Summary of JOIE article “Private Provision of Public Goods via Crowdfunding”, by Marek Hudik (Xi’an Jiaotong–Liverpool University, Suzhou, China) and Robert Chovanculiak (Institute of Economic and Social Studies, Bratislava, Slovakia). The full article is available on the JOIE website.
In 2011, Highland Park in Michigan was compelled to remove over two-thirds of its streetlights because of the city’s financial problems and large public debt. In absolute numbers, the city lost more than 1,000 streetlights. In response to this event, city representatives asked the residents to leave their porch lights on during the night. At the end of 2012, dissatisfied residents decided to build public lighting on their own. Several months later, they successfully installed the first residential LED streetlight with a solar panel (Indiegogo.com, 2012). Their project is one of many recent public projects that have been privately funded through a crowdfunding (CF) platform.
The fact that CF enables the private funding of various public goods is of great interest to economists. As has been long recognized, the provision of public goods is typically associated with problems that are considered difficult to solve by private means. These problems are the organization problem, the assurance problem, and the free-rider problem. The organization problem refers to the fact that it is costly to organize a contribution scheme for a public good provision. The assurance problem refers to the possibility that each individual will not contribute to funding the public good because he believes that others will not contribute either (and so he does not waste his effort to contribute) (Sen, 1967; Schmidtz, 1987). The free-rider problem refers to the possibility that each individual will not contribute to funding the public good because he believes that others will contribute (and so he can consume the public good without contributing) (Samuelson, 1954, 1955; Kim and Walker, 1984).
CF and the organization costs
The provision of a public good involves fixed costs: a contribution mechanism must be established and administered, and the project must be advertised to the public. Perhaps most importantly, potential contributors must be reached. Due to high fixed costs, some goods may not be provided. However, there are economies of scope: if there are many projects, contributions to these projects can be collected in a single campaign and all these projects can be jointly advertised. As dominant providers of public goods, governments can and do take advantage of these economies of scope. Once a government with a taxation mechanism is established, the marginal costs of collecting contributions for an additional project are low. In contrast, if the private funding of a public good is organized on an ad hoc basis, the organization costs may be prohibitively high because economies of scope cannot be exploited.
In the past, organizers of private campaigns have sometimes managed to reduce organization costs by employing newspapers. Nevertheless, a significant reduction in the organization costs associated with private funding came only with the internet. Online CF platforms offer fundraisers the opportunity to create their own web subpage that displays a description, pictures, and video of the project. It also contains information about the time remaining for the fundraising, the amount of raised money, the number of supporters and fans, list of rewards, and news about the campaign. All this information can be updated frequently at a low cost. In addition, the web subpage offers various opportunities for communication between the fundraisers and the campaign contributors. Perhaps most importantly, given the vast number of internet users, online CF platforms allow many potential contributors can be reached at a low cost.
CF and the assurance problem
Several theoretical models demonstrate that the assurance problem is mitigated by a credible money-back guarantee that applies if the threshold for the provision of the public good is not met (Palfrey and Rosenthal, 1984; Bagnoli and Lipman, 1989; Tabarrok, 1998). In the past, the use of refunds for a large group of contributors was costly. If the threshold was not met, collected money was sometimes used to finance inferior projects. Currently, many CF platforms take advantage of the fact that the costs of refunding are significantly lower and the credibility of the guarantee is higher thanks to fully automatic online payment methods (e.g. PayPal, Amazon payments, Authorize.net, and WePay). Nevertheless, some platforms allow for funding even if the threshold is not met. For example, #SciFund Challenge employs this model in its financing of scientific research (Wheat et al., 2013).
Some methods other than a refund guarantee are employed to mitigate the assurance problem. For example, some platforms require a minimum level of fan support that projects must reach before they are allowed into the funding phase. This strategy is used by Startnext, which is the biggest CF platform in Germany. In addition, all CF platforms publish the overall amount of funds collected on an ongoing basis so that people can update their beliefs about whether the threshold will be met.
CF and the free-rider problem
The free-rider problem is mitigated if individuals derive utility not only from the public good, but also from their own contributions. One reason why individuals may do so, is that they may care about social recognition (Becker, 1974; Oliver, 1980; Harbaugh, 1998). Indeed, the data from CF campaigns indicate that rewards that enhance the social image of contributors (e.g. t-shirts with a logo or badges) by communicating to others that the individual participated in a good cause are correlated with a campaign’s success (Crosetto and Regner, 2015). Andreoni and Petrie (2004) demonstrated experimentally that publicizing both the identity of the contributor and the size of their contribution significantly increases contributions. Interestingly, the authors also found that giving individuals the option to publicize their contribution (as some platforms, such as Ioby.org or Goteo.org, do) results in more contributions than making such publicizing a requirement.
The production of social recognition through non-anonymous contributions is made more efficient by spreading information about an individual’s contribution through social networks such as Facebook or Twitter (Mollick, 2013; Davies, 2014). These social networks provide a cheap and effective means of reaching the members of a person’s reference group. The productivity of a person’s contributions can thus be assumed to depend on the visibility of the contribution to other people.
In addition to the social-recognition motive, contributions are incentivized by various private goods (e.g. commemorative t-shirts, hats, towels, bags, certificates, personal meetings, invitations for dinner with the authors of the project, and publicly displayed commemorative plates with a message from the contributor). Although the value of the rewards to contributors may be relatively small, it can still make a big difference. Contributions in CF campaigns are usually also small, which means that these rewards can tip the cost–benefit calculation in favor of the decision to contribute.
Marek Hudik (Xi’an Jiaotong–Liverpool University, Suzhou, China) and Robert Chovanculiak (Institute of Economic and Social Studies, Bratislava, Slovakia)