5. The economics of government information
5.1 In order to achieve an efficient allocation of resources it is generally necessary for prices to be set equal to long run marginal costs (apart from exceptions where this would have implications for the viability of the service). Prices paid are assumed to be a good approximation to the private and the social marginal benefit from the product. Marginal costs are assumed to be the cost to society of supplying another unit. Hence, if the price were above the marginal cost then both the producer and consumer of an incremental unit would benefit from the unit being sold; willingness to pay exceeds the costs of supply so there must be a social gain. Resources should therefore be shifted to producing this incremental unit. When production has expanded so that marginal costs and marginal benefits are equal in all markets, resources are efficiently allocated. No reallocation can make somebody better off without making somebody else worse off. (These and the other points in this section are set out in full in the economics paper attached as Appendix C).
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5.2 This argument is at the heart of the information industry's position in relation to information - in that it suggests that information produced for the public benefit should be priced at marginal cost to other users. (However, the marginal cost meant in that context is taken to be the additional costs, normally equivalent to the variable or short run marginal cost.) This leads logically to one possible policy option - moving to a general policy of marginal cost pricing for licensing all government information.
5.3 In practice the high fixed costs relative to low variable costs of information goods provide major difficulties for such a pricing policy in relation to information. The basic point is that a price which covers only the variable cost of supplying a few more units (short-run marginal cost pricing) would be insufficient to cover the total costs. Of course in practice, in the private sector, content providers deal with the same conundrum. They do so in general by long run marginal cost pricing, or by price discrimination and product differentiation - recouping their fixed costs from the consumers of premium products.
5.4 Against this, it is argued, government information is an experience good for which consumers may generally be unwilling to pay at first. But, once consumed, they learn the true benefit to be gained. Prices must be very low if these benefits are to be reaped.
5.5 This analysis poses three questions:
- first, is the demand for government information so price sensitive that short run marginal cost pricing is the only viable pricing option ?
- second, would the fall in government income brought about by a single policy of marginal cost pricing (and consequential increased tax burden) be offset by greater economic activity elsewhere in the economy? and
- third, to what extent could and should the public sector emulate the private sector's pricing strategies?
Marginal cost pricing?
5.6 The evidence is that certainly not all demands for government information are price sensitive. The Government produces and sells value added as well as raw data for which consumers are prepared to pay a premium while in other areas such as mapping and meteorology the Government does much more than meet its own needs. It is an information service provider in markets whose existing customer base extends across the entire economy. As a result the Government is able, without abusing the dominant position it has in particular markets, to use pricing strategies which enable it to recoup at least some of the fixed costs of production.
Greater economic benefits?
5.7 The efficiency argument is in favour of long run marginal cost pricing, but it is also possible to argue that the public sector, having collected data for its own purposes, and to disseminate this data for the good of society, should bear that collection cost and price information at short run marginal cost. If it did so however the Government would need to fund the resulting public expenditure from taxation. But taxation also normally misallocates society's assets. Taxation absorbs resources and changes behaviour. The marginal social cost of raising public funds is generally agreed to be around 20-30% of the value of the extra tax receipts.
5.8 If, as the Treasury's economists suggest, the economic benefit of long run marginal cost pricing may be of a lesser order of magnitude, there may be no net benefit to the economy. In other words the case for a general move to any form of marginal cost pricing is unproven because the efficiency gains from improved resource allocation in the information market are likely to be broadly offset by fiscal burdens elsewhere in the economy.
5.9 On the other hand short run marginal cost pricing may bring considerable extra social benefits: information is a good for which this marginal cost is in many cases near to zero (once information is collected only the costs of reproduction, etc are additional); there are also prospects that demand would grow rapidly in response to lower prices (information being an experience good) and as basic information is repackaged in innovative ways. The issue needs further empirical work.
5.10 The review concludes that the case in principle for a general policy of short run marginal cost pricing is unproven. In the light of the potential implications of such a policy decision, more work would be needed before it could be considered further.
5.11 The review recommends that further work should be undertaken by the Treasury and the DTI on the economics of information pricing with a view to developing further the evidence base and to inform future policy decisions.
Could the public sector emulate the private sector in this area?
5.12 In general, and faced with similar pricing problems in relation to information (although with a different rationale - that of profit maximisation), the evidence from the market is that private sector providers use product differentiation and price discrimination so that users of some services pay something approaching short run marginal costs. Among other means, the providers do this by passing most of the fixed costs of production to other users of their "high value-added" services. So to our third question. could the public sector replicate such strategies?
5.13 For the most part we think probably not on the grounds that discrimination and differentiation strategies are likely to be less open to government agencies and departments than to the private sector, and the government is likely to be less good at pursuing them. This is because in general, government departments and agencies (other than trading funds), even if they are subject to product market competition, are not governed by capital market disciplines which are essential to effective competition.
5.14 It is recognised in the literature that the characteristics of "public goods" may make it unlikely that they will be produced in a socially efficient way by the market - hence government's historic role in many areas of provision. Information may have a "public good" characteristic (non-rival in consumption). It may often be a "merit" good, and the use of appropriate information may contribute towards beneficial externalities ie have value to others as well as to its individual user. On the other hand, none of these necessarily implies government provision or has any general implication for the pricing of information,
5.15 One public good argument - that some information may not be produced unless government produces it or requires it to be produced - allied to the natural monopoly nature of some information, makes market pricing in such cases and privatisation in particular, problematic. On the other hand, one answer to the incentives conundrum would be to transfer the collection and management of publicly gathered information to the private sector in order to introduce capital market disciplines. In other sectors these issues have been overcome through regulation so privatisation may be a solution for some parts of government with each case taken on its merits. But there may be security and other considerations and such a course of action is unlikely therefore to satisfy the requirement of the review, which is to make progress in the near future.
5.16 A second policy option is to maintain average cost pricing, augmenting the Fees and Charges Guide as it applies to information through the publication of specific guidance to improve efficiency without impacting upon the fiscal position. The problem here may be the fact that the Fees & Charges Guide requirement has been shown to be consistent with a variety of pricing strategies which cover fixed costs, and may in some cases have allowed the extraction of excessive profit from the sales of raw data. As such, pricing strategies are unlikely to be compatible with optimising public access to government-created information - as evidenced by the comments from the information industry. Whilst this option would have the benefit of involving very little if any cost it is very unlikely to satisfy the brief for the review. It is unlikely to assist in the liberalisation of access to information and it is not recommended.
5.17 A different approach is offered by looking at the distinction between various types of information; the government's role in collecting it and its ability to contribute effectively to its commercial exploitation. The difference between the information the Government has because it is the Government and that which is incidental and of which the government is not the main consumer, is particularly important and one which has been recognised by the Government for some time. There has been a movement towards the provision of traded services (including information) through quasi-commercial bodies - trading funds - that provide the capacity and incentives for public sector bodies to act in a commercial manner. The list of trading funds includes the UK Hydrographic Office, Meteorological Office, and Ordnance Survey. A full list of trading funds is at Appendix D. There is a case for treating these commercial bodies, trading funds, differently to other parts of government for this reason. Here we think there may be reasons for not moving towards a policy of short run marginal cost pricing.
5.18 The principal argument for not moving to short run marginal cost pricing in trading funds is that if additional demands for information eventually require more capital investment, then these extra costs will have to be funded from taxation. As discussed above the economic argument used in favour of such marginal cost pricing, that the demand for information is highly price elastic is less likely to hold true in relation to trading funds. There are several issues:
- the most important point is that trading funds are commercial bodies that are delivering services which go considerably beyond the scope of government's own needs while they also provide value added services as well as raw data. This makes the demand for their products much more price inelastic and the case in favour of more service users contributing to the fixed costs of the business all the stronger. Many users pay for mapping, meteorological and other data. The markets are subject to high degrees of segmentation and product differentiation, with low value product users already paying close to such marginal costs in some of the more forward thinking trading funds;
- in meetings with trading funds it has become apparent that there is the need for more transparent accounting and for the clearer separation of activity surrounding the production of raw statistics from that surrounding the value added businesses of trading funds. But such a process needs to be managed. Trading funds are businesses and very few business can mount changes of this nature in the short term and moving too quickly towards changing the policy could be destabilising, add considerably to costs, possibly without any tangible policy benefit;
- each trading fund is different. Some such as the Met Office have sought to separate their core from value-added functions but are at an early stage of doing so. Others, such as the Ordnance Survey are concentrating on generating their income from the selling low-priced relatively raw data and licensing the use of their brand to others. The Treasury's detailed analysis of the survey returns from the trading funds highlights the manifest differences between these bodies and the difficulty in applying precisely the same policy to each. So a one size fits all solution for trading funds, involving a commitment to take any particular course of action, is unlikely to provide a workable basis for the future development of each organisation;
- trading funds exist in a competitive economy. None are pure monopolists in information and there is evidence that the private sector is (in both meteorology and mapping) investing in the development of parallel capacity. Clearly a rapid change in policy which involved free access to government information could undermine these investments, made in good faith against the background of existing government policy. So changes in government policy need to consider the impact on the private sector as well.
5.19 For these reasons we recommend that a policy of encouraging price differentiation through product differentiation is appropriate. This would see fixed costs recovered equally between users of the same services but on a variable basis between services according to the type of service. This and closer management of the trading funds is likely to provide the most efficient outcome.
5.20 This leads to a third possible option. It is to manage government trading funds which trade information to improve their pricing and dissemination polices but elsewhere to move to an immediate policy of marginal cost pricing in departments and agencies other than trading funds (unless, in any specific case, a statutory enactment indicates otherwise). This is the recommendation of the review.
5.21 For these purposes, as in the context of Freedom of Information, we recommend that marginal costs be defined as costs, including costs of staff time, reasonably incurred in locating and retrieving the information, and giving effect to the requesters preferred medium for the reply (which could be different to that in which the department currently held it); and also the disbursements directly incurred in communicating the information, eg printing, postage etc. This is broadly equivalent in economic and accounting terms to assuming the government would bear the fixed costs of obtaining the information for its original policy purpose, and the requester would bear the additional cost of their request.
5.22 We recommend that the foregoing should apply to the licensing of raw data but not where the government adds value to material through for example enhancing and facilitating its use and effectiveness for the user through compilation, editing, interpretation or commentary.
5.23 We also recommend that all government bodies, including those for whom the general rule of marginal cost pricing applied in relation to raw data should continue to be free to develop value-added services charged at market prices, preferably in partnership with the private sector under the Treasury's Wider Markets initiative provided that this can be achieved in a transparent manner and in a way which creates a level playing field between all market participants.
5.24 The implications of this change in policy in relation to licensing on the government's publishing income need to be considered also. Potential private sector partners, under this marginal cost pricing regime, may be deterred from accepting financial risk and burden in publishing or producing products on behalf of government. This could lead to some unquantified increase in publishing costs and/or loss of publishing income. For example, publishers may hold back and wait for access on a marginal cost basis under standard terms. First mover advantage may no longer be worth as much as it was.