Arthur Pigou

By Julien Moreau

Arthur Pigou put a price on smoke, and the world has been arguing about the bill ever since. Born on the Isle of Wight in 1877, a Harrow and Cambridge man, Pigou was Marshall's chosen successor — the heir who took the Cambridge chair in 1908 and held it for thirty-five years, teaching through two wars and the Keynesian revolution that would eclipse him. His life's work was a single question: when does the pursuit of private gain serve the public good, and when does it diverge? Wealth and Welfare (1912), expanded into The Economics of Welfare (1920), gave the first systematic answer. Pigou drew the distinction that now organizes all of environmental and public economics: the private product of an activity — what it earns its owner — versus the social product — what it contributes to, or subtracts from, the welfare of society. Where the two diverge, there is an externality: the factory whose smoke ruins the laundry of its neighbors, the railway whose sparks set the farmer's fields ablaze, the motorist whose congestion slows everyone else. The remedy followed with Marshallian logic: tax the activity by the amount of the divergence — a Pigouvian tax that makes the polluter face the true social cost — or subsidize the activity whose social product exceeds its private return. It was the first rigorous framework for the idea that markets fail and governments can, in principle, fix them with prices rather than prohibitions. Pigou also gave welfare economics its founding definition — economic welfare as the part of total welfare measurable in money — and its founding dilemma: how to compare one person's gain against another's loss, a problem that would occupy the field for a century. His later years were shadowed by Keynes, his former student, whose General Theory (1936) used Pigou as the very embodiment of the classical economics under attack — the foil against which the revolution defined itself. Pigou never quite recovered his standing among theorists, though he outlived the slight with stoic Cambridge dignity, continuing to lecture into old age. He died in 1959. The irony of his eclipse is that his central idea outlived every fashion: the Pigouvian tax is the intellectual ancestor of carbon pricing, congestion charges, and every market-based environmental policy on earth. When governments today debate a carbon tax, they are debating Pigou's 1920 proposition — that the price of smoke should be paid by the smoker.

Impact on civilization

Pigou's impact is the price tag on pollution. The Pigouvian tax is the foundation of all market-based environmental policy: carbon taxes, cap-and-trade systems (a quantity cousin of his price instrument), congestion pricing in London, Singapore, and Stockholm, taxes on alcohol, tobacco, and sugar — every attempt to make polluters pay descends from The Economics of Welfare. The externality concept organizes modern microeconomics: public goods, common resources, network effects, and asymmetric information are all analyzed as divergences between private and social returns, Pigou's original distinction. His definition of economic welfare and his agonizing over interpersonal comparisons set the agenda of welfare economics for a century, from the compensation principles of Kaldor and Hicks to modern cost-benefit analysis. He lost the battle with Keynes for the soul of macroeconomics; he won, quietly and completely, the war over how civilization prices its poisons. The modern literature on nudges and behavioral public finance — taxing internalities as well as externalities — is Pigouvian logic extended from smoke to self-control.