Bearing Fruit
as Well as Light
PIGOU’S WELFARE ECONOMICS
AT THE TIME OF HIS ELECTION, Pigou was relatively untested and, despite Marshall’s faith in his “quite extraordinary genius,” the electors who voted for him were betting on future accomplishments. One such elector was F. Y. Edgeworth, the Drummond Professor of Political Economy at Oxford and one of Marshall’s key ideological allies. Edgeworth did not have to wait long to see his bet pay off. In 1913, he glowingly reviewed a book by Pigou in The Economic Journal, of which Edgeworth had previously been the longtime editor.1 “Originality,” he wrote, “has set its unmistakable mark on Professor Pigou’s work.” “This treatise abounds in new ideas, but it is impossible by extracts to do justice to the author’s logical arrangement of topics and lucid order.” Edgeworth even used the word “brilliant.”2
The book in question was Wealth and Welfare, which had appeared in shops in 1912. The treatise, some 500 pages long, served as the vindication of Marshall’s and Edgeworth’s faith in Pigou.3 The precursor to the more famous Economics of Welfare, it also marked the formal start of Pigou’s work on the economics of welfare and, arguably, the birth of the field of welfare economics. Though much greater in scope than any of his previous work, the book grew out of the same ethical and political commitments that had motivated Pigou since his days as an undergraduate. The American economist Allyn Young, in his own generally positive review, noted that in light of “recent proposals for social reform,” the book took on “a distinctly fresh and unconventional flavor.”4 After all, like Industrial Peace before it, Wealth and Welfare was a book of economics with an obvious moral motivation. It concerned, as the Times commented, “largely a question of ethics and psychology.”5 In Edgeworth’s words, Pigou drew from “two very high authorities on wealth and welfare.” He borrowed a version of “Utilitarian philosophy” from Sidgwick and employed “the methods perfected by Dr. Marshall.”6
Although the book had an ethical heart, it had a scientific head, evidence of Pigou’s decision to “cut out” politics and abandon philosophical musings. In his work on welfare, Pigou, even more than Marshall, was inclined to classify economics as an objective science. As he noted in the first edition of The Economics of Welfare, it was a “positive science of what is and tends to be, not a normative science of what ought to be.”7 It was also to be an applied science. Like engineering, economics was intended, in Pigou’s words, to “bear fruit” rather than just light—to yield “practical results in social improvement.”8 It was still, however, a science of abstract models, and Pigou refused to limit it “to those fields of positive scientific inquiry which have an obvious relevance to immediate practical problems.” To do so, he wrote, would “shut out inquiries that might ultimately bear fruit.”9 In Wealth and Welfare, Pigou did not offer a collection of ad hoc solutions to temporary problems. Instead, he provided a comprehensive theoretical framework for understanding how economic welfare worked in society.
Wealth and Welfare and its successor, The Economics of Welfare, published in four editions between 1920 and 1932, were to do for welfare economics what Marshall’s Principles did for economics as a whole. They would also make Pigou’s name and, to a considerable degree, secure his place in history. Pigou’s welfare economics was concerned with analyzing and correcting imperfections in the market that resulted in suboptimal levels of societal wellbeing. This premise—the idea that the market was not self-regulating—meant that much of the ameliorative potential of Pigou’s welfare economics depended on the actions of a competent administrator located outside the market. Amid a surging public respect for science and a burgeoning pressure for government to take a more active role in the economy, Pigou’s work not only made a major theoretical contribution, it was also able to provide a rigorous justification for state action at a propitious time. But Pigou’s work offered another implication. By stressing his own objectivity and technical expertise, he suggested that the Marshallian professional economist was exactly the kind of enlightened authority that might help solve the economic problems he identified.
Wealthy and Well at Cambridge
Ascending to professorship at the age of thirty, Pigou had large shoes to fill, but in 1908, he was short on most credentials except potential. His publication record, while strong, was hardly what one might expect of the institutional leader of the Cambridge school of economics. Moreover, the program over which he presided, despite Marshall’s guidance, was still in its formative years and in need of careful shepherding. And though Pigou had taught undergraduates for several years, he had little experience as an administrator. Student enrollment numbers had more or less stagnated since the introduction of the Tripos, and its nine instructors—to whom Marshall referred as the “brilliant, compact group of earnest men”—had widely varying degrees of economic competence.10
Therefore it was natural for Pigou, “the youngest professor in the youngest Tripos,” to invest time in teaching, building enrollment, and establishing his discipline’s position. To some extent, this is exactly what he did, taking over the general lecture course for second-year students in 1908 and offering a new course on the theory of value.11 Though he relied on members of the older generation, including Marshall and J. N. Keynes, for support, under Pigou, the economics program expanded rapidly, with the number of enrolled students nearly doubling from thirteen in 1907 to twenty-four two years later.12 In the words of Robert Skidelsky, Pigou supplied the faculty’s “intellectual leadership.”13
On other academic fronts, he was even more diligent. He revised an article written on land taxation in 1907 into a pamphlet that stressed the inefficiencies and “indirect costs” of taxing improvements made to land rather than the “inherent” or “public value” of the land itself. He noted that taxing improvements to the land had negative implications for social policy, as it pushed people out of the country into the cities, and for housing policy, as it incentivized cheaper construction.14 “In both cases,” he wrote, “the result is dirt, untidiness, and a general lowering of moral tone.”15 The Policy of Land Taxation, as the pamphlet was called, was a thinly disguised endorsement of the left wing of the Liberal Party’s ambition to shift a greater burden of taxation onto large landowners in order to fund new social policies—an ambition that appeared in the famous, socially progressive People’s Budget of 1909 and in the Liberal Party’s platforms up until the start of World War I.16 Despite his newfound professorial status, Pigou could not resist revisiting his 1907 article and expressing his view that the “public value of land is, economically speaking, an exceptionally good object of taxation,” one that did not violate principles of equity.17 Still, the pamphlet bore the hallmarks of Pigou’s growing restraint. During a period in which the Liberal Party was successfully pursuing a host of policy priorities—social insurance, a more progressive tax scheme, labor exchanges, and the hobbling of the House of Lords—Pigou was careful not to explicitly advocate a political program, but to explore an argument. He never mentioned Asquith, the prime minister, as he had in his 1907 article, or Lloyd George, the Chancellor of the Exchequer, or even the Liberal Party itself. After revealing his support of a land value tax, he was quick to stress the “tentative” nature of his suggestions. The pamphlet thus ends on a cautious note, stressing the importance of the issue and calling for “those who advise the Government” to “devote to it much earnest consideration.”18
A flurry of reviews written for The Economic Journal revealed a lengthy reading list of more specialized economic theory that drew extensively from foreign, especially Italian, authors.19 He published a journal article on bilateral monopoly in 1908 and two more articles in 1910, one on calculating price elasticities and another on producers’ and consumers’ surplus.20 The first marked the start of a limited but important body of empirical work on elasticities, which economist Angus Deaton later called “one of the best examples of indirect measurement by use of theory to be found outside the physical and biological sciences,” and which Milton Friedman unsuccessfully assaulted some twenty-five years after its publication.21 However, of the three articles, it was the last that was most striking.
Though significant in retrospect, the article presented itself as little more than a footnote to Marshall’s sweeping theories of consumer surplus.22 Marshall postulated that people only bought a good if they placed its value as equal to or greater than the money they spent on it. Thus, every time a consumer bought a good, he or she would gain a “surplus” of value. Similarly, producers only sold a good if they could derive some profit from it. This profit was also a “surplus.” Inspired by utilitarian ethics and the liberal conception of the public as a collection of individual consumers, Marshall was concerned with maximizing consumer surplus, which he saw as a rough proxy for utility, throughout the economy.23 In general, he reasoned that because of competition, the market would produce the most possible units at the lowest possible price so as to create the greatest possible surplus. However, Marshall recognized an important exception to the general rule that competition would yield “maximum satisfaction.” Some industries, he suggested, were characterized by increasing returns to scale: the more they produced, the more efficiently they would be able to produce a successive unit of output. Others experienced decreasing returns to scale and found each successive unit of output increasingly costly to produce. Marshall proposed that taxing industries with decreasing returns and providing bounties to those with increasing returns could provide significant benefits to welfare. Though producers would be put at a slight disadvantage, consumers would face lower prices, resulting in a corresponding overall boost in consumer surplus.24
Pigou’s 1910 article adopted Marshall’s framework almost in its entirety, but added an important nuance: the potential divergence of individual and collective interests.25 In a 1903 article that that had also drawn extensively from Marshall, Pigou had discussed how consumer taste for luxury items depended largely on the number of people who bought those items. Diamonds, for instance, were especially expensive, because the few people who possessed them were prestigious individuals. The price of top hats, in contrast, was kept up only because of their fashionability. The desire for a top hat, “is compounded of a desire for . . . the article and a desire to be ‘in the swim.’”26 Every purchase of a hat therefore had a first-order effect of signaling a particular level of demand for the good and a second-order effect of provoking further demand insofar as the wearing of the hat contributed to the hat’s becoming popular. It was this second effect that caused private supply and demand curves to diverge from their collective counterparts. In other words, by contributing to a trend, the individual’s purchase of a hat had social effects.
The 1910 article took this concept further and transposed it from consumption to production. It suggested that in industries where there were “external economies of improved general organization,” the production of an additional unit would have a greater effect on an individual firm’s supply price than on the industry’s.27 Where there were external diseconomies—as when the increased production of one firm raised the prices of raw material for all other firms in its industry—the changes to the cost of production would also be different for the individual firm and for its industry as a whole.28 These “economies” and “diseconomies”—concepts Pigou borrowed from Marshall—led “to a conclusion of some importance in connection with the doctrine of maximum satisfaction.”29 Actual prices and therefore actual levels of consumption were determined by the decisions of individual firms, but these individual firms might be acting in ways that affected other firms in their industry. Because of the gap between the firm and the industry, industries might produce above or below the quantities that would be optimal for consumer surplus, or for “ophelimity,” by which Pigou meant “economic utility.”30 If this were the case, Pigou asserted, the state might well take action by means of “the grant of a bounty . . . [or] the imposition of a tax on the production of the commodity” to affect a more “socially advantageous” level of production.31 In essence, Pigou had reproduced Marshall’s argument with the substitution of economies and diseconomies for increasing and decreasing returns to scale.32 But importantly, in suggesting that because of external effects, public and private interests might diverge, the piece presaged some of Pigou’s most important and original ideas.
In the autumn of 1910, as the Liberals were campaigning for a budget that would increase social welfare provision and land taxes, Pigou began work on what was to become Wealth and Welfare, the book in which those ideas would see their comprehensive expression. Pigou threw himself into the project; he sloughed off his main lecture course on Economic Principles to J. M. Keynes, whose father grumbled that “in many ways, [Maynard] seems to be taking Pigou’s place as Professor of Political Economy.”33 The younger Keynes himself was a bit peeved that Pigou seemed to be shirking his duties and gave the latter “rather a pi-jaw” over the matter in 1911.34 D. W. Corrie once noted that the “remarkable thing” about Pigou was how fast “he could relax from serious work and plunge with boyish enjoyment into any sort of harebrained spree and afterwards to assume the gravity of the professor of Economics.”35 Still, in spite of Pigou’s ability to move seamlessly between work and leisure, Keynes had reason to grumble. Pigou was distracted from his duties at Cambridge not only by his book but also by a construction project he was overseeing in the Lake District. Between bouts of writing and supervision, he had commissioned a Cambridge friend and aspiring architect to design him a rustic lodge to be called Lower Gatesgarth, on the shores of Buttermere, just south of Keswick.36 Thus, 1911 proved to be a busy but rosy year. As the Liberals successfully stripped the aristocratic House of Lords of its veto power and pushed through the People’s Budget, Pigou was busy working on the book that would definitively establish his professional position and, at the same time, constructing the house that would serve as his refuge from the pressures of academic life.
By the first months of 1912, Pigou’s house stood complete, an imposing structure set high on a bluff at the southern end of one of the most beautiful lakes in England. His book was also shaping up. In February, he wrote to tell his publisher that he had “now nearly completed” Wealth and Welfare, which Pigou “intended to be ‘a contribution to learning,’” but one which “ought . . . to be intelligible to others than economists.”37 The spring and summer saw “the Prof” busy correcting proofs with the help of his friends Corrie and Keynes, and in the autumn, the book was released to significant enthusiasm.38
FIGURE 4. Lower Gatesgarth, Pigou’s House in Cumbria. Courtesy of Roger Hiley.
Wealth, Welfare, and Welfare Economics
In the 500 pages of Wealth and Welfare, Pigou laid out his cohesive framework for considering questions of economic welfare. He would update the details of Wealth and Welfare for the better part of the next three decades—indeed, he began to revise it almost immediately after it was published “with the object of making it less difficult to understand and partly with that of including a number of topics not initially discussed in it.” Just three years after the book’s original release, these amendments and expansions were sufficiently extensive—they would double the size of the book—for Pigou to suggest a new title, “e.g. The Economics of Welfare.”39 But though the bulk of Pigou’s welfare economics was layed out before 1915, because of World War I, the newly titled revision was not published until 1920, with subsequent editions released in 1924, 1928, and 1932. And though there were substantive amendments and changes in tone in the twenty years between 1912 and 1932—alterations that will be explored in chapter 5—the thrust of Pigou’s welfare economics was never substantially altered. For this reason, the analysis of his welfare economics offered here focuses on the central, unchanging elements of his system, drawing not only from Wealth and Welfare but also from its significantly expanded, more systematic form, the first edition of The Economics of Welfare.40
From page one of Wealth and Welfare, Pigou’s welfare economics was firmly rooted in ethics and imbued with optimism about Liberal reform. The book’s first lines came directly from Moore’s Principia Ethica: “If I am asked ‘What is good?’ my answer is that good is good, and that is the end of the matter. Or, if I am asked ‘How is good to be defined?’ my answer is that it cannot be defined, and that is all I have to say about it.”41 To this, Pigou added: “Welfare means the same thing as good.” In setting out to study the causes and distribution of welfare, he was setting out to study the good—but, as he clarified in the next paragraph, his primary subject was not the good writ large, but only that part of the good measured in economic terms: “Of welfare in general economic welfare is one part . . . [that which enters] easily into relation with the measuring rod of money.”42 From the beginning, therefore, his welfare economics was to be a science, but a science self-consciously nested in an ethical justification.
After all, liberal social concern, shared by Pigou, Marshall, Sidgwick, and Browning, was a key force motivating Pigou’s project, which in turn provided a basis for justifying redistribution from the rich to the poor. But welfare economics was not limited, as noted before, “to those fields of positive scientific inquiry which have an obvious relevance to immediate practical problems.”43 Pigou set out to create a systematic explanatory framework for what he would later describe in a letter to his publisher as “the use of productive resources.”44 Wealth and Welfare was correspondingly wide ranging in scope and its better-known successor, The Economics of Welfare, remained similarly sweeping. For Pigou, welfare economics had a deep and encompassing unifying ambition, one that had animated British economic thinkers since Jeremy Bentham and John Stuart Mill: the maximization of societal wellbeing.45
In this sense, welfare economics had a strong utilitarian pedigree.46 Economists, especially those who followed a Marshallian lineage, took the utilitarian creed of quantified maximization to heart. Yet neither Marshall nor Pigou was willing to accept material prosperity or even hedonic pleasure as society’s ultimate good. The “good” that Pigou was interested in maximizing resided in “states of consciousness only, and not material things or conditions.” 47 Food, for example, could not be a “good,” but the satisfaction that it elicited might be. This mental “good” could plausibly be thought of as a sort of utility, but for Pigou, it was not the same utility described by Sidgwick. Given the multivariable determinants of Pigou’s “good function,” he might be considered a utilitarian only in a loose sense of the term.
Nevertheless, driven by his ethics, Pigou’s economics set itself at improving society. It did so by focusing on the maximization of a very particular part of wellbeing. An investigation into the causes of general welfare, as opposed to welfare of a specifically economic kind, he asserted in The Economics of Welfare, “would constitute a task so enormous and complicated as to be quite impractical.”48 Therefore, he sought to address only the “portion of the field in which the methods of science seem likely to work at best advantage”: the part of social welfare that could be expressed in monetary terms.49 Pigou took for granted that, all other things being equal, increasing material prosperity would make people happier and society better. This would be his goal. Though he addressed other variables in the “good function,” including equality, human beauty, and good will, for the most part Pigou evaluated them only in terms of the economic, as opposed to the general, benefit they yielded. Of good will, for instance, he wrote that “if the gift of material aid is accompanied by the interest, sympathy and counsel of friends, willingness to work and save may be largely and permanently encouraged.”50
When Pigou began writing about welfare, the principal framework in Britain for understanding distribution and maximization of economic welfare came from none other than Henry Sidgwick, who, in addition to playing a founding role in modern ethics, wrote extensively on issues of utilitarian political economy.51 Sidgwick’s key contribution to welfare economics was the assertion that the market acting by itself did not maximize a population’s happiness. He had reached this conclusion by way of another: that the price of a good was not well correlated with the average utility it created. Following the work of W. Stanley Jevons, Sidgwick argued that price was determined by marginal utility, not average utility. That is, in Sidgwick’s view as outlined in The Principles of Political Economy (1883), there were two ways of evaluating a given good: its price and its derived utility.52 Though often conflated, these metrics were actually determined by different factors.53 If price and utility were directly linked, anything that was free would have to produce as much disutility as utility, which clearly did not bear out in real life. The point was that if the goal set for society was to maximize utility—as it had been for utilitarians since Bentham and Mill—it was useless to rely simply on the price system to achieve the optimal distribution of resources, because the price system did not convey accurate information about levels of utility. For Sidgwick, this opened up the potential for useful and beneficial government intervention in the economy.
The idea of limited governmental intervention was not new to utilitarian circles. J. S. Mill had recognized that it was desirable for governments to provide certain goods—lighthouses, for example—that were not produced by private industry but would prove socially beneficial.54 Sidgwick took the role of the government a step further. In particular, he was convinced that more equitably distributed wealth would prima facie increase the aggregate utility in a society. Sidgwick felt that the poor who would benefit from such a transfer would likely value money more than the rich would, an assumption dependent on the key premise that the utility preferences of all people were similar and generally comparable.55 It is easy to see how this belief, coupled with Sidgwick’s personal conviction that the general good was to be placed above the good of any given individual, would imply advocacy for redistributive government policies.56
Sidgwick, however, was not a radical but instead quite a tentative Victorian. Despite the acknowledged case for redistribution, he very much opposed drastic socialist programs, as he was convinced that the entire competitive capitalist system—in which he firmly believed—rested on the foundation of individual incentive. Extensive taxation schemes that put such an incentive (i.e., the prospect of great wealth) at risk could endanger the very mechanism that generated prosperity in the first place. Extreme redistribution, therefore, was out of the question, but moderate socialism that would not destroy the capitalist system was still a viable option. Gradual changes, Sidgwick argued, easily fell within the limits of economic sanity, preserving the incentive to participate in the economy while also allowing the poor a slightly larger slice of the pie.57
However, because of the uncertainty of reduced incentives to earn and the inability to precisely correlate utility with a metric like prices, Sidgwick’s system was incapable of finding an “interior solution,” a balance of redistribution and laissez-faire that would maximize or even definitively enlarge utility in a society.58 As a result, his view on taxation in practice did not mark any significant departure from the views of more moderate Liberals like Mill or even the statesman William Gladstone. In short, Sidgwick’s fear that a rigorous tax system could fuel class warfare led him, like the vast majority of his contemporaries, to conceive of it as a tool primarily for raising revenue rather than as an instrument of social change.59
Sidgwick, though only four years Alfred Marshall’s elder, had been Marshall’s mentor during the period of university reform of the 1860s and 1870s, and his work both on intuitional utilitarian ethics and on marginalism were to have a great influence on the latter’s thought.60 Though Marshall was keen to separate his own self-consciously scientific economics from that of Sidgwick, who explicitly conceived of political economy as an “art,” Marshall’s theoretical framework owed Sidgwick a great deal.61 In an important sense, Marshall applied what he deemed scientific practices to Sidgwick’s ethical impulses. The former’s emphasis and rigorous mathematical work on marginalism made Sidgwick’s prima facie case for some redistribution even stronger. Yet Marshall was also unable to find the “interior solution,” the ideal balance of socialism and capitalism.62 Both Sidgwick and Marshall had a yen for equality, but without the ability to determine all the effects of redistribution, they fretted about the loss of incentives.63
Like his teachers, Pigou did not locate the long-sought perfect balance between reduced incentives and a more equitable and ethically palatable distribution of resources. He did, however, provide a systematic theoretical framework for doing so, and his fundamental critique of the market left the door open wider than ever for state action. Pigou accepted that, though they were not the same metric, economic welfare and welfare often moved in parallel, meaning that economic welfare could serve as a useful proxy for welfare in general, at least for the purposes of his economic analysis. In doing this, he was able to quantify welfare, a luxury that Sidgwick never truly allowed himself.64 Pigou himself recognized that using wealth as a proxy for welfare (or even utility) was riddled with uncertainties. As Amartya Sen has pointed out, Pigou’s desire to link the material, commodity-based conception of economic welfare with general welfare led him “into a bit of a muddle.”65 Commodities could be only loosely linked to desire by way of money, the link from desire to satisfaction or happiness was even more nebulous, and happiness itself was only one variable in the overall “good” function. Still, Pigou’s effort to quantify wellbeing came from a desire to be methodologically rigorous and was in sync with the more general movement toward the professionalization of economics as a discipline.66 It was a move that profoundly transformed largely nebulous characterizations of wellbeing into much more easily quantifiable measures of material prosperity.
Yet Pigou, like Sidgwick, did not trust free market mechanisms to reach an optimal state of welfare, economic or otherwise. Indeed, since Pigou was more comfortable than was Sidgwick with conflating money and welfare, in important ways, Pigou’s distrust of the market system went deeper than Sidgwick’s. Sidgwick objected to the market system on the grounds that money prices did not fairly reflect average derived welfare. The market, because of inequalities in material prosperity, did not maximize satisfaction. Pigou agreed and, like Sidgwick, argued that this observation provided compelling grounds for redistribution. But Pigou went further. His welfare economics was predicated on the assumption that money could, at least to some degree, serve as a proxy for wellbeing. However, the market did not even maximize material prosperity throughout the economy. Thus, in his telling, it was deeply imperfect as an engine not just of utility—unsurprising in an age increasingly cognizant of the plight of the poor—but even of prosperity.
Much like Marshall and Sidgwick before him, Pigou set out to solve an optimization problem. He believed that there were three basic determinants, or criteria, of economic welfare, all related to the national dividend. The first determinant was the national dividend’s overall size, the second was its distribution, and the third its variability.67 In all arenas, he found the free market lacking. Pigou acknowledged that all other things being equal, the larger the national dividend, the greater would be the total economic welfare. One of his goals, then, was to enable the creation of the largest possible dividend. Like his intellectual mentors, Pigou held that the way to do this was to ensure that the marginal products of all resources used in an economy were equal—in other words, that no one resource’s productive capacity could be improved more cheaply than another’s.68 Many of Pigou’s suggestions for equalizing marginal products were highly conventional: monopolies were inefficient, as were political and physical barriers to the free movement of labor and other production inputs.
However, the market’s problems ran deeper than mere impediments to the smooth operation of equilibrating forces.69 There were what would come to be known as “externalities”: economic activities whose costs and benefits operated in such a way that the price system alone could not necessarily maximize societal welfare.70 There were already, of course, the “external economies” and “diseconomies” that existed in certain industries, about which Pigou had written in 1910. But compared to the ones on which he would focus in 1912, these were relatively small and localized—their effects mattered for the public only insofar as the public had an interest in buying the most possible at the smallest possible price.
In 1910, Pigou had followed Marshall in discussing effects external to firms but internal to industries. In contrast, in 1912, his hallmark example of an external diseconomy was pollution, a phenomenon that had effects outside any single industry. Pigou’s first mention of pollution appeared in the introduction of Wealth and Welfare in connection with “Natural Beauty,” which he deemed “the most important . . . condition of welfare other than the national dividend.”71 At the time, Britain had been undergoing a period of impressive industrial growth and urbanization for at least the past sixty years, a period of transition that threw the British idyll of green hills and pleasant pastures into stark relief with ash and soot and grime. Everywhere, industry spoiled natural beauty—“the hunt for coal or gold” destroyed scenery and, of course, there was “the desecration widely wrought by the uncontrolled smoke from factories.”72 The wanton pursuit of economic goals gave birth to a whole slew of noneconomic, even aesthetic, problems. Of course, it had provoked distinctly economic ones as well: “Smoke in large towns inflicts a heavy uncharged loss on the community in respect of health, of injury to buildings and vegetables, of expenses of washing clothes and cleaning rooms, of expenses for the provision of extra artificial light, and in many other ways.”73
In an argument with a striking resonance to more recent debates over global warming, Pigou identified these “uncharged losses” as accruing insidiously as unseen by-products of the normal operation of industry.74 Externalities (e.g., pollution) might cause a great deal of collateral damage (e.g., decreased health or damage to local flora and fauna), which could certainly be expressed in economic terms, but these losses were not explicitly catalogued as external effects on any balance sheet. Pollution thus silently supplemented the individual economic welfare of the factory owner at the expense of the social weal. Pigou’s conception of externalities was built around an understanding that no economic activity took place in a vacuum, so that any economic transaction inevitably had an impact on others. He recognized that many of those impacts were not only negative but were also not priced by the open market. Moreover, they often hurt wide swaths of individuals, and thereby society as a whole.
The next step was obvious. Acting as a professional scientific economist, Pigou sought to quantitatively measure these inconsistencies and use the monetary values he found to determine whether a given segment of the economy was operating in line with the social good. As environmental economists have long recognized, valuing externalities was remarkably difficult, because the costs associated with them were not always “readily brought into relation with the measuring rod of money.”75 “Technical difficulties” of measurement prevented Pigou from offering an example of someone successfully pricing “incidental uncharged disservices” in Wealth and Welfare and the first editions of The Economics of Welfare. Nevertheless his claim remained that, given sufficient time and resources, it was theoretically possible to calculate externalities and use the result to quantify the relative benefits and costs of an economic activity.76 Sure enough, by the third edition, he had found a perfect example of an effort undertaken to calculate an “incidental uncharged disservice.”77 In 1918, the Manchester Air Pollution Advisory Board had found that on laundry costs alone, city residents spent conservatively £290,000 a year more than they would have if the city had clean air.78 This sort of quantification, in turn, could be used to approximate an elusive interior solution, at least a local one, and thereby justify moderate state intervention in the form of a tax on polluters.
Pigou, like his contemporaries, only rarely used the term “the market” to denote a force that moderated and directed economic activity. More often, he referred to “natural” forces and phenomena: to “natural” wages, or prices, or equilibria. Implicitly, the intrusion of the state was in some sense artificial, unnatural. But, for Pigou, “natural” was by no means “good,” nor did it connote tranquility. Ultimately, the market was a highly confrontational forum—one in which an individual’s wellbeing and society’s wellbeing were often at odds. It did nothing to correct for “divergences between marginal social net product and marginal private net product”: divergences between public and individual benefits.79 That is, in seeking to make oneself better off, an individual might well, wittingly or unwittingly, compromise societal prosperity or, more generally, societal welfare. Pigou’s division of social and individual wellbeing suggested that some individuals benefited materially at the general expense of society. In practical terms, then, Pigou’s invention of what would subsequently become known as “externality theory” had great importance. It meant that governments could legitimately interfere in the economy to effect a better outcome with greater justification than what Marshall and Sidgwick had considered feasible.80 Though Pigou did not advocate for any specific policy, he wrote that it was “possible for the State, if it so chooses, to remove the divergence in any field by ‘extraordinary encouragements’ or ‘extraordinary restraints’ upon investments in that field.” For laudable examples of such action, Pigou turned to the tax on alcohol or the bounty for constructing housing in crowded areas.81
Pigou’s point was that left to its own devices, the market’s “natural” forces did not identify, evaluate, and take into account all the costs of an economic transaction. Practically speaking, therefore, a theoretical framework that rationalized externalities as regularly occurring instances of imperfect information or a lack of transparency in an otherwise functioning market was equivalent to a framework in which the market did not work to produce the most societally beneficial result. With hidden externalities, prices ceased to convey all the information they purported to, and the market, by itself, would not maximize welfare.82
This alone provided a new theoretical justification for reallocation of resources—for “bounties and taxes”—that was different from that of Marshall and Sidgwick.83 But having held that the untended market would not necessarily produce the greatest national dividend, Pigou reprised the older justification, holding forth against extreme inequality of wealth as not maximizing the amount of enjoyment derived from a given national dividend. He wrote that inequality hurt society, because someone with very little would enjoy a given material benefit more than someone with a great deal. He also pointed out that economic welfare was derived from “the income . . . [a person] consumes rather than the income . . . [a person] receives,” and since the poor spent a great deal more of their income than the rich did, redistributing to the poor would ceteris paribus increase economic welfare.84 Rooting economic welfare in consumption rather than in overall wealth allowed Pigou to avoid part of the difficulty faced by Sidgwick and Marshall. The utility of the rich—and thereby their incentive to earn more money—would not be greatly damaged if redistribution did not negatively impact their consumption. That is, if redistribution only involved money that the rich were not going to spend on consumption, their own welfare would not be meaningfully hurt. Moreover, Pigou wrote, “of the satisfaction yielded by the incomes of rich people, a specially large proportion comes from their relative rather than their absolute amount, and, therefore, will not be destroyed if the incomes of all rich people are diminished together.”85 This line of thinking also sidestepped the old problem of incentives. As long as the rich still felt themselves to be on top, Pigou suggested, their welfare would not be meaningfully abated.
Trustee for the Poor: Pigou and
Government House Utilitarianism
Pigou’s welfare economics was motivated by a profoundly ethical goal: to help maximize social wellbeing. The primary beneficiaries of such a maximization would be the most disenfranchised and impoverished members of society. But though Pigou set out to help the poor, he did not respect them. Pigou, like Marshall and others before him, never made the assumption that the basic economic actor was particularly competent in pursuing his or her self-interest, and although Pigou’s welfare economics predated the expression “rational economic actor,” it clearly dismissed the notion out of hand. Late in life, after the term had come into use, Pigou laughingly quipped that “man is not a rational animal, and sometimes it’s a good thing he isn’t.”86 At the time that he formulated his welfare economics, he saw broad segments of the population as totally unfit to make even minor decisions. The masses needed leaders, or at the very least administrators, to help guide them. And few individuals, in Pigou’s vision, were more qualified to guide than the economist, a figure distinguished largely by cultivated judgment and scientific detachment. In this way, Pigou fitted the model of a so-called “Government House Utilitarian.”87
The term “Government House Utilitarianism,” calling to mind the (at best) paternalistic practices of British colonial Government Houses, comes from a modern reading of Sidgwick’s work by the philosopher Bernard Williams.88 Williams paid special attention to a section of Sidgwick’s Methods of Ethics that argued that any logical “enlightened Utilitarian” would recognize that certain utilitarian doctrines may, given existing conventions, be best propounded only to like-minded individuals and not to the general public. The utilitarian would understand that there were certain ethically valid exceptions to conventional, common sense morality, but may “doubt whether the more refined and complicated rule which recognizes such exceptions is adapted for the community in which he is actually living; and whether the attempt to introduce it is not likely to do more harm by weakening current morality than by improving its quality.”89
At first glance, Sidgwick’s conclusion was counterintuitive: utilitarians might “reasonably desire” that utilitarianism not be adopted or self-consciously embraced by a “vulgar” majority of “plain men” living in a society. The reason was that “the inevitable indefiniteness and complexity of [utilitarianism’s] calculations render it likely to lead to bad results in their hands.”90 For instance, utilitarians generally believed that a more equal distribution of wealth was preferable to great inequality. A vulgar “plain man” who held this principle above intuitional, conventional ones, might be driven to steal in order to give to indigents, a course of action with undesirably chaotic results. Sidgwick’s was the morality of an elite, whose membership would be determined not by wealth or political power, but by the ability to make “the distinction between theory and practice.”91
Although no evidence suggests that Pigou consciously adopted Sidgwick’s ethical theory to justify his attitude toward the general public and a differentiated subset of sophisticated thinkers, he himself was nonetheless a sort of “Government House Utilitarian.” Instead of endeavoring to maximize utility, Pigou was concerned with good as a “function of several variables.” But with this substitution, the model of Government House “Utilitarian” applies remarkably well to many parts of Pigovian theory as well as to his life. Pigou was a member of an academic elite insulated from financial pressures, and more than once he evinced a strong belief that the poor were not to be trusted with improving their own lot. He was, after all, raised in an age and an environment of sweeping paternalism and amidst calls to take up the “white man’s burden” abroad. Hugh Dalton recalled that during one speech at the Cambridge Union, Pigou declared, “I often like to think that we here, with our greater opportunities, are trustees for the poor.”92
It should also be recalled that Pigou’s rationale in 1902 for economists’ abstention from political debates was that if professors had taken a public stance, “they would have weakened their authority.” This was precisely the sort of utility calculation that Sidgwick expected of his “enlightened Utilitarian.” At that time, Pigou’s ultimate goal was the preservation of free trade, a goal justified by his loosely utilitarian precepts. Yet in this instance, Pigou suggested that economists, the majority of whom were devout free traders, remain quiet on the issue in order to ensure that they retain their appearance of nonpartisan credibility. With this credibility—one very much linked to scientific objectivity—the professors would be able to advocate, whether publicly or privately, for free trade in the future. In short, Pigou had identified a Sidgwickian moment when it was justifiable from within a utilitarian framework not to propound utilitarian doctrine. It is not unreasonable to think of Pigou’s shift away from noneconomic discussions after 1908 as the product, at least in part, of a similar calculation. Casting the veil of science over ethical questions itself suggested a moral calculation of sorts. By presenting himself as a scientist without an agenda, Pigou’s ethical values remained hidden and did not interfere with the public perception of the economist as an objective observer, as someone in whom “plain men” could have full confidence. One of the reasons that Pigou decided to “cut out politics all together” was that if an economist were “an active politician, his economics will always be discredited.”93
Pigou’s theoretical work also reflected a form of Government House Utilitarianism. His economics was premised on the assumption that people—particularly the uneducated—required help from an external authority. His justification for redistribution implicitly hinged on the existence of a qualified individual or institution that could not only engage in the calculations necessary to justify intervention, but could also intervene correctly. The importance of such a figure stemmed directly from what Pigou perceived as the ignorance and stupidity of the general public, especially the poor.94 In Wealth and Welfare, he pointed to several government reports that highlighted the financial mismanagement and general ignorance of the least advantaged segments of society. One report, for example, indicated that because poor parents were not knowledgeable about the relative financial merits of certain trades, they provided false information when encouraging their children to find work.95 In a similar vein, another report, this one from the Board of Education, focused on undernourishment in children:
It is probably no exaggeration to say that the improvement, which could be effected in the physique of elementary school children in the poorer parts of our large town if their parents could be taught or persuaded to spend the same amount of money as they now spend on their children’s food in a more enlightened and suitable manner, is greater than any improvement which could be effected by feeding them intermittently at the cost of the rates.96
Pigou’s argument was arresting. If poor parents could not even be relied on to satisfactorily spend their money on their children’s food, could they, as economic actors, be relied on at all? Pigou’s answer was a resounding no: “what has been said . . . should suffice to establish the thesis . . . that the poor, as entrepreneurs of investment in themselves and in their children, are abnormally incompetent.” With respect to redistribution, this belief meant, as Pigou wrote in Wealth and Welfare, that “unless the transference of resources to the poor were accompanied by special conditions, the fund transferred would be almost entirely misspent.”97 This was a strong statement. Not only could the poor not be relied on to maximize social wellbeing (this was Pigou’s assertion about all individual economic actors), but the poor also could not even be counted on to maximize their own wellbeing, a particularly striking assertion in a country whose working classes accounted for more than 70 percent of the population.98 To use a more modern term, Pigou dismissed the rationality of a vast swath of the populace. Implicit in this critique was the presumption that his own rationality was of a higher order and that theorists like himself and some government officials drawn from the elite were better suited to determine the way redistributed money was utilized. It is true that Pigou’s recommendations for state intervention were made in the abstract—he noted that “we cannot expect that any State authority will attain, or will even whole-heartedly seek” the ideal set out by economists.99 But a strong “prima facie” case still remained, especially when the parameters of state action were determined by experts. These experts, presumably, would look a good deal like Pigou himself, whose welfare economics constituted one of the most sophisticated expressions of economic science produced to date, backed up by a variety of equations, graphs, and appendices.