Burning Down the House

6 October 2010 at 8:10 pm 16 comments

| Scott Masten |

Peter posted a Facebook link to a Jeff Tucker post on the Mises Economics Blog commenting on the news report about the Tennessee man who didn’t pay his annual $75 fire protection services fee, and the fire department from the neighboring town let his house burn down. Peter, Jeff, and Clifford Grammich (who commented on Peter’s post) cover the issues pretty well. My guess is that the reason governments rather than private companies generally provide fire services has a lot to do with the difficulty of pricing fire services. (The Tennessee case involved a quasi-market transaction in that residents outside of South Fulton paid the city of South Fulton for fire protection.) It is certainly conceivable that private fire companies could offer homeowners and businesses a choice between (i) prepaid fire service for an annual fee and (ii) on-demand fire service. But how would you determine the price of the latter? I’m pretty sure you wouldn’t want to negotiate the price while your house is burning down. (Talk about temporal specificity!) And you wouldn’t want to negotiate the price after the fact either: Gee, guys, thanks for saving my house; can I buy you all a beer?

The alternative would be to set the price for on-demand fire protection ex ante. But this poses problems, too. Either you need a price list (kitchen fire, $X; smoldering electrical fire, $Y; whole-house conflagration, single family ranch-style house, $ZZZZ; and so on) or you set a single price reflecting the cost of the average fire. But even then, you have questions like, what if the fire department were slow to arrive, or sent the wrong equipment or inadequate personnel, or whatever? Even if the department did everything it should, the house might burn down anyway (maybe because, like the first little pig, I’d built my house of straw). You can imagine the lawsuits over whether or not a homeowner should have to pay the on-demand fire suppression fee if the fire department’s efforts were unsuccessful. Government-supplied fire protection avoids all of these pricing issues. Sure, government supply has its own inefficiencies, but everything’s comparative, and the problems of pricing fire services seem pretty severe to me.

A bit of (indirect) evidence consistent with this is that, toward the end of the 19th century, densely populated cities were significantly more likely than more sparsely populated cities and towns to own their own water systems. If providing water for fighting fires was one of the major benefits of centralized water (which is true), and if contracting with private water companies for adequate supplies (volume and pressure) was difficult (which is not so clear), it would make sense that densely populated cities — for which the cost of inadequate water supply would have been greatest — would be most likely to own their own waterworks.

Although a number of large fires in the 19th century were blamed on the failure of private water companies to supply adequate water or pressure for firefighting, I’m actually skeptical that this public safety rationale explains municipal ownership of waterworks. As I noted in a paper on 19th waterworks ownership (forthcoming in JLEO), “the great fires in New York (1845), Pittsburgh (1845), St. Louis (1849), Chicago (1871, 1874), Boston (1872), and Baltimore (1904) all occurred in cites with public waterworks. Even after the Great Chicago Fire of 1871, the Chicago Board of Aldermen refused to appropriate money for water system improvements requested by the Fire Department, contributing to Chicago’s second great fire in 1874.” Public ownership of waterworks didn’t clearly solve the problem of water availability for firefighting, but public provision of firefighting services may still be better than the private alternative.

Entry filed under: Ephemera, Former Guest Bloggers, Institutions, Public Policy / Political Economy.

The Ownership of the Firm under a Property Rights Approach The (Very) Early Adoption of Modern HRM Practices

16 Comments Add your own

  • 1. srp  |  6 October 2010 at 9:29 pm

    I assume you’re not talking about privatization where the local government contracts out the service to a company like Rural/Metro in Arizona but rather to one where each homeowner makes a separate contract. The former method presents no special pricing problems.

    As for individual contracting, if the danger of the neighbor getting burned down from your fire isn’t too high then I think you could get around this by combining fire insurance and fire suppression contracts. The vendor would give you a thorough inspection and quote you a price based on the inspection, your distance from the firehouse, etc. If you burned down, the vendor would lose money because they would have to pay on the insurance policy. I’m not looking to start this business, however.

  • 2. Scott Masten  |  6 October 2010 at 10:02 pm

    Agreed. A city contracting with a private company for fire service is like a city contracting with a private company for water. As with any contract, those can experience problems, but they are unlike the case in the news story where individuals contract for fire service (or not) individually. Where the city does the contracting, the city works like a central agent procuring the service for the residents.

    The combination of insurance and fire protection is essentially the real services explanation for insurance, and that gives the insurance company the right incentives. For that matter, however, the arrangement in the story, where individuals pay a fee for fire service from a neighboring town, is apparently workable — at least until some guy decides not to pay his fee some year and his puppy dies in a fire with the firemen standing by watching. And in that event, it’s not clear that private insurance/fire protection would be any different: Either a way to arrive at an ex post price for fire services for someone who didn’t buy the insurance/protection bundle would have to be found, or we’d have to let the puppy burn. (Not to mention the case of humans trapped inside.)

  • 3. Peter Klein  |  6 October 2010 at 10:22 pm

    Scott, what about volunteer fire departments as a third institutional alternative? According to McChesney (JLS, 1986) (http://www.jstor.org/stable/724362) this was the dominant organizational form in most US cities until the late 19th century. (See also http://www.econlib.org/library/Columns/Mcchesneyfire.html.) That’s one way to deal with the pricing problem, at the expense (I suppose) of free riding — though social norms may have alleviated that concern.

  • 4. Peter Klein  |  6 October 2010 at 10:23 pm

    PS: That’s one of my least favorite Talking Heads songs — and thanks to your post, I can’t get it out of my head.

  • 5. FC  |  6 October 2010 at 11:53 pm

    In some states, volunteer fire departments are financed by property taxes collected through fire districts. This system seems to work well enough in rural areas.

  • 6. Fred Thompson  |  6 October 2010 at 11:55 pm

    The issue is public financing not provision. Firefighting services are commonly provided by private contractors throughout Northern Europe and in a few cities in the US. Every property owner benefits from appropriate facilities (designed to insure the town doesn’t burn down — you cannot do much about individual structures unless you get there very quickly) in terms of reduced fire insurance premiums and higher property values.

  • 7. Scott Masten  |  7 October 2010 at 8:07 am

    Peter, Sure, volunteer fire departments should be thrown into the mix. But even if the labor is free, someone has to pay for the equipment. That, too, could be done on a volunteer basis by donations; you could have essentially nonprofit fire companies. Something along those lines obviously worked well for some time and still does in some places. But if we observe systematic variation in organizational form over time or among cities or towns, there must be a reason for it. McChesney’s argument is that it is all rent seeking. Rent seeking is clearly part of the inefficiency of public provision and may also have played a role in why municipalities took over fire protection and waterworks. But a rent-seeking rationale for municipalization needs testable predictions for (i) why some cities succumbed to rent-seeking pressures and other didn’t (or did so sooner than others), and (ii) why rent seekers chose some activities to distribute rents and not others. In the case of water, water and sanitation systems became predominantly public but not telephone, electricity, (manufactured) gas or, until relatively recently, public transportation. I’m broadly familiar with the private/volunteer fire protection literature but not well enough to know whether the literature provides such discriminating rent-seeking hypotheses. Looks like I know what I’ll be doing this weekend.

    In regard to FC’s comment, mandating payments for fire services — something a government can do but a private company can’t — eliminates the pricing problem that motivated my original post. Once the pricing problem is settled, we we are back to the procurement choice that srp raised: Does the city run its own fire department, contract with a private fire protection company or, as Peter added, rely on volunteers?

  • 8. Dick Langlois  |  7 October 2010 at 9:12 am

    Bundiling insurance and inspection is an old idea. That’s what the Hartford Steam Boiler Inspection and Insurance Company was started to do with boiler insurance in the 19th. century. (It still exists; interesting short history here: http://www.hsb.com/about.asp?id=50.)

    In a world of private fire protection, wouldn’t insurers condition rates on having purchased fire protection? And, since most property is mortgaged, wouldn’t underwriters insist that owners have fre insurance (and therefore fire protection)? And maybe in the end mortgage underwriters would insist directly that owners have fire protection, which could be paid along with the mortgage payments the way taxes and insurance now are.

    That leaves owners of unmortgaged property who don’t pay for fire protection. But what about a liability-rule solution? A fire company could provide services and bill after the fact, as long as courts uphold the idea. Doesn’t that happen now with ambulance service — and indeed medical services more generally? You are be billed for calling the ambulance or the doctor; why not for calling the fire service?

  • 9. Dick Langlois  |  7 October 2010 at 9:19 am

    P. S. Thinking about it as a liability-rule issue would speak to the pricing problem. Prices would be determined by the court in the end, though more likely there would be a standard fee (that might have been sprung from litigation in the past) as presumably occurs in the ambulance case.

  • 10. Scott Masten  |  7 October 2010 at 1:54 pm

    Dick, It is certainly the case that banks require homeowners insurance, and one would presume that insurance companies know whether or not fire protection service is available. (I think my policy indicates distance to the closest fire hydrant.) In the end, what this all points out is how peculiar this particular case is. The guy must not have had fire insurance (and therefore must not not have had a mortgage on his property) or did have fire insurance but was not required to provide proof that he had paid his annual fire protection fee. (I suppose the guy could have opted not to pay the $75 fire fee and pay a higher premium on his insurance but that seems unlikelier still.) All of which contributes to why this is news at all; if not for all of these unusual circumstances, this would be a more common occurrence and would receive little notice. But it has me interested enough now to look in more detail at where and when public fire service arose. If it varies systematically with city characteristics, then the question is whether there’s a political economy story of rent seeking that ties the characteristics to public provision or whether something else accounts for the variation.

  • 11. ProfDC  |  7 October 2010 at 2:07 pm

    In the spirit of letting the market set the price for fire services, how about a fire-forfeiture rule?

    If there’s a fire and the premium hasn’t been paid, the Fire Department puts out the fire (which is clearly efficient). The insurance company pays the homeowners’ claim for the fire damage. The Fire department, however, gets title to the home and its contents in the after-fire condition. It then auctions off the (remains of the) house in a sealed-bid 2nd-price auction and receives the proceeds. The (previous) homeowner, of course, can bid, and presumably has higher private value fro the home (and its contents) than the 2nd-highest bidder.

    The fire department now has incentives to put out the fire efficiently (salvaging maximum value of the house) and the homeowner has incentives to not have fires. Paying the 2nd-highest bid to “get your house back after a fire” should be sufficiently odious that fire insurance will be purchased for all but the worst houses.

    If the house completely burns to the ground despite the highly-motivated efforts of the FD, the insurance company ought to cheerfully pay the full claim. Further more, the fire department is now getting paid “market rates” to preserve property value from being destroyed by fire; fires which cost more to put out than they preserve will be allowed to burn (a sort of “efficient breach” of the fire dept’s social contract to preserve property.)

  • 12. Scott Masten  |  7 October 2010 at 6:26 pm

    Wouldn’t it pay fire companies to go around, spray a little water on a house (“we caught the fire just in time!”) and claim the auction money? Homeowners would then have to hire fire protection protection service companies to keep fire companies from “saving” their houses.
    Good thing the current system works pretty well, the occasional odd case excepted.

  • 13. Jon  |  8 October 2010 at 1:16 am

    A little bit special circumstances, perhaps, but ancient Rome seems to have had problems with rent-seeking and fire protection. From Wikipedia (/History_of_Firefighting): Marcus Licinius Crassus (born about 115 B.C.), “acquired an enormous fortune through (in the words of Plutarch) “fire and rapine.” One of his most lucrative schemes took advantage of the fact that Rome had no fire department. Crassus filled this void by creating his own brigade–500 men strong–which rushed to burning buildings at the first cry of alarm. Upon arriving at the scene, however, the fire fighters did nothing while their employer bargained over the price of their services with the distressed property owner. If Crassus could not negotiate a satisfactory price, his men simply let the structure burn to the ground, after which he offered to purchase it for a fraction of its value.”

  • 14. Scott Masten  |  8 October 2010 at 6:38 am

    Perfect!
    None of that would have happened, of course, had it not been for the evil influence of transaction cost economics on management.

  • 15. ProfDC  |  10 October 2010 at 8:53 am

    @Scott — the fire department isn’t in charge of monitoring whether there are fires, of course. The idea that this fire-detection function needs to be vertically integrated with the fire-extinguishing function is simply silly.

    The default for fire departments is not to be proactive; it’s to be reactive. We have alarm companies and emergency numbers that CALL the fire department, not roving fire trucks that opportunistically look for nice houses where it can’t be proved there wasn’t a fire.

  • 16. Lizeth Mercado P  |  3 November 2010 at 7:52 pm

    I am agreed, because it necessary adopt an mechanism through make the persons will feel sure and they stay agreed with the price of the service that they are paying, and not create doubts and questions about if the service is really supplying the necessity who will happen, like the house burn down and the fighters who did not nothing to save it. It is a sorrow that happen things like in Tennessee where a man for not pay a fee but he was ready to cancel a lot of the fee, for have not to look his house burning, and could not say the same of the fighters that independently that the man haven´t paid before, they realized an immoral act when they did not do nothing to see who is destroyed the dreams of a man just for give him a lesson; the same happen when doesn´t take the appropriate conditions and predict the variables that could happen and the parameters for the people knows before what is going to happen if they accept the contract, since the private companies have stipulated the terms and they are not to renegotiate the price when the person is exposed to the danger, it is to say, it know the mean price who the should pay the companies if happen incidents like this, knowing that every system have fails just because noting is perfect.

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