"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 favored candidates include John Maynard Keynes, the patron saint of stimulus programs; Hyman Minsky, an American disciple of Mr. Keynes who warned about the dangers of financial deregulation; and Milton Friedman, the late Chicago economist. (Mr. Friedman's free market principles are out of vogue, but Federal Reserve Chairman Ben Bernanke recently took his advice on how to prevent depressions by pumping money into the economy.)
Arthur Cecil Pigou in 1943.
Ramsey and Muspratt Collection
The winner's name, however, turns out to be much less familiar: Arthur Cecil Pigou. Stepping from the wings, a strapping Englishman with fair, wavy hair and a luxuriant moustache, smiles awkwardly and accepts his prize. A contemporary of Mr. Keynes at Cambridge University, Mr. Pigou was, for a long time, the forgotten man of economics. In the years leading up to his death, in 1959, he was a reclusive figure, rarely venturing from his rooms at King's College. His novel ideas on taxing polluters and making health insurance compulsory were met with indifference: Keynesianism was all the rage.
Today Mr. Pigou's intellectual legacy is being rediscovered, and, unlike those of Messrs. Keynes and Friedman, it enjoys bipartisan appeal. Leading Republican-leaning economists such as Greg Mankiw and Gary Becker have joined Democrats such as Paul Krugman and Amartya Sen in recommending a Pigovian approach to policy. Much of President Barack Obama's agenda—financial regulation, cap and trade, health care reform—is an application of Mr. Pigou's principles. Whether the president knows it or not, he is a Pigovian."
John Cassidy, "An economist's invisible hand", The Wall Street Journal (28 November 2009).
http://online.wsj.com/article/SB10001424052748704204304574545671352424680.html
John Cassidy is a staff writer at the New Yorker.
Arthur Cecil Pigou (1877 – 1959) was a Cambridge University professor and successor to Alfred Marshall. He trained and influenced many Cambridge economists who went on to fill chairs of economics around the world. One of his students was John Maynard Keynes. Pigou and Keynes had great affection and mutual regard for each other and their intellectual differences never put their personal friendship seriously in jeopardy.
Interestingly, in his General Theory of Employment, Interest and Money (1936), which ushered in The Age of Keynesian Economics, Keynes held up Pigou's Theory of Unemployment (1933) as the example of everything that Keynes claimed was wrong with Neoclassical macroeconomics. Pigou responded critically to his student's attack but mainly because he viewed it as an attack on Marshall rather than on him. Pigou later expressed appreciation for Keynes' work and said he failed to appreciate the important points Keynes was trying to say.
As an economist, Pigou made many contributions. Among the most important for which he is remembered today is the concept of "externalities", the uncompensated spillover effects of one person's actions on another. When positive or negative externalities are present prices do not reflect the full costs or benefits associated with production or consumption. Examples of positive externalities are beekeepers whose bees pollinate someone else’s crops or education that results in people who are less likely to engage in violence or crime, benefiting everyone. Negative externalities are pollution of all kinds, overfishing the sea to the point of extinction, or an underfunded pension fund that pushes costs to others. Man-made global warming, assuming it is real, is an negative externality because pollution costs generated by some people weigh on bystanders who did not create the problem.
Pigou remains important today because of his insights on dealing with externalities. Essentially, Pigou wants to tax or subsidize a market activity so as to bring the private cost in line with the social cost. A Pigovian tax (or subsidy) equal to the per unit cost (or benefit) of the negative (or positive) externality is thought to be an efficient way of achieving this. In response to the change in price, a tax would lower the level of production of the polluting product while a subsidy would raise production of a beneficial product.
Pigou's ideas are liked by liberals because they correct problems created by market failures. They are also liked by conservatives because his suggestions are seen as more efficient than direct regulations because they rely on market forces rather than government controls to correct what are acknowledged to be real problems.
When addressing problems of pollution or carbon emissions one alternative to Pigovian taxes is the creation of a market for "pollution rights" such as the "cap and tax" approach to emissions trading now under consideration by the Congress and pushed by international agencies. In general, pollution rights markets are seen as more complex and less efficient than Pigovian taxes. But to politicians pollution rights markets are more appealing than Pigovian taxes because policy makers can give their supporters "rights to pollute" for free or otherwise control their allocation. Pigovian taxes, on the other hand, say any producer can produce the product if it is willing to pay the tax and has the added advantage of providing incentives to reduce pollution and costs of production. Politicians can collect a Pigovian tax but unlike “cap and trade” they cannot favor their friends and supporters over others.
For this reason, no one should be surprised that politicians in Congress and international bureaucrats in New York prefer the "cap and trade" approach over Pigovian taxes. And, unfortunately, despite the recent resurrection of Professor Pigou and his ideas, that would seem to be the direction in which energy policy is headed.
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