DRI-444: An Economist Sees the Light

The previous EconBrief spotlighted the great Ronald Coase, 101 years old and still going, as a shining beacon of truth in economics. It is altogether fitting that Coase should occupy the limelight. He has not only seen the light – he has shown it to the profession. It was Ronald Coase who restored the lighthouse to a place of respectability in economics.

The Traditional Role of the Lighthouse in Economic Theory

For over a century, the lighthouse held a unique place in economic theory. Some of the world’s leading theorists and textbook writers used its services as their prime example of a good that could not be provided privately and had to be provided by government and paid for out of tax revenue.

Generically speaking, the term economists use for this kind of good is a public good. Its status is predetermined by its unique characteristics. A public good is both non-rival and non-exclusive. “Non-rival” means that providing it for one consumer simultaneously makes it available for all. “Non-exclusive” means that there is no way to exclude those who refuse to pay for it from its benefits.

The best example of a public good conveys the concrete meaning of these properties. National defense cannot be provided for one citizen without making it effective for the remaining 315 million or so Americans. Any attempt to withhold it from (say) one conscientious objector would risk defaulting on the obligation to defend the other 314, 999,999. Only by assigning provision to the government and mandating payment in the form of taxation can this hurdle be overcome.

You might suppose that, with national defense just sitting there made to order, textbook authors wouldn’t need to scrounge for examples. But economists wanted more than just one perfect case. They yearned to picture public goods lurking under every bush. They longed for a homely, neighborhood example to contrast with the might and majesty of the federal government at work. They wanted to depict the government providing public goods off the shoals of Cape May as well as on the shores of Tripoli.

Proponents of the lighthouse as public good focused particularly on its alleged non-exclusivity. The lighthouse owner was surely not going to brave the seas by rowing or motoring out to a ship to collect a toll before switching on the lighthouse beam, right? If not, private lighthouse provision was doomed – the lighthouse would rapidly go broke if it couldn’t collect from the beneficiaries of its service.

Some of the world’s most distinguished economists said this – not as an obiter dictum, but as their go-to textbook example of a public good.

The Embarrassing Record

Let us now braise famous men. First to feel the heat is John Stuart Mill, the most influential (if not the best) economist of the 19th century. In his Principles of Political Economy (1851), he wrote: “…It is a proper office of government to build and maintain lighthouses… since it is impossible that the ships at sea which are benefited by a lighthouse… should be made to pay a toll on the occasion of its use. [N]o one would build lighthouses from motives of personal interest, unless indemnified and rewarded from a compulsory levy made by the state.”

That seems straightforward enough. Government has to build and operate lighthouses because the private sector cannot do so profitably. Why? Because they cannot collect tolls for the benefits received from the light dispensed. Thus, lighthouse expenses should be defrayed by taxes collected by government.

The name of Henry Sidgwick is unknown today, but was well-known over a century ago. He had his own Principles of Political Economy (1883), in which he declared that “the benefits of a well-placed lighthouse must be largely enjoyed by ships on which no toll could be conveniently imposed.” This puts lighthouses among “a large and varied class of cases in which …an individual [cannot] always obtain through free exchange adequate remuneration for the services he renders….” Likewise, A.C. Pigou (The Economics of Welfare, 1932) classified the lighthouse in the category of “uncompensated services.” Basically, Sidgwick and Pigou echo the arguments of Mill.

Nobel Laureate Paul Samuelson’s Economics: An Introductory Analysis (6th ed., 1964) is the most famous economics textbook of all time. In it, he informed us that “government provides certain indispensable public services without which community life would be unthinkable and which by their nature cannot appropriately be left to private enterprise.” (Emphasis added.) Samuelson’s examples were national defense and criminal and civil law, but a footnote alluded to a “later example of government service: lighthouses,” whose keepers “cannot reach out to collect fees from skippers” of ships.

In keeping with his role as economic scientist and modernist, Samuelson saw the lighthouse as a case of market failure owing to “external effects.” He lamented that, while “[the lighthouse’s] beam helps everyone in sight, a businessman could not build it for a profit, since he could not claim a price from each user. This certainly is the kind of activity that governments would naturally undertake.”

Coase pointed out an additional argument made by Samuelson. Because the cost of allowing an additional (marginal) ship to benefit from its light is essentially zero, the price charged to the marginal user of the lighthouse beam should equal its zero marginal cost. This bow to the principle of “marginal-cost pricing” – a principle first outlined by economist Harold Hotelling – is another characteristic feature of economic modernism.

And Now – the Truth About Lighthouses

In a landmark paper published in 1974, Ronald Coase ended a century’s worth of lighthouse foolishness perpetrated by economists. Coase did something amazing – he actually checked to see how lighthouses were provided in the past and present.

The earliest reference to lighthouses in the United Kingdom seems to be 1370. From the beginning, British monarchs authorized lighthouse construction and sanctioned toll collections from ships using the service. Coase discovered that the principal lighthouse authority in England and Wales was a private organization called Trinity House, whose origin dated back to the Middle Ages and which was incorporated in 1514. British lighthouses started springing up in the 17th century and became common in the 18th century. Although most of these were constructed by individuals not affiliated with Trinity House, the authority continued to assert its authority to control their activities. Most commonly, an area needing lighthouse services would corral a willing entrepreneur, who would apply for a patent from the Crown and supply a petition from shipowners and captains who would express willingness to pay tolls. The need for ships to utilize harbor facilities provided the occasion for toll collections.

This basic framework persisted until 1834, when existing lighthouses were consolidated under the aegis of Trinity House. This structural consolidation under an organization controlled by the Crown is the only element of British lighthouses that comes close to the public good model embraced by economics textbooks. There was private ownership and operation. There was no government ownership. There was no finance out of general tax revenues. There was no provision of service at zero price.

Internationally, this pattern was mostly followed. Significantly, the International Association of Lighthouse Authorities, established in 1957 to promote information and coordination for global navigation, was non-governmental.

Lighthouses in America

LIghthouses in America evolved along lines similar to those in England and Wales, with variations. The American colonies collected tolls from ships, in the form of light dues or shipping taxes, by using customs inspectors as tax collectors.

In 1789, Alexander Hamilton imposed his vision of lighthouses on the new nation. This entailed federal ownership and control and service provided “free as the air,” apparently for purely political reasons.

Beginning early in the 20th century, tended lighthouses started to disappear. This trend accelerated in the 1960s and 70s, culminating with a selloff by the Coast Guard of remaining (untended) “light stations” early in this century.

Ratio frequency and GPS technology has virtually replaced light as the guide for coastal shipping. The lighthouse is now suffering the fate of such other “public goods” as landline telephone service and first-class mail delivery – technological obsolescence.

The Lessons of the Lighthouse

The point of the lighthouse episode is not to make fun of great economists because they made a mistake. Nor is it to deplore the fact that the source of that mistake was ideological. Great scientists have made mistakes throughout human history. Ideology has led men astray since the day when we first began to use our reason.

Mill, Sidgwick, Pigou and Samuelson fell victim to their own arrogance. Moreover, that arrogance was not so much personal as systemic. They were determined to treat the economic system as a mechanism that could be built to order and manipulated by those in the know. This philosophy has been aptly characterized by F. A. Hayek as constructivism – the belief that mankind can control its own evolution by shaping social institutions according to a blueprint. Constructivists see themselves as the draftsmen.

Classical economists have traditionally been viewed as devotees of laissez-faire. But Mill leaned ever more toward socialism as he aged; indeed, Hayek claimed in a biography that Mill may have influenced more economists toward socialism than any one else. Pigou was a famed exponent of government taxes and subsidies as correctives for external costs and benefits imposed or conferred by production decisions. Samuelson was diehard liberal and Keynesian whose faith in government economic intervention was surpassed only by his faith in his own intellectual superiority.

These men were not partisans of unfettered capitalism. Free markets do not require frequent, large-scale intervention by government. Without government intervention, there would be no call for wise economist philosopher-kings to plan and superintend the intervention.

In order to justify government intervention, there had to be lacunae in the operation of free markets. That explains the creation of the category of the public good, something that could never be supplied by private markets. In order to justify large-scale intervention, the lacunae had to be numerous. A small handful of major exceptions, like national defense, would not suffice for the constructivist purpose. That explains the public-good designation of plain, ordinary, garden-variety goods like lighthouses. Ostensibly, public goods were everywhere – we needed big, powerful government to cope with their omnipresence.

The combination of arrogance and anxiety bred carelessness. Left-wing economists took one look at lighthouses through the filter of their ideological preconceptions and decided that this service couldn’t possibly thrive under free-market conditions. They didn’t even glance at the historical record, let alone at the industrial organization of lighthouses in their own day.

One might suppose that such colossal incompetence would have severe professional repercussions. Hardly. Mill, Sidgwick and Pigou had shuffled off to Buffalo, mortality-wise, by the time Coase’s research was published. Nobody had even bothered to check up on their veracity. Samuelson was so firmly ensconced on academic Olympus that this peccadillo was little more than a blotch on his resume. His critics soon found even larger fish to fry. Successive editions of his textbook predicted that the Soviet Union would soon surpass the U.S. in economic growth – right up to the time when the Soviet empire imploded in a bloodless, spontaneous upheaval fueled by the economic impotence of the system.

Coase’s Own View of the Lighthouse Episode

We should note that Coase’s own conclusions were narrower in scope than those above. He maintained that lighthouse operations were likely to be more efficient and less wasteful when they were sponsored and funded by shipowners, who had a direct interest in their efficacy and economy. He pointed out that Samuelson’s argument for marginal-cost pricing of service was negated by the fact that light dues were collected in Britain only for the first several voyages in the calendar year. While he expressed wonder at the propensity of “…great men” to “make statements about lighthouses which are misleading as to the facts… unclear [and] …very likely wrong [as to] …policy conclusion…,” he accused them of nothing more than a desire to “provide ‘corroborative detail, intended to give artistic verisimilitude to an otherwise bald and unconvincing narrative.'”

Coase drew the same professional moral here as in his investigation of social cost; namely, economists should conduct “studies of how… activities are actually carried out within different institutional frameworks.” These should reveal “the richness of the social alternatives among which we can choose” – in other words, they should hammer home the vastly enhanced flexibility of marketplace mechanisms compared to non-market alternatives. Coase concludes that “economists should not use the lighthouse as an example of a service which could only be provided by the government.” Thus, he ended on an understatement characteristic of his native land, his profession’s better nature and his personality.

The Proper Posture of the Economist

Ronald Coase shone a light on the economics profession with his exploration of the lighthouse in economic theory and history. That light reveals the failing of the mainstream economist. It was defined by the ancient Greeks as hubris, the sin of overweening pride. The proper posture for an economist, Coase’s posture, is that of humility in the face of markets. Ironically, John Maynard Keynes himself once remarked that economists would do better to regard themselves in the same light as dentists.

Markets are an evolutionary response to the needs of mankind. They are not intractable physical structures like rocks or trees. When their initial formations prove inadequate, they adjust (or are adjusted). Those who fail to appreciate the inherent flexibility of markets end up in the dustbin of history. It is surprising how many economists there are in the bin.