Economics and similar, for the sleep-deprived

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Update: seemingly not

Update: Oh yeah!

Monday, December 23, 2002

Shine your light on me ...

edit Welcome Brad DeLong readers. Welcome also, to a slightly smaller number of Mark Kleiman and Patrick Neilsen Hayden and Junius readers and thanks for the nice things those guys said about me. I'd just like to point out at the top of this article that I'm having real misgivings about the way in which it's been taken (or to be less mealy-mouthed, they way in which I wrote it). I like Ronald Coase's work, really a lot. My only disagreements with him have to do with lighthouses, and the outraged tone of this article reflects my disappointment at discovering that he had feel of clay. I'll probably feel a lot more equanimous about this subject once I've calmed down in a couple of weeks' time. I'd also like to point out that there is a real difference between direct government provision of services and governments' contracting out services to the private sector, and that if Coase had been making this point, it would have been well made. However, I am pretty sure, and B DeL appears to agree, that Coase wasn't making this point; he was unwisely trying to claim a new province for his theory of Coasian negotiations. You might want to read my contribution to the comments section on Brad's article for a few addenda to this one. Finally, I don't think I'm nearly hard enough on Samuelson in this article; I personally regard his sin of not checking as being far less serious than Coase's of checking and not giving the full story, but he is also pretty culpable in saying some things about lighthouses that weren't true. I have a lot of beefs with Samuelson, some discussed in past articles, and a fair few scheduled for next year. Anyway, on with the fun ...

In keeping with old tradition, I would like to dedicate this post to those men who will be spending Christmas alone, in the lighthouses around our coast, selflessly guarding against wrecks in solitude.

Actually all UK lighthouses have been converted to automatic operation for quite a couple of years now, so instead of that, today�s post is dedicated to Jim Glass, a regular inhabitant of various comments sections who has done an admirable job in keeping me honest over the last week. Post-lunch (that being the only real excuse), I have on various occasions shot my mouth off on the subjects of Adam Smith never mentioning the Physiocrats in �Wealth of Nations� (he did) and of Ronald Coase not having had a really nasty spat with Paul Samuelson on the issue of lighthouses (he did). So well done Jim for picking me up on both of �em, and we�ll ignore the fact that he called Wynne Godley a crank (them�s fightin� words).

In any case, one of the good things to have come out of my little rush of blood to the head is this link: The History of British Lighthouses, provided by the British Lighthouse Society. It�s so interesting that I ended up dropping what I was doing (the threatened �longer piece� from the last post) and decided to instead investigate the Coase-Samuelson controversy on lighthouses. Stick with me, I promise that this is less boring than it sounds.

The Controversy

First up, I�m going to need to make a full disclosure; I haven�t read the full Coase paper on lighthouses in economic history, because it isn�t on the Web and I haven�t had time to get hold of the book. However, a quick google search for "Coase lighthouses" reveals a lot about the subject, and I've looked through those pretty thoroughly. In any case, the use to which an academic article is put, is usually much more important to the generality of the world, than the specifics of what was said in the first place. It is my opinion, (an unpopular one with academics) that academic economics ought to be subject to the same sort of product liability as handguns are; that there is a duty on the manufacturer to go out of his way to make sure that no harmful use is made of his product, and that it is not good enough to simply drop a concept as toxic as "shock therapy privatisations" or "liberalised capital markets" into the world and then blame other people for abusing it.

So anyway, the original Samuelson-Coase controversy. It stems back to a paper by Coase on "The Lighthouse in Economics", which set out as an attack on the typical use made by economists of lighthouses as a public good. Lighthouses make a pretty good example for explaining to undergraduates what a public good is, because they are paradigmatically non-excludable; you can't stop them from shining on people who didn't pay for them. The main thrust of Coase's article was against comments made by Mill, Pigou and others, but he also paused to have a crack at Samuelson, who at that time was author of the most popular economics textbook, and who had used this bog-standard example in the chapter on public goods.

The problem being, unfortunately, and as far as I can see, that like so many well-meaning New Deal liberals of his kind, Samuelson had to have a fucking cherry on top of it. He wrote in his book that, not only did the non-excludability of lighthouse light mean that it was unlikely that yer basic Arrow-Debreu model of competitive equilibrium would converge on the optimal level of lighthouse production, but that he actually had something approaching a mathematical proof that the only possible way in which you could provide lighthouses properly was to pay for them out of general taxation, and then to give their services to the shipping public for free. This was actually not something that Samuelson needed to argue his point; as far as I can tell, he was just trying to hammer home the concept of marginal cost pricing; the marginal cost to a lighthouse of shining on another ship is zero, so the marginal cost to a ship of being shone on ought to be zero in an optimal solution. But in trying to punch home this message to the thick kids, he left what can only be described as a massive bloody great hostage to fortune.

The hostage to fortune being that, as anyone who fancies joining the British Lighthouse Society will tell you, for most of the history of the United Kingdom, a sizeable proportion of its lighthouses have been owned, operated and financed by private individuals and corporations. This revelation was the main theme of Coase's lighthouse paper, and since in general economists are revolted and terrified by anyone who appears to have anything approaching a clue about the facts of a matter, it threw the profession into hysterics Samuelson in particular, appears to have lost his temper a bit.

Of course, neoclassical economists being the chaps they are, this hasn't stopped the profession from continuing to use the lighthouses example as if there was no problem with it. However, as is usually the result when this particular pathology of the profession swings into action (viz, the Cambridge Capital Controversy, a past and future subject of this blog), ignoring the lighthouses problem didn't make it go away. A quick glance at that Google search reveals that there are a lot of people out there on the Internet who believe that orthodox neoclassicism said that only the government could build lighthouses, that Coase showed that free markets provided optimal levels of lighthouses, and that this disproves that there could ever be public goods. Score another victory for the head-in-the-sand faction of the modern economics profession.

But what's the truth about lighthouses?
Looking through the actual history, however, it is hard not to come away with the feeling that Coase materially over-sold his results, and that Samuelson was hard done by. Thanks to Jim Glass for this extract from an interview with Coase in Reason magazine in 1993.

Reason: What can you tell us about lighthouses?

Coase: Economists had always used this as a service that had to be provided by government. How could a private provider ever be paid for it? So without government operation you wouldn't get lighthouses. My usual practice is to look into what actually happens, and if you look into what actually happens you discover that there's a long period in which lighthouses were provided by private enterprise. They were financed by private people, they were built by private people, they were operated by the people who had the rights to the lighthouses, which they could bequeath to others and sell.

Some have said what happened in lighthouses wasn't really private enterprise. The government was involved in some way in setting the rights and so on. I think that's humbug because you could say that there's no private property in houses by that logic, since you can't transfer your rights to a house without the examination of title and registration and without obeying a whole series of regulations, many enforced by government.

Reason: I thought it was interesting that the shippers were the ones that lobbied to get the toll because they wanted the incentive for the private investor to build the lighthouse. What reaction have you had over the years when Paul Samuelson or other economists would use this example of the lighthouse as a necessary government function?

Coase: Samuelson says I was wrong and he was right, and he froths at the mouth when people talk about the lighthouse example. He says Coase is wrong; he doesn't overcome the free rider problem. Who are the free riders? The foreign ships going past the British coast which do not call at a British port. Using Samuelson's approach, what do you do? Do you ask the foreign governments to give you a subsidy? Do you tax people in Britain because the foreign ships are getting help without paying for it? What do you do?

My approach is to compare the alternatives. People like Samuelson like to set up a perfect world and say that the market does not bring us to this point and imply that the government should do something. They stop their analysis at that point.

Reason: Certainly if the government builds the lighthouses and operates them at a zero price to the shippers, there's a huge free rider problem there, free riding on the taxpayer. But you had to go back to the early days to find the private ownership?

Coase: Yes, that's right. From 1838 or some such date, I can't remember it, the lighthouse people were bought out and compensation was given. Samuelson says that no one would build a lighthouse with the idea of making a fortune. Actually, people did build lighthouses and did make a fortune.

Lots of extremely disingenuous stuff here. Like I say, I haven't actually read the original paper, but assuming that Coase was paraphrasing his side of the controversy accurately, we can straight away make a couple of points:

  • Coase and Samuelson are talking at cross purposes. Samuelson is talking about the optimal level of lighthouse provision, and suggesting that the observed outcome may not have been optimal (presumably what he meant by "he doesn't overcome the free rider problem"). Coase is assuming that Samuelson thought that lighthouses couldn't be provided at all without government intervention
  • Coase is very strongly implying, when he says that "lighthouses were provided by private enterprise", "no one would build a lighthouse with the idea of making a fortune [...] people did build lighthouses and did make a fortune" and poo-poos the extent to which government involvement was a factor, that lighthouses were built in much the same way in which any other entrepreneurial business invests in capital assets. He is implying without saying that the problem of non-excludability of light which gave rise to Samuelson's public good argument, was solved by free negotiation among the parties involved, and that all exchanges of light for money resembled normal market transactions between willing counterparties.

Let's look at the evidence

First a preliminary; people build lighthouses for all sorts of reasons, but there is only an interesting economic problem with respect to one or two kinds. Lighthouses which are built in order to guide ships into a port are not problematic in the slightest. They are a service used only by users of the port, they are paid for by the port authority, and one collects revenue for their upkeep by going round to the ship when it docks and asking for it, bundled with the rest of the services which the port fee buys you. Furthermore, you only make use of this sort of lighthouse if you're going into the port, so the people who use it can be separated from the people who don't and charged accordingly. Samuelson never gave the impression that he thought ports were public goods, so there is no reason to suspect that he thought that port lighthouses should be a particular problem

There is another kind of lighthouse, however, which is much more of a problem. If you want a lighthouse to warn ships away from a hazard of some sort, rather than to draw them toward a port, then you do have a problem in collecting your revenue; if you're manning the lighthouse on Eddystone Rock, then if you're in a position to walk over to a captain to deliver your bill, he's most likely not in a position to pay you, because he's crashed. In this case, it's also much more difficult to establish who used the lighthouse, and next to impossible, with light as it is currently designed, to stop someone from using it if they aren't prepared to pay. Hence the problem. Obviously, some lighthouses perform both functions (think of a port located next to some rocks), but it's worth noting at this point, that "lighthouses" don't form a homogeneous class of capital assets.

But anyway, it seems strange to me that Coase used the date of 1838 in talking about privately owned lighthouses. Assuming he means 1836, when Trinity House began to buy out the privately owned lighthouses, this marked the end of privately built lighthouses, not the beginning. There had actually been privately owned lighthouses for more than five hundred years.

How do we know this? Well, there exists a Royal Patent dated 1261, in which Henry III allowed some private individuals to collect "light duties" from shipping to pay for the upkeep of a light. As Ken Trethewey's excellent history puts it:
These Patents were the ultimate permission of the monarch and given under the 'Divine Right of Kings'. To fail to acknowledge this authority was considered treasonable. The Patent was given to the Barons of the Cinque Port of Winchelsea who were entitled to collect two pence from every ship that entered their port. This is the origin of the entire principle by which lighthouses have been operated for centuries right up to the present: a system of taxation known as 'light dues' based on the rule that the user pays.

To be honest, a system under which the government of the day gives you the authority to demand a payment from every ship that enters a port, and which states that failure to recognise this authority is treason (at the time, punishable by death), does not really look to me to be very much like a free market exchange. In fact, in giving the producer of a product the authority to demand on pain of death or imprisonment that everyone in a particular market has to buy their product, would seem to me to be very much more government involvement indeed, than the current rather light regulation of the housing market. I'm not saying that the analogy Coase used in that Reason magazine interview was completely outrageously misleading. I'm just sayin'.

There are numerous other episodes in Trethewey's history which rather demonstrate that the provision of lighthouses by private individuals was about a million miles away from your classic interpretation of a free market. The debacle of the Isle of Man, on which ships were regularly scuppered between 1771 and 1818 while Trinity House and a group of shipowners wrangled with a Mr Ludwidge over the matter of a poorly located proposed lighthouse which ships passing en route to Liverpool would have to pay for despite being exposed to the risks of the Calf of Man (which remained unlit). There is the case of Sir John Clayton, who obtained patents for five lighthouses, but only ever showed a light in two of them, precisely because his patent did not provide for him to charge a compulsory levy. And there are numerous accounts of "rent-seeking" behaviour in lighthouses, whereby lighthouse entrepreneurs with good political connections sought to build unnecessary lighthouses in anticipation of the stream of light duties they would be allowed to extract.

From all of the above, I draw two conclusions:

  1. Ronald Coase is going straight on the "always check" list, which is a pity, because I've always liked his work. The analogy to house purchases is insanely misleading; the main source of revenue for private lighthouse owners was a compulsory levy, which was backed by full force of statute law and which was even collected by HM Customs and Excise on behalf of the lighthouse owners! This is either horrendous historical scholarship or intentional misrepresentation; subject to the caveat that he may have been misquoted by Reason magazine or misrepresented his own work in the interview, I have to say that the lighthouse study does not prove what Coase and his admirers seem to think it proves (a couple of prominent economists agree on this point)
  2. Second on methodology, while the source of my sympathy for Coase is his methodology; his determination to always look for the real world example rather than the "blackboard economics" proof, this is one area in which he and Samuelson both screwed up, and it was by adopting the arrogance which is the hallmark of the economics profession. Samuelson had a good argument about the optimal provision of lighthouses, and if he'd studied the history, he would have come up with the Isle of Man and Sir John Clayton examples to show that non-excludability of lighthouse services led to real problems, which caused real ships to avoidably crash. But he had to, as I say, put a fucking cherry on top by overextending his sensible blackboard argument into a generalisation about the world. Coase then, correctly and admirably, called him on it by falsifying the generalisation, but then fell into the trap of forcing the pieces to fit into his own grand blackboard generalisation -- that free market negotiation between willing participants could always solve problems of resource allocation so long as property rights were well defined.

We shall conclude this sermon with a hymn:
Eternal Father, strong to save,
Whose arm hath bound the restless wave,
Who biddest the mighty ocean deep
Its own appointed limits keep;
Oh, hear us when we cry to Thee,
For those in peril on the sea!

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