Market failure, ‘merit goods’ and rural proofing

Introduction

There is a long tradition of communities in rural areas taking action for themselves to provide a wide range of services that in urban areas would be provided by the market or by the state.  This was an attribute that was recognised by government in the last century through agencies such as the Rural Development Commission (RDC).  The RDC played a crucial role in rural England from 1901 until 1997. It was finally closed down and its functions passed to the Regional Development Agencies, the Countryside Agency and some, finally, to the Commission for Rural Communities.  The RDAs inherited its economic, but not its social, remit.  The RDC’s long term investment in advice and technical assistance to both rural communities and small rural businesses had until then been seen as being two sides of the same coin.

As the delivery of both commercial and public services (‘merit goods’) are now being modernised to meet the needs of this century, rural areas still need to be kept in mind and rural proofing is one process that assists in this.

Market failure

Market mechanisms work best to allocate resources efficiently when an equilibrium can easily be found between producers and consumers.  Wherever there is a large enough number of consumers to prompt the emergence of more than one producer or supplier then market competition will rapidly ease the way to an efficient allocation of resources.  Put more simply, competition between producers/suppliers will keep prices low and production efficiency high.  For some products and services, however, rural areas do not have a ‘critical mass’ of consumers and this is where there is risk of market failure.

It is easy to make the mistake of inferring that the term ‘market failure’ is one that is critical of market mechanisms. There is an even greater risk of this when it is used to describe rural communities, probably because they are generally thought to be economically successful when compared to some disadvantaged urban areas.  There are, however, circumstances where markets do not meet all of a population’s needs and must be supplemented either by the state or by civil activity; rural circumstances can be one of these.   Accepting market failure as a fact of life, one that can be addressed, rather than as a criticism of market forces, is a first step to ensuring that dispersed rural communities are empowered to help themselves and play a full part in a modern economy.

Rural proofing

It is possible for the concept of rural proofing to become viewed as ‘just another box to be ticked’ in the policy thought process.  This would be unfortunate.  The recent review by Lord Cameron has tended to lean towards a belief that greater exhortation of senior civil servants and Ministers, better high level statistical information coupled with improved mechanisms for co-ordination are all that is needed for rural proofing to be effective.  All of these are useful, but the impact of the market as a means of delivering merit goods is barely mentioned, despite its importance.

There are a wide range of merit goods for which the ‘producer of last resort’ is the state and as a result their availability to rural people needs to take account of the way in which markets work in these areas. In the mixed economy of the early twenty first century, where the pendulum that represents the mix has swung significantly away from the state and towards the market for most goods and services, this is even more important.  State institutions now seek to supply most of the merit goods for which they retain a responsibility through procurement processes that harness the market for delivery.  In this context, to fail to view rural proofing through the lens of market failure is simply to fail to understand rural proofing at all.

25% of the UK’s population live in rural areas creating a large consumer base for the same wide range of goods and services that are also required by the remaining 75% who live in towns and cities.  The critical difference is that the rural 25%’s dispersal means that for many goods and services there are not enough consumers in close proximity to each other to support more than one supplier.  This can give rise to market failure emerging in a number of different ways eg a monopoly supplier, no supply at all or a constant churn in supply as the market tries to find an equilibrium that is not there to be found.   Often, however, this does not appear to happen, or is not visible, and it is important to understand why.

Differentiating consumers in rural areas

For some goods and services, and more importantly for some consumers, a significant proportion of the 25% who live in rural areas can be treated as part of the same market as the 75% who live in urban areas.  This is either because the cost of becoming part of the nearby urban market is met by the consumer or the value of the goods or services is so great that supplier is willing to bear the transactional cost of ‘joining’ the rural consumer into the urban market.  In other words, suppliers of high value goods and services will meet the cost themselves and/or relatively prosperous consumers do not notice the cost of personal transport.  For consumers who are less prosperous personal transport costs assume a greater significance in the household budget and the lower cost providers of goods and services are less able to bear the cost of joining their consumers into the urban market.

It is not just goods and services such as groceries, furniture or plumbers that are subject to this, it is also these merit goods such as child protection services, care of the elderly, education, business support services and broadband.  It is the way in which the procurement of these services are organised by public institutions that will demonstrate whether the relationship between market failure and rural proofing is properly understood and the correct interventions put in place.

Although it is not always the case, most users of public services are those on lower incomes, the very people who, in rural areas are most affected by rural market failure.  The use of market mechanisms in procurement of public services targeted on these people must, therefore, be handled with great care.  Output related payment contracts are sometimes crudely drawn up, competing suppliers are used operating over the same area and flat rate ‘per case’ payments applied to combined urban and rural areas. All of these will all tend to result in rural people becoming excluded from services.

In the rare examples where market failure results in an impact on supply that also effects the most prosperous rural dwellers (generally services where this part of the population cannot ‘buy their way out of’ provision for the whole community, such as broadband) the issue rapidly becomes highly visible.  Procurement by state institutions to intervene in these markets, even in highly visible cases, is still far from satisfactory when it comes to its real understanding of both market failure and the rural dimension of it.  This has clearly been the case in procurement of broadband for rural areas where the bulk of the available subsidy has been spent on reaching areas that were just beyond the scope of the market rather than furthest from it.  This has happened for very understandable reasons where public sector procurement policies have sought the best possible value for money.  However, by the time the investment had been carried out the market had already caught up and much of the public investment may not have been necessary.

Social enterprise and charity

The real effect of market failure when it comes to rural areas will often not be widely visible because it tends primarily to affect just those who are least prosperous, least articulate and least able to influence policy.  This inevitably brings into play the role of community organisations, charities and social enterprises.  These organisations have a primary concern for their beneficiaries and only a secondary one for surpluses (aka profits) generated from serving a market.  Organisations of this type provide services at cost, (ie with no profit being returned to their owners), subsidise the labour costs of supply with voluntary input and meet the needs of the most vulnerable through charitable donations.   This makes them invaluable in a mixed economy that is also seeking to reduce rural disadvantage.

Market logic, however, still applies to these organisations.  Social enterprises may be able to provide goods and services on a commercial basis to a wide range of people and use any surpluses generated to support those who are most vulnerable, but only where market opportunities exist so to do.  These opportunities will be greatest where there is a concentration of population and/or access to rural people who are relatively prosperous.  Where this is not the case a greater emphasis will need to be placed on mutual activity within communities, intervention from the state to support this mutual activity and charitable donations.

Bringing together practical action with policy development

The UK is a mixed economy and with a strong preference by government for the public sector to commission its services from non-statutory providers.  The job, therefore, of an active social enterprise and charitable network, working in partnership with organisations such as LEPs and often led by local Rural Community Councils, can best be summarised as:

• Providing government with a strong evidence base of ‘what works’ in delivery of merit goods by social enterprises, charities and community groups to/with rural people.
• Support from local intelligence and experience for departmental rural proofing activity in relation to new government policies or programmes.
• Prompting, advising and supporting communities to develop local delivery of merit goods in ways that can overcome local market failure.
• Supporting and advising local government and its partners, as well as new devolved arrangements, over rural proofing procurement and commissioning of merit goods in rural areas.
• Innovation and R&D in relation to rural delivery of merit goods by social enterprises.
• Creating a focus for charitable donations from the local area to meet the needs of vulnerable rural people that cannot easily be met through commissioning from the public purse.

Jeremy Leggett

Action in rural Sussex

January 2016

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