There are three kinds of goods and services produced and consumed in a market economy: private, public, and quasi-public. A private good is a product that must be purchased to be consumed, and consumption by one individual makes consumption by another individual impossible. A quasi-public good has qualities of both public and private goods; either availability or supply is somehow compromised.

Public goods are a commodity or service that is provided without profit to all members of a society. In order for a good to qualify as being a public good, it must have two defining characteristics: non-excludability and non-rivalry. Non-excludability means that even people who don't pay for the goods are able to use them. Non-rivalry means that one person's use of a good doesn't reduce its availability to others.

Key Takeaways

  • Public goods are a commodity or service that is provided without profit to all members of a society.
  • The two main arguments for the privatization of public goods are based on the desire to eliminate the free-rider problem and the introduction of competition to reduce price and increase efficiency.
  • The free-rider problem is the burden on a shared resource that is created by its use or overuse by people who aren't paying for their share for it.
  • When the providers of goods and services are required to compete against each other, they are forced to keep their costs down, respond quickly to the changing demands of the industry and consumers, and strive more to satisfy customers.

There are some people who believe that some, or all, public goods should be privatized. Typically, they make the case for the privatization of public goods based on two main arguments, namely the desire to eliminate the free-rider problem and the introduction of competition to reduce price and increase efficiency.

Most public goods are provided by governments at the municipal, state, or federal level, and are financed by tax dollars. Common examples of public goods include national defense, police and fire services, and street lights. However, sometimes public goods are provided by private individuals or organizations.

Privatization Eliminates the Free-Rider Problem

The free-rider problem is the burden on a shared resource that is created by its use or overuse by people who aren't paying for their share for it. Because public goods are a shared resource—even people who don't pay for them can use them—they give rise to the free-rider problem.

For example, U.S. citizens and residents who don't pay taxes still benefit from military protection and national defense. In this scenario, people who don't pay taxes, but still benefit from our national defense, are referred to as "free riders." The presence of free riders in a market economy results in an increased portion of the burden of paying for public goods being shouldered by the remainder of people who are taxpayers.

Another conundrum of a system of public goods is the problem of the forced rider. Through taxation, some people are forced to help pay for public goods that they will never use. For example, childless adults pay taxes to help fund the public school system. When there are a large number of free riders in a society that has a public education system, those who pay—including forced riders who don't benefit from this good—have to cover a higher share of the cost of funding the school system.

One of the main arguments in favor of the privatization of public goods is that it would eliminate the free-rider problem. By extension, the privatization of public goods would also eliminate the forced rider problem. Under private ownership, the providers of goods can charge customers directly and exclude those who do not pay.

For example, a fire department that is privately owned could charge homeowners in its service area for fire protection. Using this model, the owners of the fire department could charge everyone willing to pay for the fire protection service a reasonable price and would not have to demand more money from a group of payers in order to guarantee service for everyone, including all of the non-payers.

Competition Reduces Price and Increases Efficiency

The second argument that is typically made in favor of privatizing public goods is that introducing competition to the public sector would reduce the price of public goods and increase efficiency. When the government has difficulty coming up with the money to provide a particular public good or service, they can simply print more money or raise taxes.

Because privately-owned companies do not have this option, their only recourse when profits are down is to improve efficiency and provide better service.

Businesses in the private sector are likely to be beaten out by their competition if they are unable to keep administrative costs as low as possible. Conversely, the public sector is known for having massive overhead costs, complex systems, and having high administrative costs.

When the providers of goods and services are required to compete against each other, they are forced to keep their costs down, respond quickly to the changing demands of the industry and consumers, and strive more to satisfy customers. 

Does Privatization Serve the Public Interest?

Prior to the 1980s, the U.S. government provided funding for services that could have been provided by the private sector, including building highways and dams, conducting research, and giving money to state and local governments to support functions ranging from education to road building.

In the 1980s, then-president Ronald Reagan reversed this shift from public to private ownership. Supporters of the Reagan administration's efforts to privatize government assets and services claimed that it would boost the efficiency and quality of the remaining government services, reduce taxes for American citizens, and shrink the size of the government.

Since then, electrical utilities, prisons, railroads, and education have all been transferred from the government to private owners. The question remains whether or not privatization serves the public interest, and there are as many arguments for privatization as there against it.