Public Goods and Positive Externalities, and Whether Singapore Should Change Its Policies

Question

(a) Explain why government intervention is advocated in the case of public goods and for goods where positive externalities are present. [10]

(b) With reference to examples, discuss whether there is a need to change the current policies adopted by the Singapore government to deal with both these causes of market failure. [15]

Answer

Part (a)

The government intervenes when the free market fails to allocate resources efficiently. Both public goods and goods with positive externalities are sources of market failure, so intervention is advocated to restore an efficient allocation.

Public goods. A public good is non-excludable and non-rival in consumption, and these characteristics mean the free market provides none of it.

Non-excludability — the free-rider problem. When non-payers cannot be excluded from consuming a good — street lighting, once provided, cannot practicably be restricted to those who pay — every consumer can free-ride. No self-interested consumer reveals his effective demand, so there are no price signals and no price can be charged; private firms will not supply, despite the valuable benefits. Government provision is required.

Non-rivalry — the zero efficient price. When one person’s use does not reduce the amount available to others, the marginal cost of providing the good to an additional consumer is zero. Since allocative efficiency requires price to equal marginal cost, the efficient price is zero — at which no profit-seeking firm will supply. Again, government provision is required. The combined effect is a missing market: no resources are allocated to public goods such as national defence, so the government must provide them and finance them from taxation.

Goods with positive externalities. A positive consumption externality confers benefits on third parties not involved in the transaction. With vaccination, each person immunised lowers the risk of infection for others, but this external benefit is unpriced and so ignored by private consumers and producers, who weigh only their own costs and benefits. The marginal social benefit therefore exceeds the marginal private benefit, the free market under-consumes relative to the social optimum, and a deadweight welfare loss arises. The good is, in effect, over-priced relative to its social value, so intervention is advocated to raise consumption to the efficient level.

Part (b)

The Singapore government addresses these two failures with distinct policies, and this part argues that, on the whole, the current policies are effective and need no fundamental change — only marginal refinement — because Singapore’s low incidence of government failure makes its provision unusually efficient.

Policy for public goods — direct provision with full funding. Because no market will supply public goods, the government provides them itself, financed from taxation; being non-profit-motivated, it can take the full social costs and benefits into account, producing the good directly or outsourcing while bearing the cost. National defence is the leading example. The limitations link to government failure. Lack of information: with no price signals, the government cannot easily identify the optimal level of provision — how large an army is enough? Lack of public funds: provision depends on tax revenue, so a recession or fiscal austerity can constrain spending on infrastructure such as roads and street lighting. Political pressures: decisions may follow electoral popularity rather than the social optimum.

Policy for positive externalities — subsidies and direct provision. A subsidy to producers — set equal to the external marginal benefit at the optimum — is a market-based correction that internalises the externality: it lowers the effective marginal cost so that the new private equilibrium coincides with the socially efficient quantity, at a lower price to consumers. For vaccination, this raises consumption to the optimum. The government may also provide directly, building and running public schools, hospitals and clinics financed largely from taxation, sometimes charging nominal or partially subsidised fees. The limitations again concern government failure: the external benefit may be mismeasured, leading to over- or under-subsidy; subsidies strain the budget and carry an opportunity cost, so in a recession the priority may shift to job-creating projects; and subsidised or directly provided services, shielded from market discipline, may become productively inefficient.

Evaluation and judgement — is change needed? The reasoned verdict is that the current policies are, by and large, effective and require refinement rather than fundamental change. In defence, Singapore is consistently rated among the best-equipped and best-trained militaries, and continually improves cost-effectiveness through smart technology — more capability per dollar. In healthcare, government expenditure as a share of output is among the lowest internationally, yet outcomes — high life expectancy, low infant mortality, good quality of life — are excellent. This combination of low cost and strong outcome reflects efficient planning and implementation, and the relative absence of government failure that undermines such provision elsewhere. The government’s responsiveness — heavy subsidies and free provision of masks and treatment during the SARS epidemic and the 2015 haze — further shows the policy mix adapts to circumstance. Refinement is nonetheless warranted: subsidies must keep pace with rising medical costs, and information dissemination on preventive screening (for instance for diabetes) can be stepped up. On balance, then, there is no need to change the current policies fundamentally; the case is for continued, incremental adjustment of an already effective framework.