The Problem of Social Cost

The Problem of Social Cost in the United States

I have examined in considerable detail one example of a divergence be-

tween private and social products and I do not propose to make any further
examination of Pigou’s analytical system. But the main discussion of the prob-
lem considered in this article is to be found in that part of Chapter 9 in Part II
which deals with Pigou’s second class of divergence and it is of interest to see
how Pigou develops his argument. Pigou’s own description of this second class
of divergence was quoted at the beginning of this section. Pigou distinguishes
between the case in which a person renders services for which he receives no
payment and the case in which a person renders disservices and compensation is
not given to the injured parties. Our main attention has, of course, centred on
this second case. It is therefore rather astonishing to find, as was pointed out to
me by Professor Francesco Forte, that the problem of the smoking chimney—
the “stock instance” or “classroom example” of the second case—is used by
Pigou as an example of the first case (services rendered without payment) and
is never mentioned, at any rate explicitly, in connection with the second case.
Pigou points out that factory owners who devote resources to preventing their
chimneys from smoking render services for which they receive no payment. The
implication, in the light of Pigou’s discussion later in the chapter, is that a fac-
tory owner with a smokey chimney should be given a bounty to induce him
to install smoke-preventing devices. Most modern economists would suggest
that the owner of the factory with the smokey chimney should be taxed. It
seems a pity that economists (apart from Professor Forte) do not seem to have
noticed this feature of Pigou’s treatment since a realisation that the problem
could be tackled in either of these two ways would probably have led to an
explicit recognition of its reciprocal nature.
In discussing the second case (disservices without compensation to those
damaged), Pigou says that they are rendered “when the owner of a site in a
residential quarter of a city builds a factory there and so destroys a great part
of the amenities of neighbouring sites; or, in a less degree, when he uses his
site in such a way as to spoil the lighting of the house opposite; or when he
invests resources in erecting buildings in a crowded centre, which by contracting
the air-space and the playing room of the neighbourhood, tend to injure the
health and efficiency of the families living there.” Pigou is, of course, quite
right to describe such actions as “uncharged disservices.” But he is wrong
when he describes these actions as “anti-social.” They may or may not be.
It is necessary to weigh the harm against the good that will result. Nothing
could be more “anti-social” than to oppose any action which causes any harm
to anyone.
Indeed, Pigou’s treatment of the problems considered in this article is
extremely elusive and the discussion of his views raises almost insuperable
difficulties of interpretation. Consequently it is impossible to be sure that one
has understood what Pigou really meant. Nevertheless, it is difficult to resist
the conclusion, extraordinary though this may be in an economist of Pigou’s
stature, that the main source of this obscurity is that Pigou had not thought
his position through.
IX. THE PIGOVIAN TRADITION
It is strange that a doctrine as faulty as that developed by Pigou should have
been so influential, although part of its success has probably been due to the
lack of clarity in the exposition. Not being clear, it was never clearly wrong.
Curiously enough, this obscurity in the source has not prevented the emergence
of a fairly well-defined oral tradition. What economists think they learn from
Pigou, and what they tell their students, which I term the Pigovian tradition,
is reasonably clear. I propose to show the inadequacy of this Pigovian tradition
by demonstrating that both the analysis and the policy conclusions which it
supports are incorrect.
I do not propose to justify my view as to the prevailing opinion by copious
references to the literature. I do this partly because the treatment in the
literature is usually so fragmentary, often involving little more than a reference
to Pigou plus some explanatory comment, that detailed examination would
be inappropriate. But the main reason for this lack of reference is that the
doctrine, although based on Pigou, must have been largely the product of an
oral tradition. Certainly economists with whom I have discussed these problems
have shown a unanimity of opinion which is quite remarkable considering the
meagre treatment accorded this subject in the literature. No doubt there are
some economists who do not share the usual view but they must represent a
small minority of the profession.
The approach to the problems under discussion is through an examination
of the value of physical production. The private product is the value of the
additional product resulting from a particular activity of a business. The social
product equals the private product minus the fall in the value of production
elsewhere for which no compensation is paid by the business. Thus, if 10 units
of a factor (and no other factors) are used by a business to make a certain
product with a value of $105; and the owner of this factor is not compensated
for their use, which he is unable to prevent; and these 10 units of the factor
would yield products in their best alternative use worth $100; then, the social
product is $105 minus $l00 or $5. If the business now pays for one unit of the
factor and its price equals the value of its marginal product, then the social
product rises to $15. If two units are paid for, the social product rises to $25
and so on until it reaches $105 when all units of the factor are paid for. It
is not difficult to see why economists have so readily accepted this rather odd
procedure. The analysis focusses on the individual business decision and since
the use of certain resources is not allowed for in costs, receipts are reduced
by the same amount. But, of course. this means that the value of the social
product has no social significance whatsoever. It seems to me preferable to use
the opportunity cost concept and to approach these problems by comparing
the value of the product yielded by factors in alternative uses or by alternative
arrangements. 1 he main advantage of a pricing system is that it leads to
the employment of factors in places where the value of the product yielded is
greatest and does so at less cost than alternative systems (I leave aside that a
pricing system also cases the problem of the redistribution of income). But if
through some God-given natural harmony factors flowed to the places where
the value of the product yielded was greatest without any use of the pricing
system and consequently there was no compensation, 1 would find it a source
of surprise rather than a cause for dismay.

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