From Pencils to Lighthouses

The world of economics and politics are fascinating, from pencils to...lighthouses.

There is constant debate over the proper venue of government. One often offered is market failure. Sometimes market failures occur because certain goods are plagued by free rider problems (i.e., people do not pay for the benefits they extract from the goods) and thus will be underproduced. This is a market failure associated with public goods where, they believe, the goods cannot be provided by markets in sufficient quantities. The best example is the lighthouse. As the light it produces is seen by all, the lightkeepers can never know who uses the light. This makes it hard to exclude free riders. Thus, if markets are left to produce lighthouses, there will be too few of them provided, increasing the occurrence of shipwrecks. State action is thus warranted to correct a market failure.

Munger wrote an article objecting. First, though markets can fail, governments can fail too. It may be that markets are unable to produce enough lighthouses, but states may do a worse job. This means that we need to accept the lesser imperfection.
Second, market failures are costly, which means that they generate strong profit opportunities for those who find solutions. For example, not having enough lighthouses may incentivize the development of different safety mechanisms such as repositioning software. Thus, market failures sow the seeds of their own solutions.

Geloso writes "two British entrepreneurs in the 18th century discovered a way to build “floating lighthouses” (i.e., lightships) that were quite cheap and charged significantly lower prices than other, stationary lighthouses. They opened a first lightship at the opening of the Thames River, which leads to London, to the delight of coal merchants and other shipowners. Their success was wild enough that they announced the launch of two other floating lighthouses in other places in England.

To mitigate the free rider problem, they used a variety of different mechanisms. They charged different prices to different people so that the price reflected each individual’s personal valuation of the service. They used subscriptions to incite people to finance production before they built the lighthouse. They also relied on certain informal organizations (such as the coffeehouses where coal merchants congregated) to ostracize non-payers. This rich combination of solutions was only brought to an end because the state-mandated monopoly sued the two inventors, prohibiting them from operating their lightship. The crown acquiesced, and that was the end of it."

 

He concludes, "There was nothing inherent to the lighthouse that made it a public good. It was a public good because government regulation made it so.

This is an important example. It speaks to how the lore of economics errs. The example used to justify state action was created by state action. Thus, justifications of state intervention on the grounds that there is a public good market failure actually may be getting the whole relation backward."

 

But there does seem to be that pesky shipwreck learning curve.