Pigou is the new Keynes

by Sandy Ikeda

A full-page article in today’s Wall Street Jounal begins:

At the Heavenly Models home for deceased economists, an award is being presented to the resident whose work best explains financial crises, global warming, and other pressing issues of today.

The winner, according to author John Cassidy, is A.C. Pigou, the new flavor of the day.

The article implies that Pigou was the first to articulate the concepts of externalities and market failure.  I’m not sure that’s right, though I haven’t gotten around to reading The Economics of Welfare, but I believe we do have to credit him with the Pigou tax.  So in some ways he’s been almost as dangerous as his “smarter colleague,” although I’ve always felt sympathy for someone who was so much in Keynes’s shadow.

The article also has a sidebar quoting Mises (as well as Friedman, Kindleberger, and of course Keynes) apparently calling last year’s economic crisis.

10 thoughts on “Pigou is the new Keynes

  1. In my Economics & the Law class, we learned about Pigou, but we also learned about Ronald Coase.

    I prefer Ronald Coase. Yes, there are externalities, but as long as property rights are assigned and tradeable the market can take care of it.

  2. I thought the Mises sidebar was odd considering he mentioned the credit bubble of 2002-2006, but didn’t discuss Mises’ theory of what such a bubble would entail.
    The author says that “Pigou pioneered the study of market failure…,” but I say there’s no such thing. Markets are just buyers and sellers haggling over prices, or just taking them as they are. Markets don’t succeed or fail–only individuals and firms do. Governments are just criminal gangs, pretending to be market fixers, providers of defense and justice, and defenders of the poor and downtroden, but their policies usually gum up the works of the market order, and lead to the failure of individuals and firms. Government policies can even lead to systemic sorts of failures. The author says the recent bust is an example of a market failure; but I submit the market worked just fine with buyers and sellers consulting their own shifting value scales and time preferences, and trading or not trading in accordance with these patterns.)
    As for spillover effects generally, for every spillover effect A, the State fails to carry out its (alleged) primary mission of
    protecting the property rights of somebody B.

    I’m going to read the author’s new book on The Failure of Markets, but my expectations are low.

    A macro prof. of mine (a hardcore Keynesian) had a “Pigou Power” sign posted in his office. In the ’90 Pigou’s grand nephew was a marketing exec at my old firm, and spoke about him fondly a few times.

  3. Bill Stepp says there is no such thing as market failure. And indeed the concept only exists in the minds of academic economists. It is not a characteristic of the real world that one can identify. It exists if the conditions of perfect competition are not met. It is a chimera of neoclassical economics, just as the Austrian concept of “malinvestment” is a chimera of their framework.

  4. Though Arthur C. Pigou is often credited with first developing the notion or idea of “market failure,” this idea predates Pigou’s “The Economics of Welfare” by several decades.

    I would recommend a recent book that covers much of this history and the “counter-attack” by the Public Choice Theorists and by Ronald Coase.

    The book is entitled “The Hesitant Hand: Taming Self-Interest in the History of Economic Ideas” by Steven G. Medema (Princeton University Press, 2009).

    Professor Medema traces this idea back, in particular, to John Stuart Mill in his “Principles of Political Economy,” but most especially to Henry Sidgwick in his “Principles of Political Economy” (1901), and his earlier book, “Methods of Ethics” (1874).

    (By the way, Sidgwick was also the first economist to make the now standard, formal textbook distinction between a “change in demand” and a “change in quantity demanded.”)

    What Medema points out is that if one reads Mill, Sidgwick and Pigou carefully, their many caveats about the imperfect knowledge and information of the political decision-maker, and the almost inherent corruption and short-run political pressures on those in government resulted in them raising many doubts about the efficacy of goverment interventions to overcome supposed “market failures.”

    Thus, while they, and especially Pigou, developed many of the standard arguments about market failure, they also were aware of the potential limits to a “pure” and “simple” government answer to it.

    This, then, leads Medema to present very clear expositions and explanations of Coase’s arguments and significance, and the development and relevance of Public Choice theory from Buchanan and Tullock to the present.

    The book is worth the read on this theme.

    Richard Ebeling

  5. Oh, yes. I might mention one other thing about Arthur C. Pigou.

    Following the partial opening of formerly secret Soviet archives, it seems that a few researchers surmised that Pigou was possibly a Soviet agent!!

    It seems that he may have gone to work for the Cheka (the first version of the NKVD and the KGB) shortly after the end of the First World War.

    He acted as a recruiting agent at Cambridge. He would cultivate young men who seemed open to the communist idea. If they appeared the right “material,” he would take them on a hiking trip to Switzerland, where they would be introduced to actual KGB “handlers.”

    So some of the famous Cambridge spies of the 1930s and 1940s may have been partly Pigou’s handiwork.

    (I must say that I have not seen in the two or three books where this has been mentioned, usually in passing, any directly quoted evidence to prove the accusation. One of these books, without explaining the actual source, claims that part of the evidence came from Hayek.)

    As for those two or three books, they are somewhere in boxes of books that I have not unpacked since moving to Midland, Michigan and my new position at Northwood University. So I apologize for not being about to reference even these secondary sources.

    Richard Ebeling

  6. Pigovian taxes on producers of externalities in a world of state and crony capitalism–basically a Keynesian world of subsidized or stimulated consumption–are a little like the farmer slamming the barn door shut after he chased the horse out of the barn. What is the point in taxing polluters who are urged to pollute either by their state sponsors or their consumers, who are likewise sponsored or urged by the state to consume?

  7. I think we are watching 50 years of economic science being flushed down a memory whole, much like figures were cut out of pictures in Stalin’s era and made to disappear. Coase won his Noble Prize in part for exposing he errors in Pigou’s analysis.

    Textbook cases for applying taxes to correct marke failures founder on the knowledge problem: where do the planners get the information on the optimal tax? Businessmen cannot figure out a way to profit from what amounts to uncaptured profit opportunities, but bureaucrats know the optimal tax. Hmmm.

  8. Richard,

    Didn’t JS Mill described the distinction between demand and quantity demanded as the pons asinorum of economics? He may not have used the word, but he certainly made the distinction bewteen the two. That would predate Sidgwick, no?


  9. Apparently, Pigou himself recognized the “knowledge problem” in determining appropriate taxes and subsidies in a 1954 article (in the journal Diogenes) on the welfare state. I have only read excerpts from it. I am trying to get a copy.

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