Privatization and the Law and Economics of Political Advocacy, Part 3 -- The Model:

This post continues my series on my upcoming Stanford Law Review paper on Privatization and the Law and Economics of Political Advocacy (see here for the technical paper). This installment is not connected to privatization specifically at all, much less prisons, but gives (in plain English) the basic economic theory behind public goods and free riding.

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I now present the main model I use to predict how industry actors will react to privatization. The central feature of the model is that industry-increasing advocacy is a public good. Privatizing part of the industry therefore introduces a collective action problem: Unless everyone in the industry cooperates with each other, they will together spend less on industry-increasing advocacy than a single firm would if it covered the whole industry, because a portion of their expenditures will benefit their competitors.

This intuition should not be surprising, as it is standard in the literature on public goods. When a good is private, everyone pays for, and enjoys, only his own consumption. By contrast, when a good is public, in the classic model, everyone benefits from the total amount, and this amount is determined by the total amount of contribution.

If we benefit from our national defense, we benefit from the full amount, not from the chunk we paid for; we cannot be excluded from the full benefit, no matter how little we paid; and the total amount of national defense is just determined by how much money Congress allocated to national defense from the Treasury. A tax-funded program that improves air quality benefits everyone who breathes the relevant air, whether or not they contributed to the program; and the total improvement is just determined by the amount of resources directed toward that goal.

Similarly, contributing to a candidate’s campaign benefits all of his supporters; and it is not too implausible to say, as an approximation, that to the extent the money he raises and spends affects his probability of winning, it is only the total amount of money that matters.

In all these cases, the temptation to free ride off one’s fellows’ contributions is strong—so strong that the category of “public goods” is standard among economists as a case of “market failure.”

To explore the basic model, consider a monopolist, who's willing to invest some amount of money in lobbying to increase the size of his industry. To determine that amount, he weighs the benefit that his money can buy—the expansion of the industry is worth something to him, and money can help his policy pass—against the cost of the lobbying.

If that firm is broken up into two smaller firms—say a 90% incumbent firm and a 10% splinter firm—the larger incumbent isn’t willing to spend as much as it used to be, because the costs of lobbying are the same while the benefits are 10% less than they used to be. And the smaller splinter firm won’t be willing to spend anything, because it will be satisfied free-riding off the larger incumbent’s lobbying. Thus, splitting up an industry tends to decrease industry-expanding lobbying.

The rest of this post will illustrate this intuition graphically.