minimum, it is therefore necessary to reinsert into public provision mechanisms capable of improving effectiveness and efficiency. Benchmarks for these mechanisms are obviously to be sought market-side, and the management of private enterprise subject to competition will appear here as the reference standard for reforms of public management. However, taking account of an entire spectrum of constraints, the virtues expected of the process of private allocation should be sought, not necessarily the institutions, whence the necessity of suppleness in the institutions implementing public provision, or the necessity of public institutional design. Thus, while it is clear that the translation of objectives into ‘requirements’ is anything but obvious, three sorts of institutional, or para-institutional, choice may contribute to improving the ability of ‘public’ providers to react and to innovate in response to their specified objectives. ●

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The first type of choice concerns the joint expression of the different rationales, public and private, at the very heart of public provision. These rationales can moreover take different forms depending on the nature of the actors implementing them: state or local collective bodies on the one hand, businesses and non-profit organizations on the other hand. The theme of governance, which on reflection proves an ambiguous concept that is understood differently according to national cultures, appears to underline the relevance of this level of analysis. It serves as the key to unlocking the meaning of terms as varied as partnership, decentralization, or agency. The second type of choice involves the re-centring of public management around the ‘citizen–user’. The reconstitution of a direct link between the consumer and the provider appears inherently to improve the effectiveness of public providers, on condition that it is possible for these consumers to make effective choices. The third type of choice is the joint expression of the coordination of the horizontal and vertical dimensions at the core of the apparatus of public provision. The growth of welfare states has led to the proliferation of offices and tasks, necessitating the consolidation or specialization of their activities to match the multiplicity of tasks with the myriads of offices.

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The Choice of Governance: Partnership, Decentralization and Agency Public provision is traditionally considered as a machine transforming the directives given by the state into sources of satisfaction for its citizen–users, with administrators holding the role of decentralized parametric bureaucrats, to use Samuelson’s expression. This representation, which one might qualify as Weberian, does not correspond at all to what is happening today. The transformation of directives into services gives rise to multiple negotiations where pressure groups play an important role, and where the delivery of public provision calls increasingly on private actors, whether they espouse rationales of profit or non-profit, and where several levels of government may be involved. This is the source of the generalization of the expressions ‘governance’ and ‘public policy’ in place of ‘government’ and ‘public economy’. They indicate that state interventions rest on the interaction of numerous public and private actors, even if the state is assumed to remain the pilot. This mixture of actors, involving a mixture of rationales, is considered capable of improving public provision. At the level of the definition of needs, it is the means of being better informed about social transformations and requirements. At the level of project delivery, it offers the possibility of benefiting from scarce resources and more effective protocols. Several schemas are possible in this connection, however. A first schema is that of partnership. The public actor joins forces with private actors in order to deliver its policies. It expects of these actors analytic and diagnostic capabilities, a different approach to the citizen–user, and efficient management capability. There are numerous examples in the domains of research, education, health, the environment, and so on. One of the most recent examples is provided by labour policies. In its European Employment Strategy, the European Union asked member states to launch territorial pacts for employment whose definition and implementation involve state services, local and regional collective bodies, private enterprises, charitable organizations, and so on. The strategy is expected to produce more effective employment policies, since it strengthens the efficiency conditions of their active component involving local mobilization. In the French framework, this expectation materialized in instruments as diverse as the PLIE (Plans locaux pour l’insertion et l’emploi), local action plans for employment, and territorial pacts in the strict sense. The presence of these partnerships in the provision of collective public goods has its problems. The first concerns the diffusion of responsibilities. Even if protocols or contracts define the role of each partner as strictly as possible, the result may not be clear. Where the partnership is presented as a means of improvement, it can become a source of confusion, dilution


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of responsibility, and, in the long term, lack of credibility. The second problem stems from the unequal sharing of advantages and costs among the partners. Thus, many associations participating in the implementation of social services complain that the state treats them as simple instruments, that they lose their originality as a result of the tasks and controls to which they are subject (Greffe, 2000). The third problem is related to windfall-seeking behaviour: some partners only participate in ‘public provision’ long enough to extract the associated advantages without contributing to the corresponding costs. This last problem concerns the possibility that private rationales may dominate or overwhelm public ones. Outsourcing of public provision may lead to the redefinition of the conditions of efficiency more in line with the interests of the contractor, especially in cases where contract revision is difficult. Everything depends on the specific agents that the private contractor is required to mobilize, and nothing here prevents the public partner from becoming a hostage of its contractor. What conditions suffice to ensure that the expected benefits win out over these inconveniences? A first condition lies in the existence of a system of clear and precise information on mutual obligations and benefits. However, the correspondence between measures of effectiveness, public accounting and private accounting is far from precisely established. A second condition rests on the durability of such partnerships. They must be sufficiently long in order to make the required investments interesting, but sufficiently short in order to allow significant reaction to contract violation by one or other of the players. Finally, a third condition is based on the very constitution of the partnership: its objectives must be such that they appear to be a collective good. Without seeking to mix public and private rationales directly, one might nevertheless hope to advance along the path of greater effectiveness by decentralizing or by creating public–public partnerships. Three reasons explain these trends and how they might reinforce effectiveness and efficiency. The first starts from the notion of local collective goods in order to justify a matching of the levels of decision making and their effects. Since the local collective good is a good whose collective character (indivisibility, external effects) is only valid for a given territorial environment, it is logical to allocate it at this level alone. The second reason consists in involving local and regional collective bodies in the provision of national collective goods on account of their ability to analyse and evaluate needs, illustrated currently by numerous initiatives favouring employment. More insidious, the third reason seeks to displace the cost of financing these national collective goods on to other collective bodies. This is particularly the case for many cultural policies.

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Such policies are never ‘pure’, for in general, there are both functional and geographical effects of domination. One of the difficulties of reforms of public management by means of decentralization will stem from the need to find palliatives or correctives for both sorts of domination effect, whence come implementations that are often complex. The concept of subsidiarity is there to show that if a level of government holds the centre of gravity for the exercise of a competency, other levels will be mobilized at the slightest difficulty encountered. Thus in France, the provision of a highly symbolic public good – the school – currently mobilizes every kind of territorial collective body. Less well known, the provision of ‘full employment’ is shared today between the state, the regions providing professional training, and the departments and communes, which are the principal actors in the struggle against exclusion (Greffe, 2003). A second difficulty arises from the fact that wealth inequalities between local and regional collective bodies can create unacceptable situations, especially if political norms demand equal consumption opportunities for all, which is the characteristic feature of public services. This results in a form of re-centralization, notably through the system of public cards and the consequent obligation of the user to apply to one office rather than another: school card, health card, and so on. A third difficulty stems from the presence of in situ natural monopolies or network economies. Effective schemas will therefore be complex. Where one would hope to find effectiveness and efficiencies, one frequently discovers a dilution of responsibility, which does not strengthen the confidence of citizens in the instruments of public provision. From a positive-sum game, decentralization becomes a quasi-zero-sum game since players appear unable to advance their positions without detriment to those of the other players. Federal states protect themselves relatively better than others against these difficulties, since the local governments benefit from a fiscal power which allows them to negotiate with the central powers. In other states, a point of equilibrium is to be sought in contractual relations, contracts being presented as the means of clarifying the issues and balancing the stakes of the parties involved. In France, it has been observed that this happens to an extremely moderate degree. If state–region contracts have allowed the state to mobilize local resources to the advantage of its own objectives, the inverse is less true. In this instance, decentralization is valuable more for the debates it stimulates on the nature of goods to be produced than for the solutions it brings to the financing of public goods. Recourse to agency represents a different choice of mixture of rationales. Without renouncing the principle of public provision, the contributory services are regrouped into a coherent and relatively autonomous totality, the agency. This unit can then be held responsible for its own actions and


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encouraged to do the best possible to achieve its aims. To achieve these, the functions of the agency are defined as coherently and objectively as possible in order to identify clearly the results of its actions. Next, the agency is ‘exported’ from the strict public hierarchy, in order simultaneously to make it accountable for its performance, and to avoid pushing its responsibilities up to the ministerial level, so that ministers no longer inhabit the explosive position of being both judge and jury at the same time. Finally, incentive formulas are put in place, both at the level of the new head of service and at the level of the service unit components (Blöndal, 2001). In this way, the ‘office’ is made into an ‘agency’, and one hopes to find the compromise dreamt of between the principle of public provision and the virtues of market allocation. To this end, the agency must adopt the modes of management based simultaneously on the search for results and the minimization of cost. As regards the conditions of effectiveness, this entails making precise the relation between the agency and its exterior environment (including other state services), the identification of products and services, and, where necessary, their corresponding prices, and the provision function used. As regards the objective of cost minimization, it entails the passage from cash accounting to accrual accounting. This is the only way to identify clearly the evolution of costs over time and the effect of alternative choices in this domain. All these conditions are difficult to achieve, and too often one relies simply on the designation of a head of service through public tender open to public and private directors, the difficulty being that the director selected will not in general have the margin of freedom imaginable or promised. There is another difficulty, often forgotten. The environment in which the agency evolves is changing, and the agency must understand the resource environment in order to adapt continually. The issue is less about the implementation of management by objectives sprinkled with incentivizing measures than that of strategic management by objectives. To show that an agency captures market share or reduces its costs does not suffice if needs are continually changing, as is often the case in personalized service provision. The agency and its environment are mutually selfdefining, and self-organization around a pole of management modes which fails to integrate a joint redefinition of ends and means is difficult. The more an agency is adapted to the management of a service of civil status or a mechanism of transport provision, the more difficulty it has to adapt when it is applied to problems of integration or health. From this point of view, reform by agency is relevant for those levels of public administration where the products and provision functions can be given definitions that are stable over time.

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Control by Users and Vouchers Placing users back at the heart of the system of public provision appears as the possible guarantee of its efficiency. In this way, one might hope to recreate a monitoring of providers by consumers and to rediscover one of the sources of effectiveness and innovation traditionally attributed to market processes: the valorization of good providers to the detriment of bad providers. However, this argument is difficult to push to its conclusion for a reason lengthily debated in public economy. If a good is placed under tutelage because one believes that agents cannot make desirable consumer choices, both for themselves and for the collective body, then the restitution of this power of choice is ambiguous. One can skirt around the problem by organizing a collective representation of users at the core of the system of public provision in order to correct its implementation, but the result is far from evident. Thus, in France, this procedure has hardly proved its effectiveness for reasons as varied as the politicization of representation and the establishment of battle lines between certain users, providers and controllers, whence the purely consultative and relatively anaesthetized character of such controls. An alternative approach consists in organizing this pressure at the individual level, leaving the choice of provider to the user, who will validate or not the quality of the services offered. This presupposes a certain latitude of choice. The approach often appears under the name of redistribution: free (or, more rarely, paying) vouchers or cheques, which allow deprived persons to have access to desired consumer goods. These vouchers benefit all citizens, independent of their income levels.2 Thus in France, private education under contract involves this rationale, even if competition allowed between the two variants of the provision of the public good of education is distorted by quantitative inequality (private education under contract represents between 15 and 20 per cent on average of global capacity) and a geographical disparity (in some areas, there is only the public system). One of the earliest and very influential pleas in favour of vouchers, and in particular of education vouchers, was formulated in 1955 by Milton Friedman (1962). He introduced the idea, unfamiliar at the time, that education financed by public funds did not necessarily have to be paid for in that way. He admitted the existence of a ‘public advantage’ of the first and second degree, and, from the fact that not all households were equally able to finance the education of their children, he inferred the necessity of a selective distribution of education vouchers. If Friedman’s ideas have been adopted by a number of conservative thinkers on both sides of the Atlantic, vouchers now enjoy the support of the liberal tradition, at least in the USA.


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Thus Christopher Jencks (1966) argued for the validity of the idea that excessive bureaucratization and the lack of proper incentive for a single public school system handicapped the quality of the education of children in low-income zones, whence the possibility of vouchers. A system of distribution of vouchers is therefore one formula in virtue of which a person receives rights to a service ‘under the tutelage’ of his or her choice. The aim is not to facilitate market transactions, but to allow the consumer to orient provision in the direction desired. For this to be achieved, the consumer must be able to use the vouchers freely across the different types of public and/or private provider. However, this flexibility is rare. The conditions of use are often conditional and the palette of providers allowing such choices does not always exist. Even where it exists, providers may very well create cartels, rendering any latitude of choice superficial. There are several ways to implement these systems. The first introduces a mediator between the buyer and the provider. A public body is then created, which buys services from providers. However, this body may very well treat consumers in an authoritarian manner and not use its financial power to uphold standards of quality and cost. This system may also introduce a certain degree of competition, for example by organizing public tenders. High-cost providers would no longer find the budgets required, a situation that would oblige them to reform or to abandon their activity. If these providers are private, this ‘solution’ is realistic. If the providers are public, and, for example, protected by statutes, this is no longer the case, and the required adjustment will at best be achieved gradually in the long term. These dispositions involve the category of quasi-markets (le Grand and Bartlett, 1993), which inject some competition into provision, even if there is no margin of choice for consumers. It appears better to leave choice to the consumer, but only under two conditions: (1) the number of providers must be sufficiently large, which is not easy everywhere, and (2) the entitlement distributed must correspond to consumer preferences. This last difficulty has led certain observers to propose a still broader system, which in the limit is indistinguishable from simple monetary transfers. The entitlements are exchangeable, hence can be sold in order to acquire the desired goods or to add one’s own resources in order to access more expensive goods or services. It is conceivable that the entitlements be non-exchangeable, but usable for several possible goods or services.3 Whatever the system, several results are expected: effectiveness resulting from better adjustment of provisions to consumer needs; efficiency resulting from cost competition; equity resulting from the allocation of collective goods; economies of transaction cost related to contractualization; mastery of public budgets since the envelopes are fixed ex ante without

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the possibility of ex post excess. Nevertheless, subtle conditions must still be fulfilled. The citizen–users will not stimulate effectiveness and efficiency unless they possess a minimum of ex ante information. Sometimes, this information is transmitted by labels, ‘benchmarking’, and so on. However, only the well-informed citizens will use them. In a more general way, this problem of information will depend on the nature of the goods used. In effect, the majority of collective services are rarely ‘search goods’, that is, goods characterized by the fact that individuals can discover all relevant features of the service before making a choice. They are more often ‘experience goods’, that is, goods characterized by the fact that individuals cannot discover the service features without experiencing the service. They can even be ‘credence goods’: even after consumption, individuals are not fully aware of the advantages, and they privilege subjective data linked to their environment. The multiplicity of providers is not evident. It may not even be justified, for example, faced with economies of scale and growth, or perhaps a natural monopoly. Moreover, the constraints of public service provision in sparsely populated zones, notably rural zones, expose one to the risk of a sole service provider. Finally, the flexibility with which providers may vary their provision or dispose of excessive capacity is not always obvious. If the chosen provider cannot satisfy demand, the incentivizing motives are blocked. Without large provisioning reserves, public offices may find it difficult to vary overnight the size of their operation, and only the appearance of queues at one office and under-use in other offices will prompt the tutelary authorities to modulate the office resources in consequence. Another limitation may arise from the specificity of certain resources, in particular human resources, which prevents adjustment of the volume of activity to the wishes of users. This large number of conditions makes the voucher experiment less simple than bargained for.4 In fact, their impact depends on the nature of the goods to be financed. Let us consider the case of education (Greffe, 2001). In the case of pre-school education, clients are probably seeking diverse services, provided on a small scale, and where inspection by the purchaser can be very effective. The goal is most probably the provision of a level of basic service to all who wish it. Given the diversity of price and the inherited coexistence of private and public providers, it is difficult to outlaw top-up payments. In light of the high level of financing of this consumption out of private funds, the introduction of a system of vouchers risks causing a considerable irrecoverable loss for public finances, since substitution of public financing for private financing will occur (unless there is a means-testing condition).


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Primary and secondary education, universal and compulsory, is characterized by important external effects. Outside sparsely populated zones, the exploitation of provider rivalry is practicable, but the existence of programmes fixed at the central level may reduce the possibilities of product differentiation. Public powers will be reluctant moreover to finance expensive or élitist private schools. Finally, if the ‘best’ schools practise creaming off, injustices will increase, and numerous households will be incapable of exercising choice. All this hardly pleads in favour of vouchers. The variety of possible forms of training at the end of compulsory education constitutes a more logical domain for the distribution of universal vouchers. However, if this sort of training is provided by the employer, it will be impossible to prevent top-up payments. Vouchers for higher education can be managed on the model of free educational choice. Price differentiation according to institutions and disciplines, and the combination of private and public providers, may allow simultaneously better management and better direction of training policies. Whatever the option chosen, it has been documented in any case that one is far from a system in which the voucher has become synonymous with the abandonment by the public service of a large number of its responsibilities, if not with their redeployment. The Organization of Offices and the Coordination of Vertical and Horizontal Dimensions The choice of administrative division – and thus of the assignment of specific public goods to specific offices – constitutes the third element of public institutional design. How should one attribute the competencies of provision among offices, in the knowledge that the provision of certain public goods may result from the joint activity of several offices (see Percebois, 2003; Mackay and Weaver, 1981)? Should the offices be consolidated so that a single decision centre should decide about the provision of that good? Or, on the contrary, should one specify subsets ‘specific office/specific provision’, in the knowledge that the provision of joint public goods is no longer monitored? This is the debate between consolidation and specialization, and several arguments in favour of one or the other can be invoked a priori. Economies of scale and growth justify concentration rather than specialization. The desire to monitor better and protect against the abuses of bureaucracy prompts the specialization of services which thereby appear easier to monitor. This debate is profitably approached from a more precise angle, since the factors are valid for every organizational question. Behind the services and their possible combinations are functions generally dependent on each

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other. Beyond their officially designated competencies, the services will be drawn to externalize certain features relative to each other or to provide certain public goods in common. The interdependence of these functions renders the boundaries between services artificial, and the relevance of these limits should be tested relative to the chemistry of the functions. Let us consider two simple examples. In France, for example, employment questions are entrusted to employment administrations, and to the corresponding departmental management teams. However, the solution to problems of employment depends on a whole series of dimensions involving health, transport, accommodation, training, and so on – functions delivered by other departmental or local services. The quality of the built environment depends as much on architectural regulation as on the protection of historic buildings, despite the fact that these services are generally the remit of different offices. The issue of public institutional design here is to define the optimal boundaries between offices relative to complementarity, not functionality. One of the characteristics of the welfare state has been to push for an ever stronger specialization of its offices, in the name of a quest for competency or the matching of specific needs. This is the origin of the perception of vertical systems and cloistered offices, little able to adapt as problems evolve, or requiring new structures to coordinate existing structures. Thus the ills of superposing offices and structures exacerbate the problems of excessive specialization. To illuminate the economic issues involved in this question, let us imagine that an office provides several public goods simultaneously. It provides in general one public good corresponding to its designated competency. In the course of this activity, it contributes to the provision of another good in conjunction with other offices. This other good may be linked to the principal good (employment, training, integration), or it may appear as a fallout linked to the activity of several offices (architecture and heritage). The fallout may be positive if the offices agree, negative if they do not; these possibilities depend on the utility functions of the offices. The simplest case is to argue from the example of two offices each providing a proprietary good and both participating in the provision of a common good. Four types of arrangement are possible. 1.

The two offices remain specialized, and each adapts its behaviour as a function of the strategy perceived as optimal for the other. This is the logic of a Nash equilibrium, and the provision of the common good will be more or less strong according to the nature of the respective utility functions, that is to say, the preferences displayed by the office between the good for which it is officially responsible and the other good.


2.

3.

4.

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The two offices are quasi-integrated, the governmental umbrella defining jointly the levels of provision of the three goods, taking account of its own preference function and of the provision functions of the offices concerned. This is the theory of external effects, and the Nash equilibrium is accompanied by Pareto-optimal situations. The tutelary authority may not be content to pilot in a coherent way the activity of the two offices, but merges them into a new single body. However, nothing says that behind this common good, other goods do not exist. Thus office A may provide a common good with office B and another common good with office C. Now it would be necessary to integrate the three offices A, B and C, which leads rapidly to monster organizations with full exposure to the risks of bureaucracy and the impossibility of monitoring. Finally, one of the offices may adopt a position of leader or follower in the style of Stackelberg. It takes the initiative, leading the second to follow in its wake, or it decides to adapt to the behaviour of the other office. Skill set differences may play an important role in this new specialization.

Comparison of these solutions may lead to very variable results as soon as certain parameters change: productivities relative to the provision of the common good; base budgetary constraints; modification of the utility function of the tutelary authority following electoral changes, and so on. Moreover, the solution likely to dominate others at one time-point will not necessarily remain the best under even limited changes in the base parameters. There again, the vision of a temporally stable organization of public provision is scarcely realistic.

MANAGING PUBLIC MANAGEMENT The sites of public institutional design are numerous. Nevertheless, whatever the perspective explored, a certain amount of ballast quickly reappears. The state cannot rid itself so speedily of the responsibilities of which one would like to relieve it. The mobilization of other actors, public or private, may create ambiguities. Electoral changes redistribute the relative weightings of utility functions, which include not only preferences for the goods to be provided, but also for the manner of their provision. Here one must recall the difference between private management and public management. The former leads or obliges all stakeholders to reason from the same valorization criteria, those imposed by the market, or run the risk of divergences of contribution and remuneration, respectively.

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The latter does not lead to regroup the systems of preference as ‘naturally’ around the same objectives. It is one thing to wish to limit these sources of complications and to stabilize the issues relative to the search for effectiveness and efficiency; it is something else to claim to abstract from the weight of political choices. Thus the management of ‘public management’ represents a work-inprogress rather than any certainties or finished products. Here we shall limit ourselves to three observations concerning the time horizon of public management, the treatment of partners, and the kind of governance sought. The Time Horizon of Public Management There is one generally accepted point: the time horizon of electoral periods is no more satisfactory than annualization. As regards the electoral period, things are simple enough: if one wants to gain in effectiveness and efficiency, it is better to define organizational schemas that are as stable as possible over time and not to anticipate systematically their modifications, even if the latter should be taken into account. As regards the annual period, the matter is more complex, but this ancient principle, grounded initially in the annual cycle of agrarian harvests, is not particularly relevant.5 For some, the period of a year is already too long, as is testified by the arrival of new objectives, new constraints, or more efficient ways of providing public goods, which are all phenomena that cause reallocations during the course of the year. The importance of payment laws at year-end is witness to a fundamental discord between the needs of monitoring and the reality of public management. The worst scenario would be arbitrary credit reduction formulas, which demobilize the efforts of precisely those who sought to improve public management, and which will in no way prevent the ‘autumn fever’ in which all non-frozen credits must be spent as fast as possible! As these ruptures often signal macroeconomic-type constraints, the temptation is to define budgets on a multi-annual basis in order for them to be more realistic, whence the incrementalism of the 1970s followed by the decrementalism of the 1980s (Tarschys, 1984). The logic of ‘Zero Base Budgeting’ or ‘Sunset Legislation’ has succeeded that of the ‘Planning Programming Budgeting System’, while waiting in the wings is the ‘Government Performance and Results Act’, which seeks an equilibrium point between these two rather erratic movements. Generally speaking, reference (if not monitoring) periods are being lengthened. The European Union defines its budget over a period of six years, the UK over a period of three years, and so on.


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Managements are thus caught in pincers between two contradictory trends: winning flexibility within the frame of an annual period, and taking account of multi-annual constraints. The solutions are not obvious. The first solution lies in recourse to public accounting, which takes into consideration the implications of accruals and recurrent expenditure (OECD, 2000a; Cardarelli et al., 2000). A second solution lies in the substitution of resource budgeting for cash budgeting. A third solution may come from treasury funds not subject to macroeconomic regulations and that allow for the smoothing of public provision over time. All this implies a policy of quality in budgeting in which certain elements are today clearly identifiable: the definition of the cost of systems of acquired rights, the forecasting of the consequences of ageing populations, and the taking into consideration of the budgetary effect of migratory flows. The issue of public accounts cannot be limited to that of accrual accounting, but must include that of intergenerational accounting too (Auerbach et al., 1999). In a certain sense, we are rediscovering some of the oldest debates in public finance, but they are far from settled if one is to believe Marxist realism, Groucho style: ‘Why should I care about posterity? What’s posterity ever done for me?’ The Treatment of Partners The involvement of public and private partners in the provision of public goods is a given of new public administrations. This involvement generally happens via contracts, allowing benefit to be derived from the best entrants, while at the same time clarifying the responsibilities of each party, which at a minimum presupposes good systems of information and monitoring. Two other questions arise. The first concerns the attitude of the state, a partner of a unique kind. According to the judicial systems, its place at the core of contracts can change, but its size may lead to its adopting practices beneficial to itself, but not necessarily to other partners. The best illustration here is that of its relations with the numerous non-profit institutions, which it uses in policies of employment, action or social assistance. Even if it has often been reticent initially to involve such institutions in the provision of public goods, it has swiftly discovered the advantages, benefiting from important sources of information, reduced costs of provision, contributions of voluntary work and the absence of profit, and so on (Salamon and Anheier, 1998; Smith and Lipsky, 1993). This opportunism wasted no time in tainting the workings of the institutions of the third sector, which found themselves facing a dilemma: become public quasiinstitutions, or lose the benefit of resources often important for them (Greffe, 1998a, 1998b).

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A further question is linked to the nature of the relations between all these partners. In order for these partnerships to work, the ‘games’ must recommence every period, and real social capital must be visible in public provision. Thus the provision of social cohesion through reintegration into the labour market involves actors as different as local and regional collective bodies, enterprises, integration associations, training institutions, and so on. Interested in the delivery of the same provision, these actors may nevertheless differ over the form to be conferred on this provision and the means of achieving it. The resulting tensions may very well derail and even block the process when opportunism enters the partnership. The rules or conventions which a partnership can set itself must seek to maintain the necessary behavioural coherence to prevent situations where the pursuit of interests would lead to a negative outcome for the partnership as a whole. To this end, partnerships must structure their social interactions so as to multiply contacts between members, to keep the cost of information on the actions of other partners as low as possible, and to effect interactions among members in a privileged way, without which the relevance of the partnership may be called into question. From these follow several conditions, taken here from the presentation of Bowles and Gintis (1997). ●

● ●

Partners must have an interest in acting on the basis of positive attitudes and in exhibiting responses that elicit positive behaviours from other partners: this is the so-called ‘reputation condition’. Partners must be aware that if they act badly today, they risk being sanctioned or even eliminated: this is the so-called ‘reprisal condition’. The composition of partnerships must allow alliances to develop guaranteeing their sustainability and allowing the integration of new entrants only if they sign up to this perspective: this is the so-called ‘parish condition’.

The Type of Governance Sought It is one thing to envisage public provision illuminated by governance; it is something entirely different to know how to use this light-source in a relevant way, given the extent to which the idea of governance serves as a vessel for various problematics. Three approaches are possible here. The first consists in seeing in governance a strategy for revitalizing traditional public provision by the infusion of the resources of competition and the market. Putting into question a Keynesian tradition of public allocation, which left little room for concepts of utility function and which opened the door to inflationary and bureaucratic biases, this approach is based on the theory of rational choices, even if it encounters difficulties in


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appropriating the base concepts of this theory.6 In it, special emphasis is placed on the crossing of interests or even their telescoping, whence arise some deficiencies of precision in the recommendations of a nonetheless normative approach. Thus the OECD (1995), like The World Bank (1992), has advocated since the beginning of the 1990s good governance of the public sector on the basis of marketing, outsourcing and the reduction of human resources costs (which had become real fixed costs), mutual respect between citizens and public powers (The World Bank, 1999), and so on. It was this same tradition that Osborne and Gaebler presented in their famous work Reinventing Government (1992). The second approach rests on an institutionalist tradition (Williamson, 1996). In this tradition, the reforms enacted have above all led to the alteration of the traditional schemata of public provision and to the weakening therein of the grip of central powers without thereby substituting markettype regulations. Thus networks have been created as an alternative to hierarchies and markets, and these networks reflect in some measure the power of the processes of functional specialization operating in societies. The state has nothing left at its disposal, save limited piloting mechanisms, and it must rely not only on the resources of others, but also on their trust. This situation flags in large part the difficulties of institutions to adapt themselves in a logical way to the pressures of globalization and of financial disciplines (Rhodes, 1997; Vogel, 1996). Once its empirical contribution has been acknowledged, this approach runs into the difficulty of being unable to take account of the interests which animate and deform these institutions, and the networks to the definition of which they contribute. The first approach assumes a little too quickly the behaviours in action without too much interrogation of their content. The second approach tends to ignore them. From the conjunction of these limits may flow a new vision of governance. For Bevir (2002), reference to an approach of ‘decentred’ governance would be appropriate, that is to say, an approach based on the cultures specific to each national system of public provision, in the knowledge that this exploration must bear simultaneously on the nature of preferences, the functioning of institutions and the resulting expression. It also means that governance should consider the links between global, national and local mechanisms of provision and not just start, as is often the case, from each level as an end in itself. Thus the strategies of decentralization which play a major role in the domain of governance must be analysed in liaison with globalization and not as ends in themselves, even if they possess inherent value. This means finally that networks, markets and hierarchies must be envisaged in their totality and that their temporal disjunctions must be explained by external pressures as well as the play of the interests present.

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Finally, governance should be the means of raising questions about democracy based on the provision of public goods. Some well-known elements of contemporary governance open the way to more dialogue and participation (Tarschys, 2001), but others generate less clarity and responsibility. Governance is an explosive mixture, and where some see only a vague metaphor, others see on the contrary the means of re-expressing in a relevant way themes as varied as the hollow state, the Westminster system, public service and participatory democracy.

NOTES 1. The more the state intervenes, the sharper debates become on the specifics of its provision and the anticipatory management of its agents. 2. Furthermore, it does not necessarily proceed via direct circulation of credit entitlements, but by posterior validation of the choices of citizens. 3. This is the case of numerous culture vouchers put in place by the regions and communes in France, where the owner can use them alternatively to go to the cinema, to watch a theatrical representation or to purchase a book. 4. To show this, let us consider the example of pre-schooling in the UK. Many arguments militate in favour of such a system. The existence of pre-school child care places allows an increase in female professional activity and a rise in their activity rate. Non-parental child care may ensure a better start in life than parental care alone. Families are unable to discern the financial losses that they bear due to career interruptions, which leads one to underestimate the loss in national production. Families can borrow on financial markets to finance child care, but they risk running into prohibitive conditions caused by the problem of providing guaranties for the loan. Thus in 1996, the British Parliament adopted the Nursery Education and Grant Maintained Schools Act, instituting, initially as an experiment, a system of vouchers for kindergarten schools. Parents could obtain vouchers to a value of GBP 1100 covering three trimesters of kindergarten in a certified establishment (private schools, private kindergartens, pre-schools, or state crèches). The private or community providers could request complementary finance from the parents, but not from the public sector. If a state school obtained a refund of a voucher, the credits cashed in previously were reduced by the voucher amount, so that for an unchanged number of pupils it did not find itself financially any better off. However, it benefited from additional fresh money if it attracted other four-year-olds, or offered a more extended range of pre-school activities. Following the coming to power of a new government (May 1997), the system was modified. Goodquality, non-paying places were to be offered to all four-year-olds whose parents so desired, which increased the role of the local education authorities in the delivery of the offer. Some characteristics of the old system were retained nevertheless: subsidies were still paid to public, private and community establishments, and parents kept the power to choose and to supplement at their own expense the amount of the subsidy. What were the observed effects? The introduction of the universal voucher formula (without means testing) in an environment where an important non-subsidized private education sector existed brought about an irrecoverable loss for public finances, to the extent that households already paying for private education benefited from subsidies. The redistributive effects appear fairly negative. In the medium term, this formula will have an impact on the work offering, positive in some cases, but negative in others (because of the income effect). The private providers of child care tend to increase their tariffs and to confiscate thereby part of the advantages of the subsidy. Finally, there is discussion about the unfavourable effect that the fragmentation of pupils into groups receiving different


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forms of education in different places might have on social cohesion. For this reason, some observers have argued that the state school system was recoverable, and expressed support for an ‘internal’ voucher that could only be used in the state school system (Fantini, 1973). 5. This provides the reason behind the introduction of annuality in the sixteenth century in England and in France. 6. It borrows in part from the tradition of Williamson, according to which good governance reduces transaction costs.

REFERENCES Alexander, E.R. (1995), How Organisations Act Together: Interorganizational coordination in theory and practice, Amsterdam: Gordon & Breach. Auerbach, A.J., L.J. Kotlikoff and W. Leibfritz (1999), Generational Accounting Around the World, Chicago: Chicago University Press. Bevir, M. (2002), ‘A decentered theory of governance’, Journal des économistes et des études humaines, 12 (4), 475–97. Blöndal, J.R. (2001), ‘Budgeting in Sweden’, OECD Journal on Budgeting, 27–57, 1 (1). Bowles, S. and H. Gintis (1997), The Evolution of Pro-social Norms in Communities, Amherst: University of Massachusetts, Working Paper. Cardarelli, R., J. Sefton and L.J. Kotlikoff (2000), ‘Generational Accounting in the UK’, National Institute of Economic and Social Research: Discussion Paper no. 147. Fantini, M.D. (1973), Public Schools of Choice, New York: Simon and Schuster. Friedman, M. (1962), Capitalism and Freedom, Chicago, IL: University of Chicago Press. Greffe, X. (1998a), ‘The Role of the Third System in the Intertemporal Equilibrium’, Paper for European Parliament/European Commission Seminar on the Third System, Brussels, 24–25 September. Greffe, X. (1998b), L’évaluation des projets publics, Paris: Economica. Greffe, X. (1999), Economie des politiques publiques, 2nd edn, Paris: Dalloz. Greffe, X. (2000), ‘The measurement of the innovation in the third sector’, International Forum on the Third Sector OECD – European Union, International Monetary Fund, Washington, DC, 12 September. Greffe, X. (2001), ‘Devolution and training in a knowledge economy’, OECD Conference on the Decentralisation of Public Policies, Glasgow, 28–29 February. Greffe, X. (2003), ‘The decentralisation of employment policies: what differences does it make?’, OECD & European Commission Conference on Decentralisation of Employment Policies and Governance, Warsaw, 27–28 March. Jencks, C. (1966), ‘Is the public school obsolete?’, The Public Interest, 2, 18–27. Le Grand, J. and W. Bartlett (eds) (1993), Quasi-markets and Social Policy, London: Palgrave Macmillan. Mackay, R.J. and C.L. Weaver (1981), ‘Agenda control by budget maximisers in a multi-bureau setting’, Public Choice, 37 (3), 447–72. OECD (1995), Governance in Transition: Public Management in OECD Countries, Paris: OECD/PUMA. OECD (2000a), ‘On the expansion of accrual base accounting and budgeting’, PUMA/SBO, 11/REV3, 179, p. 7f.

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OECD (2000b), ‘The OECD survey of budgeting development: country summaries’, OECD Working Papers No. 71. Osborne, D. and T. Gaebler (1992), Reinventing Government: How the Entrepreneurial Spirit is transforming the Public Sector, Reading, MA: AddisonWesley. Percebois, L. (2003), ‘Le design institutionnel public : une introduction’, Working Paper, Paris: Université de Paris I, Matisse. Reinecke, W. (1994), Global Public Policy: Governing without Government? Washington, DC: Brookings Institution Press. Rhodes, R. (1997), Understanding Governance, Buckingham: Open University Press. Salamon, L. and H.K. Anheier (1998), The Emerging Sector Revisited: a Summary, Baltimore, MD: The Johns Hopkins Institute. Smith, S.R. and M. Lipsky (1993), Nonprofits for Hire: the Welfare State in the Age of Contracting, Cambridge, MA: Harvard University Press. Tarschys, D. (1984), ‘Good cuts, bad cuts: the need for expenditure analysis in decremental budgeting’, Scandinavian Political Studies, 7, 241–59. Tarschys, D. (2001), ‘Wealth, Values, Institutions: Trends in Government and Governance’, Governance in the 21st Century, Paris: OECD. Vogel, S. (1996), Freer Markets, More Rules: Regulatory Reform in Advanced Industrial Countries, Ithaca, NY: Cornell University Press. Wildavsky, A. (2001), Budgeting and Governing, New Brunswick, NJ: Transaction Publishers. Williamson, O. (1996), The Mechanisms of Governance, Oxford: Oxford University Press. The World Bank (1992), Governance and Development, Washington, DC. The World Bank (1999), Why Governance Matters, Washington, DC.

6.

Knowledge as global public good: production conditions and preconditions Claude Henry

INTRODUCTION Freely circulating knowledge is sometimes held up as the perfect example of a global public good. It is both worldwide and intergenerational. It is a legacy par excellence (except in cases of historical cataclysm like the fall of the Roman Empire). Yet certain forms of knowledge – invention in particular – cannot be produced without making, at least temporarily, this global public good into a ‘club’ good.1 The opening section of this chapter analyses the tensions between the resulting club good and the public good, their effects and possible regulatory solutions. At the same time, knowledge is a necessary precondition for the production of other global public goods. In that respect, it generally assumes the form of uncertain knowledge. Neither deterministic, nor quantifiable in terms of objective probabilities, it might best be described as ambiguous. This is particularly due to the magnitude and functional complexity of global public goods. The decision to produce these goods requires that a crucial question be answered: what theoretical and empirical characteristics must this uncertain knowledge have in order to constitute an acceptable basis for decision making? The closing section of this chapter provides some responses to this question based on two particularly significant examples – climate change and the effectiveness of antibiotics. These two examples also bring to light a common temptation for decision makers to make use of uncertainty as an excuse for inertia well beyond what seems reasonably justified relative to the uncertainty in question.

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PRODUCING KNOWLEDGE AS A GLOBAL PUBLIC GOOD Some items of knowledge are potentially at the disposal of all humanity, without their use in one place diminishing the possibility of their use in another: the theory of relativity, the molecular structure of DNA, medicine, or the specifications of an electronic component. For this reason, they are global public goods. Their production, involving a process of accumulation, depends fundamentally on their unrestricted availability. Sir Isaac Newton liked to say that if he had been able to see further, it was because he had stood on the shoulders of the giants who came before him. This image expresses well the movement of the production of new knowledge from already available knowledge. It can be misleading, however, if it suggests that the number of places on the giants’ shoulders is limited and that access to those places implies rivalry. Knowledge is a public good, because there is room for everyone who wants to stand on the giants’ shoulders. The rivalry comes later, in exploiting to the fullest the possibilities of further discovery or invention provided by this available knowledge. Far from contradicting the reality of knowledge as a public good, this rivalry is one of the strongest driving forces of its production. Rivalry in the pursuit and renewal of knowledge, and freely available, sufficient material resources corresponding to the needs of discovery and invention, are the fuel of knowledge. Knowledge thus advances in a process of self-sustaining growth (even Newton needed the resources of Trinity College: the means of existence, the library, the contacts, not to mention the famous garden). This process has been responsible for most discoveries and a large portion of inventions throughout history. However, for many inventors – and particularly for the firms that employ them – to contribute to the production of a public good is not motivation enough. The material and human resources invested must provide a sufficient financial return. Under such circumstances, public goods are transformed into club goods. An example of a ‘club’ is a company which holds a patent on an invention and which does not grant any licences (which is legal, unless the regulator intervenes to impose compulsory licences; see below). This transformation is temporary as the patent is only granted for a limited period, generally 20 years, following an agreement of the member countries of the World Trade Organization (WTO).2 However, given the pace of scientific and technical progress, particularly in life and information sciences and techniques, 20 years is a very long time. Thus there is a conflict between the nature of global public goods and their transformation into club goods, which, in many cases, is necessary as

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an incentive for production. There is also a conflict between this transformation and the exercise of sufficient competition on the market for the goods and services produced by the firms that were licensed by the inventor. This is especially true if their spheres of activity are cut off from one another (for example, geographically or by the nature of the product), which is in the inventor’s best interest for maximizing the returns on the licences he or she grants. This temporary monopolistic power is often considered as the inevitable price to pay for the invention to be produced, but it is not the only one, nor the most important. There are, however, some cases, which I will come back to later, that reveal the abuse of power and dominant positioning. Joseph Schumpeter (1934) underlined that competition is a powerful factor of innovation; he called the most radical form of this competition ‘creative destruction’. Yet this competition is weakened if control of a discovery or an invention prevents its free use as a springboard for other discoveries and inventions. As Paul David has indicated, this control prevents ‘elements of knowledge from being quickly rearranged and recombined for new and fecund trajectories’ (David, 1993, p. 29). In other words, it is inefficient to ration the places on the giants’ shoulders. Philippe Aghion and his co-authors3 recently added a new argument more in favour of public goods than club goods: when competition is very vigorous (‘neck-andneck’ as the authors say) in a hotly contested market, firms have a strong incentive to innovate in order to escape competition; this competition cannot be vigorous, however, if the possibility to produce is restrained by a competition reduction mechanism, such as patent licences granted within the framework of a profit-maximizing strategy. In summary, there is a high price to pay for managing knowledge as a club good; paradoxically, for certain forms of knowledge to be produced, they must necessarily be managed as such. Where should the line be drawn? Traditional law on the protection of intellectual property used to draw a rather clear line between discoveries that cannot be patented and inventions that can, on the condition that they satisfy the equally traditional criteria of novelty, non-obviousness (for a specialist in the field) and utility (sometimes qualified as ‘industrial’). As John Barton (2003)4 shows, however, the major patent offices (US, European, Japanese) and the special courts (especially the US Court of Appeals for the Federal Circuit5) have rendered the distinction between discoveries and inventions more or less null and void legally. It is thus necessary to turn to the characteristics of patents in order to find tools to achieve a balance between club goods and public goods. Since the duration of patents is set institutionally, almost everything depends on its other fundamental characteristic – scope.

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The scope of a patent can be measured by the minimum degree of differentiation (vertical, horizontal or in production costs) that a new product must display in relation to the products already on the market without contravening the patent concerned. There is thus a protection zone outside of which competitors must position themselves for innovating. Their efforts can nevertheless be made easier by the requirement that patent holders give a clear and sufficiently documented description of their methods and results. This information is made public by the patent offices. If the scope of the patent is not too broad, this revelation of pertinent information is a better springboard for future innovations – and is in line with the nature of knowledge as a public good – than a secret, which could be used as a means of protection in the absence of a patent. On the other hand, if the scope of the patent is too broad, it reserves for the patent holder, or his or her licensees, all kinds of future possibilities (during the duration of the patent) to innovate across the entire field covered by the patent – a situation, as noted above, which is very unfavourable to innovation.6 How can the scope of a patent be correctly calibrated, or in other words, in deciding on the scope, how can a satisfying compromise be reached between public goods and club goods? Theoretically, economic analysis provides answers by characterizing an optimal scope.7 The optimal scope of the patent is all the narrower: ● ● ●

●

the lower the cost of the discovery or invention; the more non-financial incentives there are to discover or invent; the fewer close substitutes there are for the products, whose production is made possible by the patented discoveries or inventions; and, more importantly, the larger the number of subsequent discoveries or inventions that are dependent on the patented discovery or invention.

These attributes are significant economic elements that tend to justify the legal tradition, currently out of favour, which consists in refusing to patent discoveries. Indeed, a discovery can be very costly, but it mobilizes nonfinancial incentives (academic competition, for example) much more often than most current inventions and is less likely to have substitutes. The identification of genes and their functions in controlling the expression of proteins in living organisms is a clear example: the purely economic arguments indicated above lead to the recommendation of zero scope, in other words, non-patentability.8 However, another factor needs to be taken into account: if there is a club good, or if a patent has been granted and licences negotiated, is it a restricted licence or a broad one? The Boyer–Cohen patent9 covers some of


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their most fundamental results and has been of immense utility to biochemical research and biotechnical applications. The patent holders mostly granted non-exclusive licences at a modest price and have never opposed its free use for non-profit research. However, a fundamental invention or discovery that is made available universally and freely is even more efficient for the development of future research and applications: such is the case of the Kohler–Milstein (1975) method for the in-vitro production of monoclonal antibodies. This method opened up profound new possibilities not just in fundamental research,10 but also for the fine-tuning of very precise diagnostic devices in medicine. Kohler and Milstein received the Nobel Prize in medicine for their work, which was entirely funded by the Laboratory of Molecular Biology at Cambridge (UK) where they worked. Such favourable circumstances for managing knowledge as a public good do not always exist, however, and so, in other circumstances, the Boyer–Cohen approach constitutes a lesser evil with an acceptable social cost. What can be done, however, when licences are refused or are very restrictive for a patent on an essential discovery or invention?11 For example, the company Myriad Genetics (Salt Lake City, Utah, USA) refuses to sell licences for its patent, which covers the mutations of the BRCA1 and BRCA2 genes. These mutations indicate a significantly higher propensity for breast cancer. The legislation in many US states, along with the TRIPS agreements (trade-related aspects of intellectual property rights) within the framework of the WTO, open up the possibility for a competent public authority – which will be called the ‘regulator’ here – to impose the issuance of compulsory licences at a price that it sets. This arrangement brings to mind access royalties to an essential facility, like a high-voltage electrical network, that a regulator (in this case, the electricity or energy regulator) can pricecap, if without regulatory intervention the access conditions to the network would distort competition in the sector. It is often for the abuse of dominant position (or a threat of abuse) that the public authorities in the USA have imposed compulsory licences.12 They have also done so in the electronic and aeronautic sectors for national security reasons. Furthermore, in 2002, the US public authorities threatened the German company Bayer with a compulsory licence on the only effective anthrax medicine if Bayer did not make this medication available to the USA in sufficient quantities and at a much more moderate price than its patent allowed. The Canadian authorities have also used compulsory licensing for competitive reasons, but more often within the context of their health policy. In Europe, many countries, including France, potentially have access to the same kind of regulatory instruments. Many developing countries, on the other hand, relinquished this possibility under pressure from the USA

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at the time of the transcription of the TRIPS agreement into their respective national laws.13 Today, the transfer of knowledge counts for far more than the development aid the developed countries give them. Having signed the TRIPS agreement, the developing countries that have abdicated the faculty of imposing compulsory licences have in fact renounced their main source of scientific and technical transfer.

SCIENTIFIC UNCERTAINTY, KNOWLEDGE AND PRODUCTION OF GLOBAL PUBLIC GOODS The production of global public goods has well-known handicaps that are mostly due to the absence of an arbitration authority at the global level, analogous to a national government, endowed with democratically legitimated power to raise appropriate resources. In this section, I shall display an additional informational handicap: given the magnitude and functional complexity of global public goods, the understanding that one has at any given moment is inevitably uncertain (in the sense that it cannot be expressed in purely deterministic terms or relations where the uncertainty can be described using purely objective probabilities). Uncertainty can justify the deferment of premature decisions; but it can also serve as an excuse for unjustified postponements. This ambivalence is the root of the informational handicap affecting the production of global public goods. Of the numerous examples in which this obstacle is present, I have chosen to discuss two: climate change and the therapeutic effectiveness of antibiotics. Climate Change The climate is a global public good, produced by mankind, in that people have it in their power to be less destructive by reducing manmade greenhouse gas emissions (the accumulation of greenhouse gases in the upper atmosphere is at the origin of climate change). This fact seems to be well established, but too general and too imprecise to be operative. What else, and how else, do we know about the conditions of production of the greenhouse effect? In this case, the scientific basis of our knowledge is provided by the research of the Intergovernmental Panel on Climate Change (IPCC). Climate change will emerge principally in the form of higher temperatures, stronger and more chaotic hydrological cycles, a rise in sea level and some possible ‘surprises’, such as, for example, the weakening in thermohaline circulation. To estimate these effects, the IPCC has distinguished six greenhouse gas emission scenarios in the context of several climatic models.


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The main results, reported in the third and most recent IPCC report (it was released in 2001; the next one is expected in 2006) are the following: ●

● ●

the concentration of CO2 (the principal greenhouse gas) in the upper atmosphere will reach levels between 540 and 970 ppm by 2100, that is to say between 1.5 and 2.7 times the level in 1990;14 between 1990 and 2100, the average global temperature will increase from 1.4 °C to 5.8 °C; the average sea level will increase from 0.09 to 0.88 metres over the same period.

These changes will be more significant than anything the planet has experienced in the last 10 000 years, and too rapid for the fauna and especially the flora to adapt properly. In certain places, the changes could be even more pronounced (accelerated desertification, or on the contrary, a spectacular increase in violent rainstorms, a rise in parasitic illnesses towards the north, and so on). The uncertainty of the geographic distribution is currently too great for such maps to be seriously drawn up. What is the reason for this uncertainty? Several critical factors are fundamentally uncertain: the intensity of greenhouse gas emissions (for example, the CO2 emissions between 1990 and 2000 were markedly higher than they had been imagined at the beginning of the decade); the impact of clouds and aerosols (for example, we have discovered that, paradoxically, we will regret, from the viewpoint of climate change, having reduced the emissions of SO2 and NOX, because the presence of these gases in the lower atmosphere tends to reduce the greenhouse effect); the capacity of oceans to stock CO2 (if there were a threshold at which oceans start to release CO2 rather than stock it, which we do not know, the rhythm of the concentration in the atmosphere would greatly accelerate); the capacity of new technologies to stock CO2 in large quantities in the earth or in rocks (some researchers cherish great hope on this subject); and, of course, the natural variability of the climate. No probability distribution, whether objective or subjective, can be directly associated to the possible magnitude of these critical factors; the same obviously goes for the climatic changes compiled above. In that sense, the science of climate change is uncertain. It is thus essentially different, for example, from the physics of the disintegration of particles in large accelerators (disintegration products are perfectly predictable in terms of objective probabilities) or from the determinism that has been shown to characterize protein expression by genes. Nevertheless, the science of climate change is sufficiently structured and based on empirical observations (even in glacial core samples in which fossil CO2 has been trapped) for

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certain limits to be set for this uncertainty with reasonable confidence. These limits are not set by the canonical methods of scientific investigation carried out under the controlled conditions of a laboratory and guided by stabilized and exhaustive theory. However, they are the result of a process of methodological scientific production that is subjected to critical scrutiny, and which leaves no room for scientific illusions or unverifiable predictions. The IPCC is an international group of scientific experts working under the aegis of the United Nations and the World Meteorological Organization. These scientists are selected by their peers, country by country, and their appointment is simply confirmed by their respective governments. Their work is organized into subgroups according to research field. These subgroups collate their results and gather them into periodically published reports (1990, 1995, 2001). To do this, they collect available pertinent data from all over the world, produce new data as needed, and from this, mobilize their respective expertises (in physics, chemistry, biology, ecology, economy, and so on) to evaluate the various elements and consequences of climate change. All this seems to indicate that the IPCC’s continuous process of investigation contributes to the theoretical and empirical scientific knowledge of climate change in a rigorous, systematically organized and well-monitored way. The physicist John Ziman characterizes scientific credibility in the following way, ‘The credibility of science depends as much on how it operates as a collective social enterprise as it does on the principles of regulating the type of information that this enterprise accepts and transforms into knowledge’ (Ziman, 2000, p. 132). It seems that the work of the IPCC is favourably placed with respect to both these criteria, and that its findings constitute a basis justifying a significant reduction in greenhouse gas emissions, that is, the significant production of the climate as a global public good (or more precisely, climate quality). The basis of this argument, however, does not possess all the attributes of canonical science; its call for action is thus contestable. It was on such grounds that the US government rejected the work of the IPCC as scientifically unfounded. In 2003, the Bush administration produced its own plan to understand the perspectives of climate change better and face the issues involved. This plan was examined by an expert panel put together by the National Academy of Sciences. According to The New York Times (1 March 2003), ‘The panel described Mr. Bush’s plan as a redundant examination of issues that had largely been settled; bereft of vision, executable goals and timetables – in short, little more than a coverup for inaction’.


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Antibiotics in Animal Feed The problems arising from adding antibiotics to farm animals’ feed are less spectacular than climatic problems, but no less significant. The fact that the administration of antibiotics in sub-therapeutic doses promotes animal growth was recognized at the beginning of the 1950s, and quickly exploited on a large scale throughout Europe and North America. Could this practice present any dangers? Darwinian theory suggests a positive response. In a different context, but with general pertinence, Alexander Fleming gave his own warning against the uncontrolled use of penicillin, cautioning in an interview with The New York Times in 1945, ‘germs will learn to resist penicillin’. This reference to natural selection, though pertinent, was too general. It suggested a course of investigation, but could not, in itself, constitute the scientific basis of a strategy. In particular, it was necessary to understand how administering an antibiotic to cattle affected other antibiotics in the human body. Several antibiotics used as nutritional additives corresponded to certain therapeutic antibiotics used in human medicine. Two antibiotics correspond to each other if they have similar molecular structures and closely related modes of action. In 1968, there were enough positive experimental data based on available theoretical and empirical research for a commission, created by the British government under the chairmanship of Professor Michael Swann, to recommend a ban on three specific antibiotics from animal feed due to their similarity with antibiotics used or recently approved in human medicine. These recommendations went uncontested, except in agricultural circles and pharmaceutical companies. Nevertheless, they also went largely unheeded in the UK and the European Union as a whole. It was first in Sweden, but not before 1997, that things began to change. At that time, more and more Swedish farmers were becoming worried about progressively losing consumers’ trust. A commission created by the Swedish government quickly produced a report recognizing ‘that the risk of an increased resistance associated with the general use of antibiotics for growth purposes is far from insignificant and could have potentially serious consequences on the health of humans and animals’. The Swedish commission underlined that this scientific knowledge was sufficient in justifying these conclusions, even if the causal links between the absorption of an antibiotic by animals and the resistance of another antibiotic in the organisms of the consumers of those animals were not completely elucidated. In response, the European Union Council of Agricultural Ministers banned four antibiotics from animal feed (in which two had already been identified 30 years earlier by the Swann commission) in 1998, presenting its

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decision as ‘a precautionary measure that aims to minimize the risk of the development of resistant bacteria and to preserve the effectiveness of certain antibiotics used in human medicine’. The USA continues to contest the scientific validity of these theoretical and empirical elements, which seem convincing to Europeans. Concerning antibiotics, it appears that a proper scientific basis was available well before adequate decisions were made, as is often the case. The basis was proper in the sense that a theoretical model, without doubt incomplete but which took into account the principal elements of reality, existed and was consistent with empirical, non-anecdotal data. It is on comparable, and perhaps even weaker, scientific grounds that important medical decisions are routinely made. We can thus seriously advance the hypothesis that the nature of knowledge leads to a bias that systematically undermines the production of global public goods. These two examples reveal clearly two types of requirement of completely general import. First, there are epistemological requirements that must be satisfied by the available knowledge, so that even though uncertain, this knowledge can serve as a basis for actionable decision making; and second, there are institutional requirements that are necessary to neutralize the strategic use that is made of the uncertain character of knowledge, with the aim of stalling any action, or in other words, blocking the production of the global public goods at stake.

NOTES 1. 2. 3. 4.

5. 6.

7. 8.

For a discussion on the classification and range of public goods, see Todd Sandler (2004). Exceptions are possible. For example, it can take up to five or six years for some medicines to be authorized by the health authorities and placed on the market. See Aghion et al. (2001), and Aghion (2003). John Barton, Professor of Law at Stanford University, with Robert Merges, is the most eminent US lawyer on intellectual property matters. He presided over the British Royal Commission, which studied the integration of intellectual property laws in development policy; see Commission on Intellectual Property Rights (2002). With dual expertise in science and law, Barton’s analyses and propositions concerning intellectual property are very precise and pertinent. Since the creation in 1980 of the Court of Appeals for the Federal Circuit in the USA, its influence has been far-reaching, as it has had a strong tendency to always grant longer extensions on patentable material and a wider scope on patents. In a painstaking legal as well as economic analysis on the scope of patents granted in the USA Merges and Nelson (1990) come to the conclusion that ‘when a broad patent is granted, its scope diminishes incentives for others to stay in the invention game’, compared with ‘a patent whose claims are trimmed more closely to the inventor’s actual results’. Among the most significant contributions see: Merges and Nelson (1990), Scotchmer (1991), Chang (1995), Denicolo (2002), Gallini and Scotchmer (2002). See Barton (2003), as well as Henry et al. (2003).

Knowledge as global public good 9.

10. 11.

12. 13. 14.

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Herbert Boyer (University of California at San Francisco) and Stanley Cohen (Stanford University) were the first to transfer artificially an exogenous DNA fragment to a bacterium, so that the bacterium could, from that point on, produce at will proteins expressed by this DNA fragment (for example, human insulin); this is the fundamental process of genetic engineering. At Stanford, Irving Weissman and his team separated blood cells using the Kohler–Milstein method, and then identified the different kinds of cells; they were the first to isolate stem cells. Essential in the sense that one speaks about essential facilities in public utilities: the highvoltage network is an essential facility for the electric sector; it cannot be duplicated, and without access to this network most of the other sectors’ activities are made impossible. See Henry and Matheu (2001). On the tension between the protection of intellectual property and the promotion of competition, see Anderson and Gallini (1998). All countries, both developed and developing, with the exception of the poorest, implemented the TRIPS agreement in January 2005. Reference year taken from the Kyoto Accord; see Guesnerie (2003) for the economic aspects of greenhouse gas emissions.

REFERENCES Aghion, P., C. Harris, P. Howitt and J. Vickers (2001), ‘Competition, imitation and growth with step-by-step innovation’, The Review of Economic Studies, 68 (3), 467–92. Aghion, P. (2003), ‘Empirical estimates of the relationship between product market competition and innovation’, in J.-P. Touffut (ed.), Institutions, Innovation and Growth: Selected Economic Papers, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Anderson, R. and N. Gallini (eds) (1998), Competition Policy and Intellectual Property Rights in the Knowledge-based Economy, Calgary, Alberta, Canada: University of Calgary Press. Barton, J. (2003), Patents and the Transfer of Technology to Developing Countries, OECD Conference on IPR, Innovation and Economic Performance, Paris, 28–29 August. Chang, H.F. (1995), ‘Patent Scope, Antitrust Policy, and Cumulative Innovation’, Rand Journal of Economics, 26 (1), 34–57. Commission on Intellectual Property Rights (2002), Integrating Intellectual Property Rights and Development Policy, London: UK Department for International Development. David, P. (1993), ‘Intellectual Property Institutions and the Panda’s Thumb: Patents, Copyrights and Trade Secrets’, in M.B. Wallerstein (ed.) (1993), Global Dimensions of Intellectual Property Rights in Science and Technology, Washington, DC: National Academy Press. Denicolo, V. (2002), ‘Two-stage Patent Race and Patent Policy’, Rand Journal of Economics, 31 (3), 488–501. Gallini, N. and S. Scotchmer (2002), ‘Intellectual Property: When is it the best incentive system?’, in A. Jaffe, J. Lerner and S. Stern (eds) (2002), Innovation Policy and the Economy, vol. 2, Cambridge, MA: MIT Press. Guesnerie, R. (2003), Kyoto et l’économie de l’effet de serre, Rapport du Conseil d’Analyse Economique, Paris: La Documentation française.

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Henry, C. and M. Matheu (2001), ‘New Regulations for Public Services in Competition’, in C. Henry, M. Matheu and A. Jeunemaitre (eds) (2001), Regulation of Network Utilities: the European Experience, Oxford: Oxford University Press. Henry, C., M. Trommetter and L. Tubiana (2003), ‘Innovations et droits de propriété intellectuelle: quels enjeux pour les biotechnologies’, in J. Tirole (ed.) (2003), Propriété intellectuelle, Rapport du Conseil d’Analye Economique, Paris: La Documentation française. Kohler, G., and C. Milstein (1975), ‘Continuous cultures of fused cells secreting antibody of predefined specificity’, Nature, 256, 495–7. Merges, R., and R. Nelson (1990), ‘On the Complex Economics of Patent Scope’, Columbia Law Review, 90 (4), 839–916. Sandler, T. (2004), Global Collective Action, Cambridge, UK and New York, USA: Cambridge University Press. Schumpeter, J. (1934), The Theory of Economic Development, Cambridge, MA: Harvard University Press. Scotchmer, S. (1991), ‘Standing on the Shoulders of Giants: Cumulative Research and the Patent Law’, Journal of Economic Perspectives, 5 (1), 29–41. Ziman, J. (2000), Real Science, Cambridge: Cambridge University Press.

7.

Global public goods and global finance: does global governance ensure that the global public interest is served? Joseph E. Stiglitz

INTRODUCTION This chapter focuses on some aspects of global public goods and global finance relating to global governance. The central question it addresses is whether global governance, that is, the way decisions are made in the global arena, ensures that the global public interest is served. Global public goods and their externalities constitute powerful tools for the analysis of global governance, its institutions and their flaws, the fundamental problems of market failure in the provision of global public goods, and potential solutions. I shall explore these issues through an analysis of the global economy, the global financial system and its principal international economic institutions. I examine two specific policies of the International Monetary Fund (IMF), and highlight problems relating to the global reserve system. In conclusion, I shall argue the case for special drawing rights (SDRs) and make some remarks on mechanisms for financing the provision of global public goods.

BASIC CONCEPTS The concept of global public goods lies at the core of the issues that I shall discuss.1 Public goods have two critical properties: non-rivalrous consumption and non-excludability. They may be pure or impure, and the scope of their application may vary. Some discussion of these terms will be valuable for the development of my argument.

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Pure Public Goods Paul Samuelson is credited with the idea of pure public goods.2 In his 1954 paper, he identified the defining properties of non-rivalrousness and non-excludability. These are most naturally explained in terms of consumption.3 The property of non-rivalrous consumption means that consumption by one individual does not detract from consumption by others. The Jefferson Memorial in Washington carries a powerful metaphoric example of nonrivalrous consumption: knowledge is a candle, which, in lighting other candles, does not diminish its own light. That is a poetic expression of the idea of non-rivalrous consumption: when I learn a piece of knowledge, that same piece of knowledge is still there for others to learn. Furthermore, knowledge is a non-excludable good: no one can be excluded from consumption of the good. For example, as soon as a mathematical theorem is published, it can be enjoyed by everyone. This non-excludability is the second defining property of a public good. Non-excludability means that it is difficult or impossible to exclude any individual from enjoying the good in question. Knowledge is one of the most important examples of a public good.4 Impure Public Goods There are many public goods that are not pure public goods, where there is some degree of rivalrousness or excludability. For example, since the returns to some forms of knowledge may be appropriated through patents or trade secrets, and hence there is some degree of excludability, knowledge is often conceived as an impure public good.5 There are also many goods provided by the public sector which are not really public goods. I have referred elsewhere to these as publicly provided private goods. Simply because a good is in the public sector does not mean it is a public good. The issue of which goods are in the public sector, and which are not in the public sector, that is, the extent to which a good exhibits the defining properties of a pure public good, is of critical importance. Local Public Goods6 The range, region, or locale over which its benefits are conferred is a further important feature of a public good. For example, there are local public goods, whose benefits are enjoyed only by those in the locality. Examples include a local clean river, or a local fire or police department.

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There are also national public goods. National defence is an example of a public good having a defined region: the defence of a country involves the defence of everyone in that country. Most of the public goods discussed in traditional textbooks have been national public goods, which benefit the entire national economy or society.7 More recent debate has started to focus on the analysis of global public goods, whose benefits are enjoyed by everyone on the planet. In Stiglitz (1995), I list five examples of such global public goods: international economic stability, international security, the global environment, international humanitarian assistance, and knowledge. Provision of Pure Public Goods: Market Failures One of the reasons why pure public goods are typically provided in the public sector is that if there is no public sector provision, then there will be an under-supply. By the same token, one of the standard arguments why pure private goods are provided by the private sector is that if markets are working well, then the market provision of those goods is efficient. It is important to emphasize that, generally, there is a market failure whenever a pure public good is involved. The reason why no adequate supply of these goods is available is sometimes formulated as the free-rider problem: if I cannot be excluded from the non-rivalrous benefit of the publicly available good, why should I pay? I shall free-ride on the provision of others. Since everyone has an incentive to free-ride, there is a strong tendency towards under-provision of pure public goods. Public Goods: Externalities One further aspect of public goods will be relevant in my analysis of global decision making and international public policy. Goods involve externalities. Externalities are actions by one party that have effects on other parties. They fall into two categories. Positive externalities are those where others bear the effects without the active party receiving compensation; negative externalities are those where others bear the effects, but for which the active parties do not pay compensation. The outcome of R&D is an example of a positive externality, where ideas make others better off, perhaps enabling the production of goods at lower cost; however, in research, the originator of the ideas may not be fully compensated. Pollution is an example of a negative externality: polluters do not pay compensation to those bearing the effects of the polluting activities. The reach of externalities, like that of public goods, can be local, national or global. The externality of pollution from greenhouse gases is global.

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Externalities and Market Failures As in the case of pure public goods, there are market failures in externalities. Markets produce too little of the goods with positive externalities. The private incentive to produce the good is attenuated, because the private producer does not receive all the benefits of its production. There is too much incentive to produce goods with negative externalities, because the producer does not pay for the damage that is done to others. In both cases, markets do not deliver an efficient level of resource allocation. Whenever market failure occurs, whether in public goods or externalities, there is a potential role for government. Government actions can take on a variety of forms: taxes and fines, regulations, and government expenditures. These interventions are potentially more efficient than pure market solutions.8

A GLOBAL PUBLIC GOOD: THE GLOBAL ECONOMY As noted in Stiglitz (1995), examples of global public goods and global externalities are reasonably abundant: security (political stability), economic stability, the environment, humanitarian assistance, and knowledge.9 Indeed, one of the reasons for creating the United Nations was to have a means, at the global level, of controlling international security and its externalities. I shall examine the example of the global economy as a global public good in more detail. In that example, the global public goods of economic stability and international standards interact in a significant way. Global Economic Stability Global economic stability has long been recognized as possessing an international externality: a downturn in the economy of one country can have effects on the economies of neighbouring countries. The institutions that were created in the aftermath of the Second World War were intended to enhance international economic stability. Everyone benefits when the global economy is strong; many people suffer when the global economy is unstable or weak. It is a global public good. Global Standards Global standards are also global public goods. Establishing a set of standards enhances the efficiency with which market economies can function. Standards mean uniform practices and common ways of doing things.


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Furthermore, huge advantages are associated with the establishment of industry standards.10

GLOBALIZATION AND COLLECTIVE ACTION It is a trivial observation that globalization is increasing. A consequence of this increase is that countries of the world are closer together and more closely integrated. This has resulted from the lowering of transport and communications costs and the reduction in a whole variety of manmade barriers. As globalization increases, so global public goods and their externalities become more important. The global economy assumes increased importance. A further consequence of this interdependence is a greater need for collective action. There are more areas where the actions of firms of one country have effects on others. The birth of the global community increases the potential for global public goods and international externalities, both positive and negative. Hence there is a correlative increase in the scope for collective action. Global Governance: Treaties and Institutions The problem is that collective action requires mechanisms for decision making. These mechanisms are called governance. We have developed over the decades an ad hoc system for decision making and international public policy, which I call global governance without global government. While we lack the formal structures of a full global government, similar to that of each of the nation states or localities, there exists, nevertheless, a complicated set of arrangements which we call governance. This includes a variety of international treaties (for example, Montreal, Kyoto), and a framework of international law. Many treaties include decision-making parts. In addition, we possess international institutions, such as the International Monetary Fund (IMF), the World Trade Organization (WTO) and the World Bank. Many essential global economic decisions are taken within these economic institutions. International economic institutions: undemocratic and opaque My concern is that these international economic institutions are very badly flawed. They are undemocratic and opaque. In the first place, the principal international economic institutions are undemocratic. Of course, the institutions would deny these charges, pointing to the existence of voting procedures under rules. My point is that, for example, in the IMF, which makes decisions that affect people all over the

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world, there is only one country that has the power of veto: the USA. Voting rights are based on economic power, as of the end of the Second World War, with some adjustments. Countries that have grown fast in the last 50 years are underrepresented. These institutions are also non-transparent. In responding to the criticism of opacity by developing better websites, these institutions simply permit one a retrospective vision of their actions after these actions have been completed. The idea that one might be entitled to, or wish to have, a prospective vision prior to execution is an unfathomable concept for these institutions. The contrast between national and international institutions in this regard is very marked. In the USA, there is the Freedom of Information Act, reflecting the basic perspective that the government is supposed to be working for the people. Citizens have a right to know what the government is doing. A US citizen can request from any government agency information about what that agency is doing and the papers supporting its decisions. Access to information is widespread and very important. The press relies on it. In my view, this principle is a pillar of American democracy. However, US or French citizens cannot find out how their representatives in the IMF or the World Bank vote. That is a secret. There have been cases where the US Congress has instructed its representatives to vote in one way, only for them to vote in another. The representatives could get away with this disregard, because the US Congress did not know how they had voted. On the positive side, these institutions leak very badly, so eventually the information does become available. International economic institutions: smokestack structures A further problem with the international institutions, in some ways more deeply troubling, is that they have a smokestack structure. That is, the WTO is run by trade ministers and the IMF by finance ministers and Central Bank governors. This is in stark contrast with decision making within our own democracies, where all the relevant decision makers are assembled around the table: Trade, Labour, Treasury, Commerce, the Justice Department, the Office of Science and Technology Policy, and so on. Some are more influential than others, but the voice of each is heard. In the international arena, this is not how decisions are made. Only the finance ministers and Central Bank governors are involved in making decisions about the global financial system. In trade decisions, only the trade ministers are present. If the trade ministers are debating an issue whose environmental consequences are important, those consequences are given very little weight. For example, in the Uruguay Round of the discussions on the TradeRelated aspects of Intellectual Property Rights (more commonly known as


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the TRIPS agreement), there were very serious consequences for science, health and less developed countries. As negotiations progressed, the Council of Economic Advisers and the Office of Science and Technology Policy in the White House both strongly opposed the position that the US trade representative was taking in the TRIPS agreement. The US trade representative paid little attention to this opposition, because he was bargaining. His ‘trust me’ attitude expressed the fact that, in bargaining, he was paying attention to the drug companies and the entertainment industry. The result was an agreement that was bad for science, even worse for the developing countries, and terrible for health. A consequence of the smokestack structure of these international institutions is that relatively narrow representation provides many opportunities for special interests to prevail. The outcomes of these processes therefore often fail. These failures are no surprise to me. Corollaries: Two Problems The principal problems associated with the above weaknesses of the international economic institutions and their failures are twofold. First, critical global market failures are not addressed. There are some global public goods that ought to be provided and global externalities that need to be addressed. Too often, these are not. Second, attempts are frequently made to use the international arena to achieve objectives that have little to do with correcting global market failures. In addition, the processes in international institutions provide opportunities to attempt to achieve in the global arena what could not be achieved at home, precisely because the international institutions are less democratic and less transparent.

THE GLOBAL FINANCIAL SYSTEM AND THE INTERNATIONAL MONETARY FUND The global financial system is the entity that I shall use to examine in greater detail these issues and the failures of provision of global public goods and externalities. At the end of the Second World War, the central problem was recognized that an economic downturn in one country hurts the economies of other countries. To understand the creation of the IMF, one has to return to the Great Depression of the late 1920s and early 1930s. Many observed that the global economy only exited the Great Depression through the Second World War. As that war came to an end, there was a worry that the world would regress into recession and under-consumption. The international

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economic institutions were established to prevent that from happening. There was recognition that the problem was neither local nor national, but global. There was also recognition of the market failure associated with the international externality. John Meynard Keynes was very clear that when there is an economic downturn, the economy must be stimulated, and since monetary policy very often does not work, deficit spending is necessary. There was a problem, however: deficit spenders must be able to borrow money, and many countries found it difficult to do so. Creation of the International Monetary Fund The remedy was to create the IMF, whose original mandate was to provide funds to countries to enable them to have stimulatory fiscal policy in the event of an economic downturn. It was also intended to exert peer pressure to ensure each country maintained as close to full employment as possible, recognizing that the benefits of full employment accrue not only in that country, but also in its neighbours. International Monetary Fund policy 1: contraction There are strange tides of history: the world did not work out that way. Global capital markets do not function the way they are pictured in textbooks. Capital market imperfections make it difficult for countries to finance expansionary fiscal policy. Indeed, Keynes worried about how the situation might develop for a reason that I shall consider below. The IMF, rather than fulfilling its primary mandate of financing expansionary fiscal policy, typically only provides money when a country agrees to follow a contractionary policy. In effect it advises countries in recession to make their recessions deeper. The policies that were such a worry in the years of the Great Depression were called beggar-thy-neighbour policies: countries, seeing their economies sink, imposed tariffs so as to reduce foreign spending and increase domestic spending. However, by shutting down imports from their neighbours, the countries made those neighbours worse off. The IMF has come up with something even worse: beggar-thyself policies. In making their neighbours worse off, the countries do not make themselves better off. Their contractionary policies cause economic decline, thereby reducing imports from neighbouring countries, so their export trade suffers and their economy declines too. Everyone loses. Beggar-thy-self policies were visible in the disastrous consequences of the crisis in East Asia. Although the issues are complicated, the essential problem, and one to which Keynes was sensitive, concerns governance and decision making. The USA is the sole country with veto power. It is represented by the Treasury,


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not by the President, nor the Department of Labor, nor the Council of Economic Advisers. Historically, financial markets have taken a traditional position that is dominated by strongly anti-Keynesian perspectives. The Treasury maintained during the Great Depression that the remedy was to cut expenditures and eliminate the deficit. The decision whether to make the economy a global Keynesian institution was turned over to policy makers who were anti-Keynesian. The result was anti-Keynesian policies. Moreover, the particular anti-Keynesian strategy of the decision makers was consistent with the ideology that markets worked over time, and that, given sufficient time, the economy would recover, provided the size of government was kept small. It was also consistent with the interests of the decision makers. My experience is that Central Bankers, when they habitually remark that there are big asymmetries between unemployment and inflation, then proceed to assert that, while one of these policies leads to long-term damage that is difficult to reverse, it is inflation that is the really dangerous threat: people get over unemployment. Each view has a grain of truth. Clearly, the Central Bankers’ mindsets are focused on inflation and the cost to those who lose their wealth more than the cost to the people who lose their jobs. In other words, inflation is bad for bond markets, hence inflation is the real enemy. The advantage of the IMF strategy for the creditors is also quite clear: recessions lead to a cut-back in imports, a build-up of reserves, which facilitate the repayment of creditors. After the crisis in East Asia, if repayment was the objective, the policies of forcing Korea and Thailand into depression worked because, as these countries went into recession, their imports were reduced enormously, reserves were rebuilt in an incredibly short time, and creditors could be repaid in the blink of an eye. Originally, the IMF possessed a broader set of objectives than to help countries going into an economic downturn. Its goal was to create a global economic system with greater stability. Analysis of the achievements of the IMF, however, reveals that it has created just the opposite, a global economic system with greater instability. In bringing this about, the key policy that the IMF championed was capital market liberalization. International Monetary Fund policy 2: capital market liberalization In 1997, at a meeting in Hong Kong, the IMF argued for a change in the charter to require all countries to open up their markets completely to speculative hot money that could enter and exit overnight. The timing could not have been worse: it was universally known that East Asia was about to have a crisis caused by hot money movements. As an academic, I was struck by the fact that no evidence was provided to support the claim that countries ought to be forced to accept capital market liberalization (CML). No studies showed that CML would lead to faster economic

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growth in the developing world. At the World Bank, we had already undertaken some studies which had shown that CML leads to greater instability for the most obvious reasons: hot money destabilizes economies. Over the following six years, the examples came rolling in to corroborate this fact. The IMF, however, did not need evidence. It had an ideological position. This had nothing to do with a global public good or a global externality. The IMF was actually creating a negative global externality through public institutions, in covert pursuit of its own private interest. A study written later by Dani Rodrik (2000) at Harvard showed that in fact CML led to more instability and did not lead to faster economic growth. It was risk without reward. One of the ‘advantages’ of the IMF is that it does economic ‘experiments’ around the world. The IMF has now given us data on approximately 100 countries with crises in the last 30 years. Analysis of the data provided by these countries reveals that capital and financial market liberalization is systematically related to their instability. This provokes the question of why the IMF exceeded its original mandate and promoted capital market liberalization. It was not necessary to make the ‘international order work’, nor was it like a ‘standard’ that had to be agreed. If CML was good for a country, the country had an incentive to adopt it; if it was not, the country had an incentive not to adopt it. If anything however, CML results in a negative externality on other countries, because the resulting instability in one country spills into others through the phenomenon of contagion. The IMF had always talked about contagion, hence it was well aware of the disease. It nevertheless advocated the underlying disease. This is an example of private interests attempting to use public institutions. In order to achieve CML, those private interests tried to achieve internationally what could not be achieved at home (other forms of investment guarantees). The IMF did finally produce a report examining the evidence. Confirming the long-held view of academics, it found that CML did lead to instability and did not promote economic growth. The IMF began thereafter to adopt a more cautious approach. The official position on CML in turn became more cautionary. Thereupon, the USA and Europe, seeing that CML could not be achieved through the IMF, since ironically it was an undemocratic institution, attempted to use trade agreements. They sought to achieve at the WTO what they could not obtain at the IMF. The USA first did this in a trade agreement with Chile, yet Chile’s period of most rapid economic growth (7 per cent) occurred in the early 1990s when capital market restrictions were in force and helped to stabilize the economy. The new issues that were put on the agenda by the USA and Europe at the Doha meeting – the so-called Singapore issues – were accorded


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priority before the old issues, such as the unbalanced agriculture and service agreements, had been addressed. One of the new issues was the complete opening up of the capital markets of the developing countries. The reason for this was simple: trade ministers know nothing about capital; therefore, they make better negotiators. Ignorance is a valuable weapon in bargaining. Quite rightly, the developing countries argued that they had seen the damage that CML inflicts, pointed out that CML is not a trade issue, and cited the new research of the IMF. In short, the attempt by the USA and Europe to force through CML was based on special interests rather than global interests.

RISK TRANSFERS AND THE GLOBAL RESERVE SYSTEM There is in fact a host of other market failures in the global arena which should have been addressed, but have not been. We are not providing the kinds of support that countries require when they experience an economic downturn. We are creating instability by forcing countries to adopt CML. Risk and Global Market Failures A further example of global market failure is the functioning of risk markets. Financial markets in the USA and Europe pride themselves on the ability to slice and dice risk, and to transfer risk from those less able to bear it to those more able to bear it. That is one of the quintessential functions of capital markets. In actual fact, the transfer fails to happen for the risks that are really important. The developing countries are forced to bear the risks of exchange rates and interest rate volatility. The consequences can be and have been enormous. Exchange rate risk In the lost decade of the 1980s, Latin America borrowed money, recycling the petro-dollars, and thereby avoiding the downturns faced by other countries when oil prices rose. The debt was manageable until the Federal Reserve Board raised interest rates to unprecedented levels. It effectively bankrupted America’s savings and loan industry, but it more than bankrupted Latin America. The interest rates went up to a level that Latin America could not pay and that no one had ever expected. Latin America – not the more developed countries – bore the risk of that interest rate fluctuation. The consequence was a lost decade of growth, increased poverty, and a real disaster.

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Interest rate risk The same thing is true of interest rate fluctuations. Moldova is one of the poorest countries of the former Soviet Union. It used to be one of the better-off countries. It is an instructive example of how we have mismanaged the transition from communism to a market economy. The prediction was that the elimination of communism would bring unprecedented prosperity, as central planning was scrapped, distortions were removed, and incentives were provided through private property. In Moldova, GDP fell by 70 per cent. In 2001, Moldova was spending 75 per cent of its public budget servicing the foreign debt. There was neither light in the streets, nor oxygen in the hospitals. It happened because the currency of Moldova was linked to the rouble. When the rouble devalued in 1998, Moldova’s currency devalued. Since Moldova had borrowed in dollars, however, the burden of dollar debt became overwhelming. Moldova bore the risk, rather than the rest of the world. Latin America and Moldova are just two examples of market failure in risk distribution. The standard theory is that in well-performing markets, risk would be transferred from those who are less able to those who are more able to bear risk. There is a role for a global financial institution to improve this riskshifting process. Unfortunately, our current international financial institutions have not undertaken this role. A Fundamental Problem: the Global Reserve System The most fundamental problem relates to another global public good – the global reserve system – which, in its present form, is the cause of great instability in the international economy. In the current global reserve system, dollars are held in the recognition that exchange rates, import and export prices, and import–export demands, are subject to huge volatility. This system promotes instability and is inequitable. Let us examine why this is so. Instability The instability of the global reserve system is visible if we start from a very simple trade–surplus–deficit equation. The sum of trade deficits equals the sum of trade surpluses. This is a basic identity of trade. In fact, the numbers do not add up exactly, because of inaccuracies of measurements, but that is not significant. It follows that if some countries always run surpluses (China, Japan), then the rest of the world runs deficits. Deficits are like a hot potato: if one country eliminates its deficit, then, by the trade–surplus–deficit equation, the deficit shows up somewhere else. Hence, when some country winds up with a high deficit, and that country,


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under instruction from the international financial institutions, reduces its deficit to zero, then the deficit does not disappear: it is simply transferred to another country, and the cycle of crisis and instability recurs. This system only functions as well as it does because the USA acts as a country of ‘deficit of last resort’. The USA is willing to run enormous deficits. In that respect, the global economic system is very peculiar. The richest country in the world lives beyond its means year after year. Its borrowing approached USD 600 billion per year in 2003, close to USD 2 billion per day. Nevertheless, the USA lectures poor countries to live within their means. However, if the USA eliminated its deficit, it would reappear elsewhere and other countries would have the deficit problem. So far, the USA has been able to manage its increasing indebtedness to foreigners without a crisis. The long-term prognosis is not good. As debts become large, the appetite of foreigners for holding US debt may diminish. How much US debt would non-US countries be willing to hold? Twenty years ago, the USA was a net creditor; today, it is a huge net debtor. Foreign creditors should wake up to the riskiness of US debt, particularly because the current macroeconomic management in the USA is the worse it has ever been, and fiscal deficits are reaching untested levels. This also leads to a deflationary bias in the global economy. Every year people have income that they do not spend. This surplus, held as a reserve, is metaphorically ‘buried in the ground every year’, that is, it is invested in US Treasury bills rather than spent on goods. This creates a deflationary bias in the economy. In the past, the strong inflationary bias of Central Banks kept spending up, helping the global economy. Now that this bias has been reined in, an important stimulus has disappeared, reinforcing the deflationary trends. Inequity The global reserve system is also an inequitable system. This is best illustrated in the case of the government of a small developing country in Africa borrowing USD 100 million at, for example, 20 per cent interest from a US bank. The country’s international advisers tell it that if it is borrowing in dollars, it should keep reserves. The current standard is to require dollar reserves equal to short-term dollar indebtedness. The government follows the advice and holds USD 100 million in reserves. These reserves are held as US T-bills. To own US T-bills means simply to lend money to the US Treasury. The catch is that the interest rate of the US T-bill is 1 per cent. Thus the poor African country is borrowing USD 100 million at 20 per cent while lending the same amount at 1 per cent. In short, the African country is sending USD 19 million foreign aid to the USA every year. As the USA lends to developing countries at high interest rates and borrows from them

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at low interest rates (since they hold US Treasury bills as reserves), there is a large net transfer from developing countries to the USA. This is a great programme for helping the USA to grow. It does not help the developing world. It is easy to understand why the US Treasury is enthusiastic about this particular regime. One cannot but feel that it is somewhat inequitable.

SPECIAL DRAWING RIGHTS A simple remedy exists: the creation of global greenbacks or special drawing rights (SDRs), issued annually to offset additions to reserves, and which can be used to finance global public goods, including development support.11 A variety of mechanisms exists to allocate funds. They should, however, be outside the IMF since a broader, better governing structure is necessary. This SDR proposal would increase stability, since countries would only have problems when the trade deficit exceeds the SDR allocation. It would not be inflationary, since the emissions would only be to offset the deflationary bias. The USA would gain from this greater stability and the bias it creates for an excessively strong dollar. On the other hand, shortsightedness may undoubtedly result in resistance to the idea of SDRs, as the USA sees the loss of its seigniorage. Actually, if one compares the benefits of seigniorage with the costs of the overvalued dollar and the instability of the global economy, the USA would be better off. One way to induce the USA to switch to the proposal of SDRs would be for the rest of the world to ‘force’ it to cooperate, by forming a club whose members agree to hold each others’ currency and issue SDRs, a strong incentive for membership.

FINANCING GLOBAL PUBLIC GOODS: MECHANISMS Finally, I shall discuss briefly two topics relating to the mechanisms for the financing of global public goods.12 I have argued for the importance of global public goods in the context of increased globalization. One of the problems of global governance without global government is that there exists no effective way of raising revenue for the financing of these goods. I should like to mention some ways in which this might be accomplished. First, SDRs are an important source of funds. In addition, potentially large revenues could be derived from managing global natural resources. The idea is that, for example, in the case of greenhouse gas emissions,


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emission permits are granted, and the revenues from the sale of those permits can be used to finance the provision of global public goods. This concept might be applied to other natural resources: the use of the global seabed, the management of global fisheries, and so on. A second source of finance for global public goods is taxation. A characteristic of a good taxation system is that it attacks bad phenomena. Taxation could be used to attack negative global externalities. Short-term capital flows that are volatile and speculative create negative externalities. These flows could be taxed. Whether such an approach is administratively feasible remains to be explored, however. Finally, at the Monterey Round, Finland suggested the idea of a global lottery. National lotteries have been relatively successful mechanisms for funding national public goods, a success that might be replicated at the global level.

CONCLUDING REMARKS Globalization increases the importance of global public goods. Good performance of the global economic system requires adequate provision of these global public goods. The rules of the game, however, are set by international institutions that are undemocratic and non-transparent. Therefore, the special interests of advanced industrial countries prevail, resulting in the original mission of institutions like the IMF not being pursued, and a broader agenda of global stability not being effectively addressed. As a result, adopted policies have led to greater instability and have exacerbated economic downturns. New items have been added to the agenda which are not necessarily focused on addressing the provision of global public goods, but which are directed towards the pursuit of a private agenda using the nontransparency and undemocratic weakness of global economic institutions. It is important to find ways of financing global public goods. The proposal of SDRs illustrates one potentially valuable source of finance. At the same time, it contributes to global stability and increases international economic equity.

NOTES 1. 2. 3.

On global public goods, see Stiglitz (1995) and US Council of Economic Advisers (1997). Samuelson (1954). For a fuller exposition of the defining properties of global public goods, see Stiglitz (1999), pp. 308–9.

164 4. 5. 6. 7. 8. 9. 10. 11. 12.

Advancing public goods Stiglitz (1999) provides a detailed analysis of knowledge as a global public good. Ibid., pp. 309–10. See Tiebout (1956) and Stiglitz (1977, 1983). Stiglitz (1986). See Stiglitz (1999), pp. 311–16 for an examination of the role of the state in ensuring the efficient production of knowledge as a public good. See Stiglitz (1995). See Katz and Shapiro (1985). See Buira (2002) on special drawing rights. See also Kaul et al. (2002).

REFERENCES Buira, A. (2002), ‘Allocating Special Drawing Rights to Increase International Financial Stability’, in I. Kaul, K. Le Goulven, M. Schnupf (eds), Global Public Goods Financing: New Tools for New Challenges. A Policy Dialogue, United Nations Development Programme. Katz, M.L. and C. Shapiro (1985), ‘Network Externalities, Competition, and Compatibility’, American Economic Review, 75, 424–40. Kaul, I., K. Le Goulven and M. Schnupf (eds) (2002), Global Public Goods Financing: New Tools for New Challenges. A Policy Dialogue, United Nations Development Programme. Rodrik, D. (with A. Velasco) (2000), ‘Short-Term Capital Flows’, in Annual World Bank Conference on Development Economics 1999. Samuelson, P. (1954), ‘The Pure Theory of Public Expenditure’, Review of Economics and Statistics, 36, 387–9. Stiglitz, J.E. (1977), ‘Theory of Local Public Goods’, in M.S. Feldstein and R.P. Inman (eds), The Economics of Public Services, New York: Halstead Press. Stiglitz, J.E. (1983), ‘Public Goods in Open Economies with Heterogeneous Individuals’, in J.-F. Thisse and H.G. Zoller (eds), Locational Analyses of Public Facilities, Amsterdam and New York: North-Holland. Stiglitz, J.E. (1986), Economics of the Public Sector, New York: W.W. Norton. Stiglitz, J.E. (1995), ‘The Theory of International Public Goods and the Architecture of International Organizations’, United Nations Background Paper 7, New York: United Nations, Department of Economic and Social Information and Policy Analysis. Stiglitz, J.E. (1999), ‘Knowledge as a Global Public Good’, in I. Kaul, I. Grunberg and M.A. Stern, Global Public Goods. International Cooperation in the 21st Century, United Nations Development Programme, New York: Oxford University Press, pp. 308–25. Tiebout, C.M. (1956), ‘A Pure Theory of Local Expenditures’, Journal of Political Economy, 64 (October), 416–24. US Council of Economic Advisers (1997), Economic Report of the President, Washington, DC: US Government Printing Office.

Index accountability 25–6, 62 accounting in public management 130–31 actors multiple 22–8, 32–3 nation states as 31–3 non-state 23, 27, 28, 32 administration systems 127–9 African countries 97 agency 55–8, 122–3 aggregation technology 25, 35 anonymity condition 42, 46–7, 48–9, 55 anti-Keynesian policies 157 antibiotics in animal feed 145–6 asymmetric information 43–4, 51–2, 54 banking provision 105–13 bilateral agencies 29 Bretton Woods Institutions 29, 32 Britain 92, 94, 134–5 budgeting, public management 130–31 building blocks 23, 24 capital, access to 55, 57–9 capital market liberalization (CML) 157–9 Central Bank 154, 157, 161 charities 53 child-care 59–61 China 97 citizen ownership 56 civil society 25–6, 31–2, 89, 98 climate change 10, 142–4 club goods 69, 137, 138–9 Coase, Ronald 2 coercive powers 27 collective action 152–5 collective-action components 26–8, 31–3 collective public goods provision 120 commercial banks 106–7

common market 71–3 common pool resources 17 communication services 23, 70, 80 communism 160 competition 105, 132–3 cross-border 90 perfect, conditions for 42–50 rules of 71–2, 74 competitive multinational space 68 conflict management 7, 26 consumer choice 124–5 consumer cooperatives 53 consumer demand 46 consumer groups 25 consumer well-being 41, 42–55, 61 consumption non-rivalrous property of 150 publicness in 14, 15–21, 22 contractionary policies 156 control by consumers 124–7 cooperatives 4–5, 53, 54, 58 credence goods 126 cultural norms 26 decentralization 121–2, 133 decentred governance 133 democracy 134 developing countries 97–100, 155, 158 capital markets, opening up to 159 and inequity in global reserve system 161–2 and transfer of knowledge 141–2 direct control mechanism 52 discoveries and inventions 139 diversity 8, 81, 87 East Asia 156, 157 economic activities 60, 75 distribution of 41–2 economic growth 26 economies of scale 43, 50 165

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education 59–61, 75 basic 18, 19 vouchers for 124–5, 126–7 efficiency 55–9, 62, 74, 77 electricity 72, 85, 91, 113 energy 92, 104, 106 essential services 8, 69–70, 72–3, 85, 99 European cross-border networks 68 European Investment Bank (EIB) 86, 115 European Legislator 76–7, 95 European public goods provision 68 European Union banking 105–13 common market 71–3 competition within 71, 72, 77, 80, 90 conflicts of national interest 72 consumer protection 85 cross-subsidies 83, 91, 112 cultural misunderstandings 72 and developing countries 97–9 diversity 76–81 economic activities 75 and the environment 79–80 essential services 72, 76–7 financial services 81 fundamental rights 75 and information 79–80 integration networks 80–81 legal framework 74–5 liberalization 71, 72, 91, 96–7, 98–9 local administration 78 market failures 73 member states, rights 76–7 national regulatory authorities 80–81 network regulations 93–5 non-discrimination 78 pricing 83–5 principle of separation 72–3 principles of free movement 71 projects of general interest 85–6 public-private partnerships (PPPs) 79, 88, 104, 114 Public Service Obligations (PSOs) 80–82 regional administration 78 sector directives 80–81 SGEIs see services of general economic interest

SGI-related infrastructure funding 113–16 SGIs see services of general interest single market 72 social activities 75 Special Differentiated Treatment (SDT) 97–9 Treaties 75–6 unity 76–81 and World Trade Organization 99–100 Eurotunnel 114 exchange rate risk 159 excludability condition 42, 46, 48–9, 55 see also non-excludability exclusion 111–13 infeasibility of 21 exclusive goods 17, 19, 30 externalities 29, 31, 54, 114, 151–2 Federal Reserve Board 159 final public goods 18, 24 financial crises 13 financial incentives 57 financial institutions 88, 92–3, 105–13 see also International Monetary Fund (IMF); World Bank Fleming, Alexander 145 food safety 23–4 for-profit firms 40, 47, 51, 55–9 comparison with government and non-profit organizations 59–62 failures 50–55 profit maximization 55 provision by 27, 53, 61 violations of optimality conditions 42–50 France 40, 69, 72, 128 banking activities 106–12 free riding 20, 32, 151 free-roaming public goods 18 fundamental rights 68, 73, 75 GATS (General Agreement on Trade in Services) 96, 98–9 Germany 40, 69, 72, 94 banking activities 105, 106–12 global capital markets 156 global conferences 32 global crises 32–3

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global economic system 157, 161 see also International Monetary Fund (IMF); World Bank global economy 152–5 global financial system 149, 155–9 global governance 149, 153–9 global lottery 163 global market failures 159 global natural resources 162–3 global public bads 29 global public goods 28–34, 151 climate as 142–4 definition 28 financing of 162–3 global economy as 152–3 knowledge as 137–47 production of 142–6 underprovision of 32 global public interests 149 global public–private partnerships 23 global publicness of goods 32 global reserve system 160–62 global risks 13 global standards 152–3 global warming 5, 26, 34 globalization 29, 34, 153–5 globalized national public goods 28, 31 governance 55–9, 119, 120–23, 153 types of 132–4 government 51 coercive powers 27 comparison with for-profit and nonprofit organizations 59–62 correctives to for-profit failures 42, 50–55 efficiency 58 failure 25, 28, 31–2 financial role 27 intervention in economy 25 management problem 56–7 provision 41, 52–3, 55, 61 Great Depression 155, 156, 157 greenhouse gas emissions 10, 19, 29, 142, 151, 162–3

IMF see International Monetary Fund imperfect competition 41 impure public goods 150 incentives 23, 27–8, 56, 57 inclusiveness 19 India 97 indivisibility 11 inequity in global reserve system 161–2 inflation 157 information 68, 97, 126 asymmetric 43, 54 as public good 80 information condition 42, 43–5, 48–9, 52, 54, 55 information technology 68, 70–71, 99 infrastructures 78, 80–81, 106, 113–14 innovation 27, 140 instability in global reserve system 160–61 institutionalist tradition of governance 133 intangibles 16 intellectual property rights 19 interdependencies 6, 11, 29 interest rate risk 160 intergovernmental cooperation 32, 33 intermediate public goods 18 internal monopolies 72 international cooperation 29–33 international economic institutions 153–6 international economy, instability in 160–61 international externalities 153 International Monetary Fund (IMF) 153–4, 155–9 international public goods 32, 99–100 international relations theory 31 international terrorism 3, 13, 34 international treaties 153 inventions and discoveries 9, 138–42 investment 57, 58

health 22, 77, 104, 145–6 horizontal system of administration 127–9 human-made global public goods 29 human rights 18

Keynesian tradition of governance 132–3 knowledge 3, 9, 19, 150 as global good 137–47 production of 138–42

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land mines 32 Latin America 98, 159, 160 liberalization 71, 72, 91, 96–7, 98–9 local collective goods 121 local public goods 150–51 malaria 22–3, 35 management 56–8 by objectives 117 public 129–34 market allocation 118 market economies 40 market failures 22, 25, 151–2, 159 maximization of consumer well-being 41, 52 maximization of profits 41 monopolies internal 72 national 71, 73 natural 43, 71, 79, 80 public 90 multilateral trade 29, 98 multiple actors 22–8, 32–3 Nash equilibrium 128–9 nation states 5, 6–7 as private actors 31–3 and services of general interest 77–9 national identity 70 national interests 10, 72 national monopolies 71, 73 national provision of public goods 32 national public goods 28–9, 151 national self-interest 33 nationalization 71 natural global commons 28–33 natural monopolies 43, 71, 79, 80 naturalization services 22 negative externalities 25, 47, 151, 152, 158, 163 networking 18 no externalities condition 42, 47–50, 55 no market power condition 42, 43, 48–9, 55 non-excludability 1, 13, 16–17, 46, 150 see also excludability condition non-exclusive goods 15, 17, 18, 30 non-governmental organizations (NGOs) 7, 26 non-market common goods 79

non-profit organizations 27, 53–4, 57–9 comparison with government and for-profit organizations 59–62 correctives to for-profit failures 50–55 efficiency 58 internal organization 40 provision 53–4 and public management 131–2 non-rivalrous goods 18, 25, 30, 52–3, 54 non-rivalrousness 1, 11, 13, 16–17, 150 see also rivalry condition non-state actors 23, 27, 28, 32 norms 14, 18 North America 7 not-for-profit organizations 4–5, 87 obligations see public service obligations (PSOs) operators 86–9, 98, 119 opportunism 131, 132 optimal provision 25, 41 optimality conditions for consumer well-being 41, 42–55, 61 outsourcing 117 partnerships 23–5, 61–2, 120–21 relations within 131–2 see also public-private partnerships (PPPs) patents 17, 19, 99, 138–42, 146 perfect competition, conditions for 42–50 planetary scale 9 policy conditionality 29 policy harmonization 29 pollution 11, 17, 19, 151 positive externalities 47, 104, 151, 152 positive utility goods 20 power, abuse of 139 price caps 84, 90, 91, 101 price equality 44 price volatility 84, 92 pricing 83–5, 90–91 private actors 29 private goods 14 private management 129–30 private provision 25, 27 private self-interest 33

Index privatization 23, 25, 71 properties of public goods 1, 13, 16–17 see also non-excludability; nonrivalrousness provision 22–8, 31–3, 68, 131–2 for-profit firms 27, 53, 61 government 25, 41, 52–3, 55, 61 non-profit organizations 53–4 private 25, 27 public 118–19, 120, 124–7 public aid 83, 87, 98 public allocation 118 public bads 14, 20, 21, 25, 29 public by design 18, 19 public goods definition 1, 13, 20–21, 33 externalities 151 multi-actor products 14, 26 properties 1, 13, 16–17 public health 19, 22, 27 public institutional design 117–35 public intervention 9, 71 public management 117, 119, 122–3, 129–34 public monopolies 90 public policy incentives 23 public–private partnerships (PPPs) 23–5, 88–9, 114–16 see also partnerships public provision 118–19, 120, 124–7 public service 69, 104 public service obligations (PSOs) 82, 83, 84–5, 89 public services see services of general interest (SGIs) public utilities 23 publicness in consumption 15–21, 28, 35 pure private goods 15 pure public goods 16–17, 30, 69, 150, 151 railways 70, 86, 92 reforms 75, 117, 122 regional administration 78–81 regional level 24 regulation 51–2 in European Union 80–81 of services of general interest (SGIs) 93–5

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regulators 51–2, 92, 94 reputation 43–4, 50 reputation condition 132 resource environment 123 resources, lack of 32–3 risk markets 159 risk transfers 159–62 rival goods 44, 50, 54 rivalrous benefits 15 rivalry 138–42 rivalry condition 42, 44–6, 48–9, 55 see also non-rivalrousness rollout 18, 34 rule of law 14 Samuelson, Paul 1, 11, 120, 150 SARS (Severe Acute Respiratory Syndrome) 21 scientific discoveries 9, 138–42 scientific uncertainty 142–6 SDRs (special drawing rights) 10, 149, 162 self-interest 26 self-regulation of non-state actors 27, 32 service network industries 71 services of general economic interest (SGEIs) 80, 84–5 and European Union jurisdiction 73–6, 77 services of general interest (SGIs) cross-border 73 definition 69–70 diversity of 76–81 ecological dimension of 69 economic dimension of 69 and the environment 79–80 and European Union jurisdiction 73–6 financing of 89–93, 105, 113–16 infrastructures of 86, 106, 113–16 and national identity 70 social dimension of 69 threat from World Trade Organization 96–7 SGEIs see services of general economic interest simultaneity of consumption 20 single market 71, 72, 75, 79, 80 smokestack structures 154–5

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social concerns 27 social constructs 3, 15–21, 81 social effects 23 social norms 26 social responsibility 25–6 socially determined status of goods 15, 17 Special Differentiated Treatment (SDT) 97–9 special drawing rights (SDRs) 10, 149, 162 standards 14, 44 state as core provider 28, 32, 33 financial institutions 105–13 internal organization of 40 as a partner 131–2 regulatory powers 27 regulatory role 51–2 state agencies 27 state aid 74 state intervention 22, 23, 32, 120 state provision 26–8 subcontracting 23 supranational level 5, 7 Sweden 94, 145 taxation 27, 162–3 technological changes 70–71 terrorism 3, 13, 34 theory of external effects 129 trade agreements 158 trade–surplus–deficit equation 160–61 transnational organizations 5, 31 transparency 74, 78, 94, 154

transport 70, 76, 80, 81, 92, 104 infrastructures 86, 106, 113–14 TRIPS (Trade-Related Aspects of Intellectual Property Rights) 19, 141–2 underconsumption 25 underprovision 25 unemployment 157 United Nations 32, 144, 152 universal compliance 27 universal services 80–81, 82, 83, 84, 104 universalization 19, 77 US Treasury bills 161–2 USA and antibiotics in animal feed 146 and climate change 144–5 and International Monetary Fund 153, 156–7 vertical system of administration 127–9 violations of optimality conditions 41–50 voluntary actors 27 vouchers 124–7 water distribution 47, 50, 72, 79, 106, 113 welfare state 119, 128 well-being of consumers 41, 42–55, 61 World Bank 99, 133, 153, 158 World Trade Organization (WTO) 96–7, 99–100, 153, 154, 158

Advancing Public Goods (The Cournot Centre for Economic Studies Series)

Public Goods, Private Goods

The Logic of Collective Action: Public Goods and the Theory of Groups (Harvard Economic Studies)

Public Goods: Theories and Evidence

Public Goods, Redistribution And Rent Seeking (The Locke Institute Series)

The Future of Economic Growth: As New Becomes Old (The Saint-Gobain Centre for Economic Studies Series)

Cournot oligopoly

The Gratis Economy: Privately Provided Public Goods

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