Samuelson's Theory of Public Goods

In 1954 Paul Samuelson published his landmark paper The Pure Theory of Public Expenditure, which formalized the concept of public goods (which he called "collective consumption goods") -- i.e. goods that are non-rival and non-excludable. He highlighted the market failure of free-riding when he wrote: "it is in the selfish interest of each person to give false signals, to pretend to have less interest in a given collective consumption activity than he really has". His paper showed that "no decentralized pricing system can serve to determine optimally these levels of collective consumption".

Excludability is the ability of producers to detect and prevent uncompensating consumption of their products. Rivalry is the inability of multiple consumers to consume the same good. A public good is defined as a non-rival non-excludable good, such as national defense. Because public goods are not excludable, they get under-produced. The pricing system cannot force consumers to reveal their demand for purely non-excludable goods, and so cannot force producers to meet that demand.

The evidence for under-production of public goods is so overwhelming that, as anarcholibertarian professor Walter Block admits about the resulting justification for state intervention, "virtually all economists accept this argument. There is not a single mainstream text dealing with the subject which demurs from it." For standard treatments, see e.g.

• Ch. 11 Public Goods and Common Resources in Principles of Economics by Greg Mankiw (Harvard economist fired as Chairman of White House Council of Economics for defending outsourcing).;
• The Free Rider Problem in the Stanford Encyclopedia of Philosophy;
• Public Goods and Externalities in the Concise Encyclopedia of Economics by Tyler Cowan (libertarian economist at GMU, co-blogger at Marginal Revolution).

Underproduction of public goods is inevitable in the presence of 1) the ability to free-ride (i.e. non-excludable goods) and 2) rational self-interest. Samuelson's paper did not fully explicate the modern quadripartite theory of private/public/club/common goods, let alone formalize all the kinds of market failure inherent in that analysis. There was important work related to this both before and after 1954:

• The 1939 generalization of Pareto optimality by Kaldor and Hicks to launch modern welfare economics;
• The 1950 formalization of the Prisoner's Dilemma and the subsequent avalanche of developments in game theory;
• Arrow's 1951 impossibility theorem, leading to Sen's 1970 liberal paradox;
• The 1953 discovery of the Allais paradox, and many subsequent discoveries about bounded rationality and cognitive bias and the development of Prospect Theory by Tversky and Khaneman in 1979;
• Tiebout's 1956 theorem about the optimal local provision of public goods;
• Coase's 1959 proof that markets can handle negative externalities only in the absence of transaction costs;
• The 1962 creation of public choice theory by Buchanan and Tullock; and
• Arrow's 1963 formalization of the problem of asymmetric information.

This nascent thread of work was largely ignored when Rothbard and Rand were setting their (and the future LP's) worldviews in concrete in the 1940s. That's a tragedy, because the mainstream modern libertarian theory of political economy is a far more formidable -- and palatable -- intellectual edifice than the brittle deontological dogma of Rothbardian Austrianism.