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Sam Peltzman wrote of this 40 years ago. Liberal economist Larry Summers wrote about it 20 years ago. The paradox is quite simple. Suppose the government provides universal free services, such as education, of modest or even good quality. Many people would rationally find it optimal to consume the “free” product than to pay higher costs for slightly better or even much better provision of the good (education in this example). This is a paradox because if they had to pay for all of their education themselves, they would have chosen to purchase the high quality, more costly education, than the lower quality, less costly education.

Summers recognizes that this difficulty could be resolved by “public programs” that partially compensated those seeking higher-quality private sector services. He goes on to say that, “it is hard to imagine the government contributing substantially by providing the cost of a public school education to parents who send their children to private schools, or giving rebates to the poor who choose not to take advantage of low-income housing programs.”

In many cases, we see government provision completely crowd out other alternatives – hence this is the way we solve the paradox today. We never get to see or imagine the counterfactual. And in fact, if you believe in Friedman’s law, if we were to see the counterfactual, the paradox might not be as strong, since the better services are likely to be much cheaper than the real cost of the free ones.

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