Politics, Policy, and the Pigovian Margins

Abstract

Since Sidgwick and Marshall, and notably since Pigou’s The Economics of Welfare, economists have accepted the presence or absence of external effects in production and consumption as a primary criterion of market efficiency. When private decisions exert effects that are external to the decision-maker, “ideal” output is not obtained through the competitive organisation of economic activity even if the remaining conditions necessary for efficiency are satisfied. The market “fails” to the extent that there exist divergencies between marginal private products and marginal social products and/or between marginal private costs and marginal social costs. This basic Pigovian theorem has been theoretically refined and elaborated in numerous works, but its conceptual validity has rarely been challenged.2 The purpose of this paper is to bring into question a fundamental implication of this aspect of theoretical welfare economics, namely, the implication that externalities are either reduced or eliminated by the shift of an activity from market to political organisation. I shall try to show that this implication will stand up to critical scrutiny only under certain highly restricted assumptions about human behaviour in modern political systems. When these restrictive assumptions are modified, the concept of divergence between marginal “social” product (cost) and marginal private product (cost) loses most of its usefulness.3