Positive externalities vs Public Goods

Universal or quasi-universal payments such as parental leave and childcare rebates are sometimes justified on the basis they generate a benefit for the public. At times this argument is used interchangeably but incorrectly with the characterization of these payments as ‘public goods’. This misnomer is perhaps not an accidental one.

A public good is a product or service that is non-excludable (an individual cannot easily be prevented from accessing it) and non-rivalrous (use by one person doesn’t limit the use by others). The benefits accrue to everyone generally, not one person in particular. The most obvious example is national defence. These characteristics lend themselves to public provision of those goods, paid for through taxation, rather than private provision paid for by fees for use or access.

Childcare, paid parental leave and other welfare payments do not have the characteristics of public goods. They are money or services provided directly to individuals who qualify, and as such are obviously excludable and rivalrous (no other person can have the money provided to the recipient). Their benefit flows directly to the person who receives the payment or service.

What these payments and services (arguably) generate are positive public benefits in addition to that private benefit. That benefit is called a positive externality and is secondary to the primary benefit, which accrues to the person receiving the payment or service. Education is an example of a positive externality: the main beneficiary of a child receiving an education is the child themself, but there are additional ‘spill-over’ benefits to society that come from its citizens being educated (eg higher expected lifetime tax receipts).

As I point out in Welfare reform beyond decades of dependence, ‘dole bludgers’ and ‘double dipping’ (published this week), the distinction between public goods and positive externalities is important. Government is reasonably expected to fund and provide public goods, however government should only fund positive externalities if the benefit of the positive externality would not be received without government funding and the cost of government funding does not exceed the benefit received.

In short, government intervention should occur only to maximize the benefit from the externality. Incentive payments should be targeted to minimize the payments made to those who would undertake the activity anyway. There is no general cause for taxpayers to compensate people for the generation of positive externalities, even if that person incurs a financial cost to do so.