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Free rider problem

In economics, collective bargaining, psychology and political science, "free riders" are those who consume more than their fair share of a resource, or shoulder less than a fair share of the costs of its production. The free rider problem is the question of how to prevent free riding from taking place, or at least limit its negative effects.

Because the notion of "fairness" is controversial, free riding is usually only considered to be an economic "problem" when it leads to the non-production or under-production of a public good, and thus to Pareto inefficiency, or when it leads to the excessive use of a common property resource. See also collective action problem.

In the labor union context, a free rider is an employee who pays no union dues or agency shop fees, but nonetheless receives the same benefits of union representation as dues-payers. Under U.S. law, unions owe a duty of fair representation to all workers they represent, regardless of whether they pay dues. Some jurists have questioned the fairness, if not the legality, of this practice.

Free riding is also a term used by brokerages when a client purchases shares beyond his or her means. Free riders are those who purchase shares and then do not pay for them. (See margin.)

Politics

A common example of a free rider problem is defense spending: no one person can be excluded from being defended by a state's military forces, and thus free riders may refuse or avoid paying for being defended, even though they are still as well guarded as those who contribute to the state's efforts. Therefore, it is usual for governments to avoid relying on volunteer donations, using taxes and, in some countries, conscription instead.

Government is indeed the primary mechanism by which societies address free rider problems. In addition to fiscal measures noted above, regulation is another form of collective action taken by governments to resolve free riders problems such as environmental degradation or excessive resource use.

The free rider problem is also one justification for the existence of governments which provide public goods. Some ideologies, such as libertarian capitalism, are often rebuked, because in such a system all property in a society would be privately owned, away from any state involvement or regulation. Libertarians counter that potential free riders within their system could face social ostracism, which may deter those who accept services without donating any payment for them. Libertarians stress that the need to healthily co-operate and interact with others in society would lessen the risk and likelihood of free riders.

Bargaining

The free rider problem has deep roots in more general bargaining, and issues to do with incentive compatibility. That is to say that, when involved in bargaining problems, players may often bid less than they are prepared to pay in the hope of improving their own position. This creates problems because it is impossible to discover the players' true demand payoff curves, and therefore inefficient allocation of resources is likely to ensue.

Example

Suppose there is a street on which 25 people live. There is a chance to install a street-wide litter collection system to reduce unseemly garbage, the cost of which is $2,500. Suppose that each person is prepared (i.e., able and willing) to pay $100 or more for the benefit of a cleaner street.

If the system is installed everyone will benefit. However, it is possible that some people on the street will refuse to pay, anticipating that the system will be installed in any event.

Despite the fact they may be prepared to contribute $100, they will claim that they are not prepared to pay, and instead hope that others in the street will pay for the system anyway, and they receive the benefit for no personal expense.

The result is that it is possible no system will be installed, an example of market failure. This is despite the fact that allocative efficiency would be improved.

Solution

One common solution to the problem is to gather the 25 participants and make them behave like one customer, so the decision is reduced from 25 independent decisions to one. A vote can be taken, but if the answer is yes, everyone will be forced to pay regardless of their individual support. This is why public services such as military defense and police service are almost exclusively provided by governments.

Problems

The solution suggested above is not without its problems. The utility for the 25 people may vary from one person to another, and each person may place a different value on the service. Some people may even consider the service to have negative utility. Deciding how the cost is split among the people raises important political considerations. A simple even split ($100 each) may not be equitable.

References

Cornes, Richard; Sandler, Todd (1986). The Theory of Externalities, Public Goods and Club Goods. New York: Cambridge University Press.
Venugopal, Joshi (2005). "Drug imports: the free-rider paradox". Express Pharma Pulse 11 (9): 8. This article refers to the free-rider problem in global pharmaceutical research.
Antonin Scalia's dissenting opinion in Lehnert v. Ferris Faculty Association, 500 U.S. 507 (1991).