Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Saying No to Pigou?

Written by johnleemk on 11:59:34 am Jul 25, 2007.

One of the more interesting groupings of economists is the Pigou Club, founded by Greg Mankiw, a Harvard professor of economics who was once a top economic official with the Bush administration until he made some politically incorrect but economically impeccable remarks about outsourcing and international trade.

The basic premise of the Pigou Club is that the world needs more Pigovian measures to internalise the effects on society of economic externalities, especially those imposed by carbon combustion.

Every time a car emits its toxic fumes, it is imposing a cost on society — it shortens your lifespan, forces you to make more visits to the doctor, ruins the environment, etc. These costs are not internalised in the price of petroleum, as they should be.

This is why Pigovian taxes — indirect taxes on goods and services which impose a negative externality on society — have been touted as, among other things, a solution to global warming and environmental pollution.

Mankiw has been one of the most aggressive advocates of a carbon tax, and formed the Pigou Club to promote his ideas. Arthur Pigou was a British economist who first came up with the concept of externalities, which today are widely recognised as a form of market failure because the market fails to take into account all relevant costs and benefits.

Naturally, opposition has sprung up to Mankiw's ideas, embodied in the Nopigou Club, formed by a right-wing Canadian newspaper. I was hoping they would be able to present a coherent case against the concept of externalities, or at least the carbon tax, but it seems they have been unable to do either.

Of course, their case has some merit. They are correct that the Pigou Club has been unconvincing on the subject of whether carbon taxes would reduce American reliance on oil imported from the Middle East. I can't really think of how this could be a reliable economic justification for a carbon tax.

A substantial portion of their criticisms rely on the assumption that all state intervention in the economy is bad — but if they want to overturn the economic theories of market failure, they need a lot more than a few diatribes based on an apparent misunderstanding of economics.

One criticism of the carbon tax has been that it will disadvantage the poor; similar criticisms have been leveled against taxes on gas heating in the United Kingdom. But as British economist Tim Harford has pointed out, the solution to the latter problem is not to reduce those taxes, but to give some money to those affected by the taxes. The point of the tax is to increase the marginal cost of something that is harmful to discourage people from doing something that harms society; thus, the government is actually justified in making lump sum payments to those affected by the taxes, since this does not counteract the standing policy.

The best thing that the Nopigou Club has come up with is some criticisms from economists of how we would go about calculating the best tax rate for a carbon tax. There's no accurate way to gauge the external costs, so there's no accurate way to internalise them.

This criticism is already known to any economist worth his salt, but the question is, are we willing to say that not trying is better? Frankly, even a small tax on gasoline consumption would be a lot better than what we have now.

If the Nopigou Club wants to have some semblance of credibility, it should stick to economic criticisms of Pigovian taxes, rather than farfetched alarmist diatribes warning of excessive state intervention in the economy. Economic theory justifies Pigovian taxes, and the onus is on the Nopigou Club to show why there is no market failure occurring here, or why we should not at least try to correct that market failure.

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