The Demand and Supply of Public Goods

In the fifteen years immediately following World War II, unquestionably the most significant development in public economics was the emergence of “public expenditure theory.” This development arose in the attempt to define a comprehensive theory of the state around the notion of “market failure.” For public economics, this was a significant development because, until that time, analysis focused on the tax side of the budget. Most of public economics could aptly be called “public finance” because the central preoccupations revolved around how “best” to raise the revenue required for public activities—public activities whose rationale lay entirely outside economic scrutiny. There were, to be sure, hints of what such a rationale might look like, for example, Pigou’s famous treatment of the “smokey factory.” But these hints remained partial and disparate until Paul Samuelson, in what became a famous series of articles on “public goods,” set out what purported to be a coherent and synthetic justification for governmental intervention in economic processes. Samuelson provided an account of what James M. Buchanan was later to refer to as the “productive state.”
*1 In the Samuelson formulation, the critical element in this justification is the market failure that public goods give rise to in an extreme form. In this sense, public goods are a kind of distillation of various possible barriers to the market’s capacity to exploit all the possible gains from exchange—gains that might in principle be appropriated by the citizens who compose the relevant group-polity-nation. The 1950s and 1960s saw a huge burgeoning in the normative analysis of markets, most of it oriented toward showing some market failure, so understood, and often associated with a putative case for some form of governmental intervention.

It is now folklore that the normative thrust of public goods analysis was an important element in the birth of the public choice movement. One central ambition of public choice scholarship was to insist that “political success” needed to be demonstrated before the market failure in question could establish a preference for government activity—and to demonstrate that such political success might be more difficult to achieve than the public economics presumption might suggest. Put another way, market failure was itself assessed by reference to a benchmark that economists came to understand only by contemplation of market operation in other (private goods) arenas. Market failure on its own meant nothing: Politics would have to submit to the same test. This much is familiar. And Buchanan’s work has been critical in making it so.

It is, however, important to note that the public choice tradition has never denied the logic of the market failure argument as such. Indeed, Buchanan himself made extremely significant contributions to the market failure-public goods literature. For example, what are almost certainly Buchanan’s two most famous articles—”Externality,” with W. C. Stubblebine, and “An Economic Theory of Clubs”—fall precisely into this area of inquiry. In fact, public goods theory constituted a major (perhaps the predominant) element in Buchanan’s research agenda throughout the 1960s.
The Demand and Supply of Public Goods is to be seen as an important part of that body of work and should be read alongside the articles in volume 15 in the Collected Works,
Externalities and Public Expenditure Theory, as Buchanan’s attempt to synthesize and focus his views on those “public goods” issues.
The Demand and Supply of Public Goods should perhaps also be read alongside the earlier contributions of Samuelson and Richard A. Musgrave. John G. Head provides a survey of this literature contemporaneous with
The Demand and Supply of Public Goods that includes an article-length review of Buchanan’s book.
*2

It is interesting specifically to contrast Buchanan’s approach with the earlier Samuelson exposition. Two features are notable. First, whereas Samuelson’s central purpose is to establish “optimal conditions” for the supply of public goods, and to show thereby that the Pareto optimum could never be a market equilibrium, Buchanan seeks to derive that market equilibrium directly. Such derivation is necessary to Buchanan’s broad purpose of explicitly comparing market performance with political performance: Buchanan has much less interest in conceptually possible but institutionally infeasible ideals. Second, and related, much of Buchanan’s treatment reads like a purely positive account of institutional choice. The quest for mutual advantage through exchange—whether a two-person exchange as for ordinary private goods or a many-person exchange as in the public goods case—serves in
The Demand and Supply of Public Goods as a motivator of action as well as a relevant normative test. Accordingly,
The Demand and Supply of Public Goods is an important piece of Buchanan’s contractarian theory of the “productive state” with the ambiguity between the positive and normative use of the contractarian approach deliberately allowed full rein.
*3 The contrast with Samuelson’s much more overt (if incomplete) normative treatment, with the independently derived “social welfare function” as an express articulation of the “ethical observer’s optimum,” is worth noting. In this respect, Buchanan is much more faithful to the Wicksellian approach than is Samuelson, although both Samuelson’s and Buchanan’s treatments of the public goods question derive ultimately from Wicksellian sources. (In Samuelson’s case, the derivation is through Musgrave’s paper on Erik Lindahl’s version of Knut Wicksell’s analysis.)
*4

And it is worth emphasizing that Wicksell’s original contribution represents the origin of public choice to politics as well as the point of departure for subsequent literature on public goods and market failure. It is therefore unsurprising that Buchanan, for whom the Wicksell influence is more explicit, should have made independent contributions in both areas and been a determined proponent of their inextricable connections.

The particular occasion for writing the first draft of
The Demand and Supply of Public Goods was a series of lectures given at Cambridge University in 1961-62. The audience originally conceived for the book was therefore a group of relatively able undergraduate and graduate students. But little of the flavor of a textbook is detectable here—there is no dry pedagogy and surely no concession to the undergraduate concentration span. What Buchanan provides here is a clear statement of the contractarian approach to public goods problems, very much in the “voluntary exchange” tradition of Wicksell and Lindahl.