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Public Versus Private Is Not The Same As Smart Versus Stupid…

December 8th, 2011 · 20 Comments
Buyer Beware · Markets · Policy

Another day, another case of firefighters letting a house burn because the owner didn’t subscribe to fire service. I wrote about this before in the context of pay-for-service ambulances, and what I’m beginning to realize is that, well, everyone is wrong. Here’s a summary of what I’ve been hearing on the fire department issue:

  • one group: See, this is the bad shi*t that results when essential services are privatized.
  • second group: See? Markets work.

In reality, private fire services could work if implemented properly, it just so happens that they seem to have been implemented in a less than thoughtful manner. (In addition, these fire services aren’t technically privatized, since the services are still being provided by a government.) As a result, the outcomes that we see are not economically efficient.

At a very basic level, it’s not efficient to let the house burn down because the value to society of the house and whatever contents would have been recoverable most likely outweighs the cost of putting out the fire. Therefore, any efficient private system would have to result in the fire getting put out. This is likely why most fire services are provided by the government and not limited to paying customers. A private system, however, would encounter problems if it didn’t restrict its service to paying customers, since at least some people would try to free ride and get their fire put out without paying the fee. One potential solution would be for the government to allow a privatized fire department but stipulate that, if a fire occurs at the home of a non-paying customer, the government will pay the fire department to put out the fire but then take possession of the house. (Please hold all conspiracy theories about the government committing arson on homes of non-paying customers for another time.)

Since the value of the house probably far outweighs the marginal cost of putting out the fire, you might be pondering why anyone wouldn’t subscribe to the fire service. Contrary to most economic assumptions about rationality, one simple explanation could be oversight. It seems a little strange to me that the only way to get fire service would be to subscribe to a form of insurance rather than just pay for the fire department to come and put out a fire, if for no other reason than the latter sort of system would mitigate the oversight problem. In addition, offering a pay-for-service model would alleviate a lot of moral hazard issues associated with insurance. (In other words, moral hazard occurs with the subscription version of the service if people are less careful because they know that the fire department will come bail them out for “free.”) Obviously the pay-for-service fee would have to be large compared to the subscription fee if the fire department’s goal is to actually get people to subscribe to the service.

If the fire department were to offer a pay-for-service product, should the government still serve as the backup customer as described above? Probably. Most economists would assume that, if a family doesn’t pay to have the fire put out, it must be the case that the house isn’t worth what the fire service costs. However, it could just as easily be the case that the family doesn’t have the money or access to credit to hire the fire department. On the other hand, it could also be the case that the family doesn’t value the house as much as other members of society do. (This could either be because of differing valuations of the property or because there are negative side effects associated with having a burnt-down house on one’s street.) If this is the case, then the government could act as a market maker to transfer the house to someone who values the house enough to pay for the fire service.

I hope that it’s clear by this point that neither a public nor a private offering of some goods and services is automatically good or bad, and it matters a lot how the markets are implemented…so can we please stop arguing about public versus private and start arguing about smart versus stupid?

Tags: Buyer Beware · Markets · Policy

20 responses so far ↓

  • 1 Eat The Babies! // Dec 8, 2011 at 11:35 am

    I am all for smart versus stupid. Definitely. But here’s two propositions I would like to make.

    1) The firefighters in the model linked were right to stand by and watch.

    2) Whatever reason you want to ascribe to it — doesn’t matter — if you make fire service subscription optional, there are going to be lots of low and moderate income people who aren’t going to pay it.

    Of course, insurance agencies could demand proof of subscription, but if you don’t have a mortgage then you don’t have a bank forcing you to have insurance, and the same people who won’t subscribe to fire service won’t have home insurance either.

  • 2 econgirl // Dec 8, 2011 at 12:15 pm

    You are correct on both points, but I think that it’s important to understand a little more about why the lower-income people wouldn’t subscribe, since the why aspect has implications for the policy recommendation debate.

    Nonexcludable fire services are, to a large degree, a reflection of the fact that society overall feels that everyone has the right to not have their house burn down, and that’s a question of values rather than one of economics.

  • 3 Jake Lopata // Dec 8, 2011 at 12:38 pm

    This is the general problem with insurance and why we are required to have certain kinds of insurance.

    Example: Car insurance. You can say, I won’t get into an accident because I will drive extra careful. Fact is, things happen that are out of our control and we don’t plan for those things.

    The purpose of insurance is to help smooth out those rare and devastating events in our lives, like a car accident, a house fire, etc.

    As another note, this is a good example of how starving your government will effect you, your community, and society as a whole.

    Taxes suck, but we pay them for a reason, reasons like paying our firefighters so they will put out a fire to save your home.

  • 4 Roger // Dec 8, 2011 at 2:00 pm

    There is one big reason why fire service does not function as a market that you didn’t discuss. When needed, the “customer” is not in any condition to negotiate or price-shop. To an extent, this is why the health insurance market will never function as a market. Someone in an accident can’t shop for an ER.

  • 5 Lucas M Engelhardt // Dec 8, 2011 at 2:15 pm

    I think a “fee-for-service” model is a good idea. Putting out a fire isn’t like replacing a house. As long as there’s a reasonably competitive market for the service, we should expect putting out a fire to cost the customer just a touch more than it costs the fire department. (Normal profit, etc. etc.)

    To me, though, it seems that there’s no reason we can’t have a subscription model operating alongside a fee-for-service model. After all, I can subscribe to The Economist, or I can just buy the issues that I want. So, have a subscription fee that is relatively low and a relatively high fee-for-service.

    Also, I’d not worry too much about credit market frictions here – after all, the fire department can offer a payment plan.

    I’d also not be surprised if insurance companies offered substantial discounts to customers who went for a subscription service. After all, a fire that gets put out limits the insurance company’s liability substantially…

    Very interesting idea, indeed…

  • 6 Dave // Dec 8, 2011 at 2:20 pm

    There are so few fires that a “fee for service” model would require thousands of dollars per fire put out. Most people would rather pay $75 for “insurance” than pay thousands if/when a fire occurs, just as we would rather pay $100/month for car insurance than self-insure and potentially be out several thousands of dollars if we get in a car accident that is our own fault.

  • 7 econgirl // Dec 8, 2011 at 2:46 pm

    Fun fact: In a lot of states, one isn’t required to purchase auto insurance if she can prove that she has enough money to pay whatever liability judgments may come her way from her getting into an accident. Also, it’s usually only liability insurance that is mandatory, which suggests that no one really cares if your personal vehicle doesn’t get repaired after an accident. The fire situation is different, however, in that the fire department is preventing damage rather than repairing it, and there are significant externalities associated with a burnt-down house on a neighborhood street.

    I think that the reasonable solution would be to offer both the subscription service and the fee-for-service option, for the reasons mentioned above. What I find interesting is that if the fire department offered only the fee-for-service option, we would see insurance companies jumping to offer a subscription option, but there’s not really a way for a third party to offer the fee-for-service option when the fire department only offers the subscription model.

    As a side note, people price shop in plenty of markets before they actually need the purchase so that they know who to call when they need to, so I’m not convinced that this is as much of an issue as some suggest. On the other hand, it is an issue in extreme circumstances since it’s not like I can utilize the fee-for-service model if I am passed out with carbon monoxide poisoning, which brings up the sticky question of what happens in any of these models if there are people stuck in the house.

  • 8 Eat The Babies! // Dec 8, 2011 at 6:40 pm

    I’m going to quibble with you a bit on fire services. Don’t you think general fire service originated in the pre-automobile days when buildings were, by and large, attached to each other or at least very close?

    So that fire services was less about the right to have a home protected from fire and more about my right for my home to be protected from your carelessness?

    I can’t help but think that that is the true origin (tho I know there was a time when fire services in NYC were private, for example – there’s that great scene in GANGS OF NEW YORK), and that ended up extending out to the rest of the country because it was just kind of “the thing to do.”

  • 9 Eat The Babies! // Dec 8, 2011 at 6:42 pm

    Oh yeah… and why poor people don’t do it: at the end of the day, it’s because they don’t have the money and want to spend it on other stuff.

    I’m not entirely shooting from the hip here, either. I spent 5 years doing low-income, very poor people organizing, so I know a thing or two about them. Their sense of priorities were not what we would think of as entirely rational or responsible, and they took all kinds of crazy risks in order to have a few more dollars today.

    That’s really the beginning and the end of it.

  • 10 David Welker // Dec 8, 2011 at 9:51 pm

    I think the book Nudge actually has a lot to say about this sort of thing.

    What Jody asserts “most” economists think just doesn’t make any sense.

    Fact 1:
    Everyone values fire insurance at higher than the cost of the policy if a fire occurs.

    Fact 2:
    Everyone values fire insurance at less than the cost of the policy if a fire does not occur.

    For the view that to pay for insurance reflects actual value judgments of most families regarding the value of their home to make any sense whatsoever, it has to be assumed that the family actually has some sense of the probability of a fire occurring. A “rational” family would multiple the market value of the home times the probability of fire + market value of saving lives of family members * probability of a life being saved + market value of avoiding injury to family members * probability of avoiding injury.

    Well, I have worked with enough people to know that the majority of homeowners aren’t even sure what their house is worth. Much less do they know what the probability of fire is. Much less do they know what the probability of a family member dying, given that there is a fire. Much less have they calculated the monetary value of the life of a family member. Much less do they know what the probability of an injury is. Much less do they know how much an injury would cost to treat or how much they would value avoiding an injury. Much less do they know exactly to what extent fire protection services actually decreases the probability of various bad things from happening (given that many fires can be put out without the help of a fire department, and the service level provided by different fire departments varies).

    OK. Real human beings don’t actually make decisions about getting fire protection based on how much they value the fire protection. Practically no one actually KNOWS how much fire protection is worth to them.

    This is why we should keep things simple. Just tax everyone and provide everyone with fire service.

    We have enough problems in life. We actually are less not more free when we get to individually spend the very limited number of minutes and hours we have on this earth “calculating” some hypothetical value for how much we “really” value fire service.

    The main reason people probably don’t pay for fire services in cases where it is voluntary is simply neglect, procrastination, or lack of money rather than any sort of “rational” calculation.

  • 11 David Welker // Dec 8, 2011 at 10:00 pm

    Eat the Babies:

    So, do you know?

    (1)
    The monetary value you would put on the of the lives of family member or others put at risk of a fire?

    (2)
    The monetary value of avoiding various injuries to family members or others put at risk of a fire?

    (3)
    The market value of your house?

    (4)
    The probability of a fire?

    (5)
    The probability distribution of different consequences occurring when a fire does happen?

    (6) How these risks are changed by the presence or absence of a fire department?

    (7) The quality of your particular fire department compared to other fire departments?

    Here is a fact. Even the “responsible” people who get fire protection don’t really have any idea what the “value” of such services are.

    I think people who are poorer tend to be less organized than average (although I know wealthier people who are not organized and poorer people who are more organized), more likely to procrastinate, and less likely to have money.

    THIS, rather than any sort of rational calculus is the sort of thing that will actually explain purchasing behavior when it comes purchasing fire protection.

  • 12 David Welker // Dec 8, 2011 at 10:02 pm

    “I think that the reasonable solution would be to offer both the subscription service and the fee-for-service option, for the reasons mentioned above.”

    I think the reasonable solution is just to tax everyone and provide fire services to everyone.

    Based on the KISS (“Keep it simply, silly.”) principle.

  • 13 noiselull // Dec 9, 2011 at 12:39 am

    History of Private Fire Protection:
    http://www.jstor.org/pss/724362
    http://mises.org/journals/jls/3_3/3_3_6.pdf

  • 14 Joseph // Dec 9, 2011 at 10:20 am

    I wonder if another issue is record keeping. What is the liability of the fire department if they let a covered house burn due to a book keeping error? What if the homeowner claims the house is covered? How do you check?

    Alternatively, if they are immune to liability due to errors on their part, how much is the insurance really worth?

    The Roman (Crassus, I think) who had a fire fighting company and would buy houses as they burned was actually acting in a more socially efficient manner. And we’d consider that predatory, today.

  • 15 Dave // Dec 9, 2011 at 12:42 pm

    Econgirl: you assert that nobody cares if their car is fixed after an accident, yet you cite no statistics about the percentage of people that purchase collision insurance. I would think you would understand the difference between requiring liability insurance (so others are protected from your bad driving) and not requiring collision (so you are additionally protected from your bad driving). Your comment implies you don’t.

  • 16 Michael Ryan // Dec 9, 2011 at 12:58 pm

    I mentioned Crassus to Jodi yesterday online, so I suspect that she will have more to say about him.

    An interesting footnote from the second article linked to above, http://mises.org/journals/jls/3_3/3_3_6.pdf
    quoted in full:

    “An outstanding exception, though not the only one, is the Rural Metropolitan Fire Department of Scottsdale, Arizona. Rural Metro was incorporated in 1948 and for a time sold its services to individuals on a subscription basis. It now provides fire-fighting to Scattsdale (sic) and some neighboring communities on a contract basis, but continues to serve other homeowners for a subscriber’s fee. It will also answer calls for non-subscribers, in which case it charges 17 times the annual subscription fee if it can save the property, but nothing if the damage is total. Subscribers’ fire insurance rates are lower. It would be interesting to know whether their liability insurance, which would include insurance against damage to the property of others by fire, is also less expensive. Per capita costs to Scattsdale (sic) under its contract with Rural Metro are only about a fourth the cost of the average municipal fire department. The company has kept costs low through technological innova-
    tion and effective personnel management. Although members of neighboring paid depart-
    ments are critical of Rural Metro, researchers have found it efficient.”

    It is an old article, so the information may be out of date, but I do like the model (if you reject the simpler tax based model):
    -They still put out the fire.
    -If you weren’t a subscriber, and they save your house, you pay more (17* regular subscription rate)
    -They have an incentive to save your house because if they don’t they get nothing.
    -Subscribers benefit from reduced insurance.
    -The company seems to be (or have been) more efficient than tax funded fire departments (perhaps accounting for the animus)
    -Reduction of negative externalities from fires that are allowed to burn.
    -General reduction of stupidity

    I tend to agree with David Welker that tax based fire departments are the simple solution, but if you are going to have a private solution, this one seems to make sense (or have made sense – not sure if it still exists)

  • 17 J.D. // Dec 9, 2011 at 10:17 pm

    I’m thinking the better result here is that in such cases the fire department should put out the flames and subsequently place a lien on the property until the department is paid for its services. Then, if they property owner still doesn’t pay, they sue to obtain title in court and then auction off the property to recoup their expenses. Simple enough.

  • 18 J.D. // Dec 9, 2011 at 10:25 pm

    This made me chuckle:
    “Most economists would assume that, if a family doesn’t pay to have the fire put out, it must be the case that the house isn’t worth what the fire service costs.”

    The house doesn’t have to be worth less than the fire services for this to happen. A more appropriate formulation would be that the present value of the house multiplied by the probability it will burn down today is less than the cost of fire services [that is, PV * P(B) < FS].

  • 19 Håkan Arnoldson // Dec 10, 2011 at 12:51 am

    Well for starter it is impossible to know what the market solution is because there are so many minds working on solving problems for others to make a buck. Left alone it is however very unlikely to come up with a solution that isn’t smarter then that of a few government bureau-rats.

    But it is always fun to speculate what might be most efficient. I don’t think putting out all fires is the best. If the family doesn’t value there house enough to have fire insurance and there insurance company or fire department doesn’t offer voluntarily to buy out the house when they can’t pay for having the flames put out it is probably not worth saving that house. The market value of the house with the fire, smoke and water damages will probably be next to nothing.

    Really it is not uncommon at all to demolish houses after fires that have been put out and use the insurance money towards building a new house rather then fixing the damages on a old building that needed lots of repairs and had no historical value anyway.

    The most important thing is to have working laws about liability to third parties because fires tend to spread. If your fire is a danger to someone else’s property and you can’t pay it should be possible to expropriate the property to pay for firefighting.

    Most communities will probably solve this by entering to agreements that ties having some kind of fire insurance to the property rights in the area when they are sold. I would also consider being able to force someone to get fire insurance if they pose a fire risk to my property that is far greater then what would be considered normal and if I have the first user rights there.

  • 20 David Welker // Dec 10, 2011 at 7:24 pm

    “If the family doesn’t value there house enough to have fire insurance”

    Objection!

    Assumes facts not in evidence.

    Many (most?) people don’t even know for sure what their house is worth, given fluctuations in value and the expense of finding out this information.

    Back here in the real world, we say that someone who hasn’t done any calculation is IGNORANT of the value of fire protection to them.

    In fact, the vast majority of people are ignorant of the probability of fire. Therefore, they would be ignorant of the value of fire protection to them.

    What I don’t understand is how perfectly smart people have gotten it into their head that you can make the huge logical leap from someone doesn’t buy fire protection to that person doesn’t value the fire protection enough to pay the premium.

    That is completely unscientific. You want to know why people don’t buy fire protection? How about actually studying the problem and making real observations of real data, as a real scientist would do, and finding out? I know it is LESS WORK to assume you already have the answer, but that isn’t really a very good justification.

    The bottom-line:
    If someone hasn’t even done a calculation of how much they value fire protection then you can’t say the reason they didn’t buy it is because they didn’t value fire protection enough.

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