The 'free rider' problem

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, January 15, 2011

A free rider is a person who enjoys the benefits of goods without contributing to the full cost or partial cost of providing them. This problem usually arises when there are spillover benefits or costs in the provision of goods.

The free rider problem is usually more acute in the case of public goods. Public goods are those where we cannot exclude others from their consumption, unless incurring substantial cost if the goods are provided at all, and the consumption by anyone does not reduce the amount available to others. Examples of pure public goods are national defense and environmental quality. The spillover effects of public goods deem it necessary to provide these goods collectively either through taxes and/or subsidies.  However, there are other areas where the free rider problem may arise due to significant spillover effects.

 Suppose in a neighborhood, a homeowner improves his house and pays for the improvements. This action by a homeowner also improves the value of houses of his neighbors. Neighbors enjoy this benefit even though they do not pay for it. Similarly, if a neighbor does not maintain his house, it will bring down the value of other neighbors' homes. This is a cost to the neighbors. In fact, the self-interest of the next-door neighbors dictates that they should also not maintain their homes. This type of behavior is responsible for the deterioration of housing in many inner cities around the country. That is the reason we have zoning laws, a collective action to make people maintain their properties.

If zoning laws are not enforced promptly and efficiently in neighborhoods, all households bear the consequences of diminishing housing values. Salt Lake City's recent decision to enforce sidewalk snow removal regulations for homeowners is meant to mitigate this problem.

A variant of the free rider problem may also arise in condo developments and/or gated communities where homeowners' associations impose flat maintenance fees on all units irrespective of their sizes and acreages. If there is a flat maintenance fee assigned to each homeowner, owners with bigger houses and acreages free ride on others with smaller units and land area. An appropriate policy will be to assign fees based upon the square feet of the unit and acreage outside the unit requiring maintenance.

The free rider problem also exists in public school systems. Low-income people, who have more than the average number of children in public schools and live in smaller homes with lower property taxes, free ride on others who have fewer children in public schools, have higher income and live in bigger homes with higher property taxes. The counter argument in public education is that higher income people with smaller families benefit from the education of others in terms of knowledge base and reductions in other harmful activities like crime when the population is more educated. Hence, they enjoy the flow of benefits from others' education. But the same argument can be made by high-income earners and the effect of their children's education on others, including low-income earners.

A stronger argument for public education at all levels is that it increases the knowledge base of the community, the state and the nation. Knowledge has significant spillover effects, where the more educated the general population, the more knowledge accumulation. It is like a public good. Accumulation of knowledge capital, especially in the modern economy, is crucial for economic development and the prosperity of a nation.

Pharmaceutical companies free ride on basic research and development at universities, but that has not stopped the public from supporting institutions of higher education. Drug companies, as well as other companies, are recognizing the benefits they derive from basic R&D at universities and hence are increasingly supporting those R&D programs. This free riding is beneficial to the society in the case of drugs' development. Drug companies face very large investments and risks in clinical trials. A very small fraction of efforts result in successes, but success brings substantial rewards to drug companies as well as to the society.

The free rider problem in the health insurance market is very pervasive. The so-called mandate in the health care law, that all must buy insurance or pay additional tax, implies that those who reap the benefits of health care by showing up in emergency clinics of hospitals must pay at least some amount for those benefits. Uninsured people are passing costs of their benefits by increasing others' insurance premiums.

There are many other areas where the free rider problem may arise, but it is important to note that the spillover benefits have to be significant enough to outweigh the costs of fixing such problems. We definitely do not want to impose a tax on people who benefit from neighbor's gardens, because costs will outweigh benefits.

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden. He also blogs for the Standard at http://blogs.standard.net/economics-etc/.