Mitigating the Free-Rider Problem

by Khairul Rizal

I wrote this piece of paper some ten years ago. The main idea is how to deal with the free-rider problem that is demonstrated in a real situation of the 2008’s Global Financial Crisis (GFC). The context might be out of date for sure. The idea, however, is highly relevant still, particularly for situations that require global collective actions. 

The GFC in 2008 did severe impact not only to the global economy but also to the dominant idea underlying the economy itself. Neo-liberalism idea, which is in favors on the role of market with limited roles of the states (Quiggin, 2005), is being questioned whether it is the ideal form of economic organization for the society. At the same time, the idea of the role of the state in economy is re-emerging calling for states’ action. As stated in the Washington Action Plan 2008, the governments of G20 agreed to enact a coordinated international approach in dealing with the GFC. However, collective action, especially in the global scale, is challenging partly because of the persistence of countries with the idea of neo-liberalism (Crouch & Marquand 1995, p.15), and partly because of the free-rider problem which is always be an obstacle in providing public goods (Olson, 1965). This paper focuses on how to deal with the free-rider problem in promoting global collective action. 

How the free-rider problem looks like.

The key issue in encouraging global cooperation to mitigate the GFC is how to deter countries from being free-riders. Free-rider is an important issue because it can undermine the effort to attain global purpose of a stable financial system. The incentive for being free-rider is high at least for three reasons. First, in international context (large group in Olson’s definition), free-riders are less visible. The incentive for being free-riders becomes stronger as there is no international government that can impose a credible punishment on sovereign nations. Second, as long as the global marginal benefit is higher than country’s own marginal benefit from contributing to global public goods, a country tends to avoid participation (Barret & Stavins 2003, p.358). The contribution here is the fiscal stimulus should be spent while the benefit is the increased demand from stimulus measure taken by other countries due to the interconnected nature of the global economy. Third, countries tend to pursue their national interests instead of broader interests. Even if it is in a country’s interest to act collectively, the level of engagement largely depends on the size of its interest (Olson 1965, p.35). Here, country’s interest depends on how it perceives uncertainties and damages caused by the GFC. Severely affected countries would have a strong incentive to contribute while less affected countries would have a strong incentive to be free-rider, or at least avoid full participation. Different impacts of the GFC on countries affect the incentive to act collectively. In dealing with the free-rider problem, two options are put forward.

Option 1: Strengthening global institution[1]

In the absence of international government, global institutions can play important role in facilitating consensus and coordinating action among countries. The IMF and World Bank, for example, can encourage collective action by providing accurate information about the damaging impacts of the GFC and offering advices for common economic policies. Therefore, the roles and capacity of these institutions should be strengthened in order to empower them to deal with global problems such as the GFC.

This option has several advantages. First, we do not have to create a new institution since they are already there. Second, these institutions can get rid of the free-rider problem. Working like a club, these institutions have selective membership benefit characteristic. Those who are not members cannot benefit from coordinated action offered by these organizations. As Sandler (1992) stated, the theory of clubs has similar idea to Olson’s selective incentive and exclusive membership proposal in dealing with collective action (p. 63).

However, these institutions are suffering from criticisms. Two are worth to be mentioned here: legitimacy and performance issues. Legitimacy refers to representativeness and decision-making process which are less democratic in these global institutions. Some challenges have been put forward on the legitimacy of the existing global institutions, including ‘democracy deficit’ by Stiglitz (2000) and ‘legitimacy dilemma’ by Best (2007). Likewise, performance of these institutions is also in question, particularly in the case of IMF in dealing with Asian crisis (Stiglitz, 2000) and the effectiveness of development aids by the World Bank (Easterly 2006, Mojo 2007, and Sobhan 2002). Thus, reforming governance arrangement of these global institutions seems to be more important before giving them more roles in coordinating global actions.

Option 2: Restructuring global incentive

Sovereignty issue and difficulties in punishing free-riders would make incentive more appropriate because it is less direct and more persuasive. Thus, altering the existing incentive so that being a free-rider would be disadvantages and cooperation is beneficial is a good strategy. This is based on the game theory (Sandler, 1997) which explains that a symbiotic cooperation would result in higher benefit to all parties involved[2] than acting individually in party’s own interests.

According to the game theory, the incentive for countries can be changed to be in favor for cooperation. This can be done by offering more benefit ‘linkage’ (Tietenberg 2007, p. 327) for getting involved instead of being free-rider. For example, Polaski (2006) shows that positive incentive in terms of knowledge transfer and market access to the US has improved labor’s rights condition in Cambodia. Another successful application of this approach is in the case of ozone layer depletion. There was strong incentive of not producing CFC-based content products since they were banned in the developed countries’ market (Barret 2003, p. 223). These two examples demonstrate how the structures of incentive were changed as a result of positive (i.e. market access) and negative (i.e. trade restriction) incentives. This option, however, prefer for the former (positive incentive) since negative incentive is a bit difficult, although still possible, to implement (Barret and Stavins, 2003).

Preferred option

Considering its effectiveness and political acceptability of the two options, the second one is preferable.  The selective membership characteristic of global institutions might effectively eliminate the free-rider problem. However, the legitimacy crisis suffered by global institutions makes this option politically less acceptable to some countries, thus undermining their effectiveness to promote participation. On the other hand, international experiences show that participation in global action can be encouraged by providing more positive incentives, particularly for developing countries. In some cases, free-rider can also be eliminated by creating negative incentive like limitation on access to developed markets, which is less coercive and politically more acceptable.

References

Barrett, S 2003, Environment and Statecraft: the strategy of environmental treaty-making¸ Chapter 8 the Montreal Protocol, Oxford University Press, New York.

Barrett, S & Stavins, R 2003, ‘Increasing participation and compliance in international climate change agreements’, International Environmental Agreements: Politics, Law and Economics, vol. 3, pp. 349-376.

Best, J 2007, ‘Legitimacy dilemmas: the IMF’s pursuit of country ownership’, Third World Quarterly, vol. 28, no. 3, pp. 469-488.

Crouch, C and Marquand, D 1995, Re-inventing collective action, in  Crouch, C and Marquand, D (eds.), Re-inventing Collective Action: from the Global to the Local, Blackwell Publisher, Oxford.

Easterly, W 2006, The White Man’s Burden, Chapter 1, Oxford University Press, New York.

Moyo, D 2009, Dead Aid: Why Aid is not Working and How there is a Better Way for Africa, Chapter 1, Farrar, Staus and Girox, New York.

Olson, M 1965, ‘The Logic of Collective Action, Chapter 1 and 6, Harvard University Press, Cambridge, Macssachusetts.

Polaski, S 2006, ‘Combining global and local forces: the case of labor rights in Cambodia’, World Development, vol. 34, no. 5, pp. 919-932.

Quiggin, J 2005, ‘Economic liberalism: fall, revival and resistance’, in Saunders, P and Walter, J (eds.), Ideas and Influence: Social Science and Public Policy in Australia, UNSW Press, Sydney.

Sandler, T 1992, Collective Action Theory and Application, Chapter 2 and 3, the University of Michigan Press, Michigan.

Sandler, T 1997, ‘Chapter 2 Global interdependencies: basic tools and principles’, Global Challenges: An Approach to Environmental, Political, and Economic Problems, Cambridge University Press.

Sobhan, R 2002, ‘Aid effectiveness and policy ownership’, Development and Change, vol. 33, no. 3, pp. 539-548.

Stiglitz, JE 2006, Making Globalization Work, Chapter 10, W.W. Norton & Company, New York.

Tietenberg, TH 2007, Environmental Economics and Policy, 5th ed., Chapter 15, Addison Wesley, Boston. Washington Action Plan 2008, viewed on September 1, 2010. <http://www.londonsummit.gov.uk/en/summit-aims/washington-follow-up/washington-action-plan1/>


[1] This option is listed in the Washington Action Plan 2008.

[2] Confession by both parties in the case of prison dilemma

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