Economists tend to partition the world’s goods into:
- Capital goods (made because they help to produce something else),
- Consumption goods (made because they’re desirable in and of themselves).
This is an incomplete partition, and its failings have cost us dearly.
There is a third category: overhead. Overhead goods aren’t made for productive purposes, nor are they satisfactions of any positive desire. We make them because, without them, we’d suffer losses or be seriously impeded in our more positive activities.
Insurance is an obvious example of an overhead good. No one wants insurance for its positive features. No one buys insurance because with it he can produce something else. We buy insurance because, without it, we’d be exposed to an undesirable degree of risk from some more positive activity, such as driving or owning a house.
With the exception of postal service, the activities permitted to the federal government by the Constitution are all overhead activities. They’re also all goods with pronounced externalities — that is, once these goods have been produced, everyone gets the benefit of them, not merely the people who’ve paid for them. This is no coincidence.
When such goods are left to the free market, they tend to be under-produced. Their overhead nature means that people won’t experience any positive lure to produce them. Their externalities mean that there will be an incentive to “free ride” on the contributions of others, and that some appreciable fraction of the beneficiaries will do so if possible.
The proper sphere of government, if it has one, can be seen in the light of this insight. Indeed, if there were no such things as these overhead-cum-externalities goods and services, there would be no conceivable justification for government. Individuals pay for their own overheads all the time, provided they don’t thereby pay for the overheads of others. And individuals and corporations produce goods with strong externalities as well — broadcast television is an example — so long as there’s a sufficient prospect of gain to the producer.
The great question of political economy is how to confine government to its proper activities — the production of overhead-cum-externality goods and services — and how to ensure that those things will be produced in sufficient quantities. Suffice it to say that, as of yet, no satisfactory solution has been found.