Arthur Cecil Pigou (1877 – 1959).

Background A kind and honest person, climbing mountains, living peacefully in Cambridge, not especially interested in committee work in London and a conscientious objector during ww1 – volunteered as an ambulance driver. Typical example of the slightly left of center Cambridge don. Close to Keynes, even though he later became Keynes’ “classical” scapegoat no. one. Very productive. Professor in Cambridge, succeeded Marshall. As Sandmo explains, his exposition is not as technically demanding as Pareto’s. Like Mill, Edgeworth, Marshall, Pigou is working in the utilitarian tradition – insists on comparing utility between individuals. Cardinal utility, however not very keen on these fine distinctions.

In favor of redistributing income 1 It is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old law of “diminishing [marginal] utility” thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provides that it does not lead to a contraction in the size of national dividend from any point of view, will, in general increase economic welfare (Economics of Welfare, 1920). Notice reservations with regard to incentives. (Referred to as “announcements” by Pigou)

In favor of redistributing income 2 Let us not make it too complicated! Pigou (like Edgeworth) believed in cardinal utility as a way of defending income redistribution. That one should do this appears so obvious to Pigou that he is not taking any serious discussion about the theoretical foundations. Pareto showed that a utilitarian kind of utility – cardinally measurable and (therefore) comparable between individuals – was unnecessary for understanding of consumer demand. That did not interest Pigou!

Efficiency and Market Failures Social and private marginal net product. We increase production by applying one extra unit of input from an optimal situation. We obtain an increase in national income or production. Only when all costs and benefits are taken into account social and private net products will be the same. If an increase in production creates a positive external effect (break down of a monopoly or better conditions for the poor), increase in social net product is greater than increase in private net product. Subsidies! When an increase in production creates a negative external effect (more pollution or more traffic jams), increase in social net product is smaller than increase in private net product. Pigouvian taxes!

Pigouvian tax This, of course, is leading on to……….

Pigou on public economics Simple principles first! Public expenditure is good; (almost) all taxes are bad! Cost of Public production is equal to cost of use of resources + cost of increase in efficiency However, how should taxes be collected? With the possible exception of environmental taxes and taxes on dangerous and unhealthy items, taxes are bad in the sense that they create distortions. On the other hand, we must finance government expenditure. How to minimize negative effects?

Ramsey’s rule on optimal taxation “…it can be proved, differences in in the marginal utility of money to different people being, of course, ignored, that the optimum system of proportionate taxes yielding a given revenue is one that will cut down the production of all commodities and services in equal proportion. (A Study in Public Finance, 3 rd ed 1947, p 106) So highest taxes on goods with inelastic demand and supply – not wholly uncontroversial as political debates on tax policy often assumes that some consumption (car use) should indeed be cut more than other private expenditure (public transport). Most (Danish) debate on taxes often assumes that the government should intervene!

Unemployment and Public Policy With perfect competition among employees and perfect mobility there cannot be unemployment. The scapegoat of Keynes. However, in later “Keynesian” models wage inflexibility is precisely the cause of unemployment. It may have appeared ridiculous – writing in the early 1930s – to argue that inflexibility was the cause of unemployment. Is this a short run /long run issue, or is it that Keynes’ arguments for the existence of unemployment equilibria were more convincing?