Wednesday, July 9, 2008

Public facilities as inferior goods

Inferior goods are those whose consumption decreases as incomes rise. As Samuel Staley argues here, public transport, which are fixed route transportation modes designed to carry large numbers of people, is one of the classic examples of such goods. The same logic can be extended to include government schools and hospitals as examples of inferior goods.

Since higher income consumers do not form a significant share of public transport users, the transit systems suffer from the crucial demand side pressures which are important to improve quality. The lower and lower-middle income users, having no other transport alternatives, are invariably less demanding on the quality. Further, roping in a significant share of higher income users enables public transit operators to generate additional incomes by differentiating services and charging higher user charges on them.

This challenge is the same as that being faced by other public service facilities like government schools and hospitals. The poor or lower middle income users of these schools and hosptitals most often have no choice and have to bear with the quality of service offered. The higher income citizens, who are more likely to demand better education and health care in these government run facilities, have private sector alternatives and therefore stay away from the public schools and hospitals.

Therefore, the challenge is to make these public facilities more attractive, so as to draw in higher income consumers. Public policy seeks to find regulatory answers to solve this problem. Thus, instead of incentivizing people to use public schools, hospitals, and transit systems, governements use regulations to force people to use these facilities.

But as Samuel Staley argues, any effort to do this by regulations which seek to make the private alternatives unattractive (by using public policy to undermine the use of cars, regulatory restrictions on private schools and hospitals etc) is unsustainable and economically inefficient. It will result in numerous incentive distortions that will do more long term harm than good. The focus will therefore have to be on improving the quality of these government run facilities, so as to incentivize atleast certain categories of higher income users to use them.

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