by From Duncan Austin and current issue of RWER The key issue is not that economics is not a valuable way of thinking – it clearly is – but rather that the discipline lost sight of its boundaries and unwittingly propagated an exaggerated sense of its scope. Ironically, it achieved this by fatefully downplaying the significance of one of its own discoveries made a century ago. Given the profound influence of economics within modern culture, this oversight cannot be dismissed as mere academic error, for it has potentially existential real-world consequences. In 1920, Arthur Pigou, a Cambridge economist, conceived the idea of externalities to describe how market transactions may create unintended harms or benefits for which no monetary compensation or reward occurs. Market exchanges
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from Duncan Austin and current issue of RWER
The key issue is not that economics is not a valuable way of thinking – it clearly is – but rather that the discipline lost sight of its boundaries and unwittingly propagated an exaggerated sense of its scope. Ironically, it achieved this by fatefully downplaying the significance of one of its own discoveries made a century ago. Given the profound influence of economics within modern culture, this oversight cannot be dismissed as mere academic error, for it has potentially existential real-world consequences.
In 1920, Arthur Pigou, a Cambridge economist, conceived the idea of externalities to describe how market transactions may create unintended harms or benefits for which no monetary compensation or reward occurs. Market exchanges effectively generate ripple effects for human value that go beyond what is captured by the originating transaction. These ripple effects may be positive – I benefit, too, from you being vaccinated – or negative – think of pollution or congestion. However, there is an important asymmetry. Positive externalities take the form of “free goodies”, whereas certain negative externalities constitute systemic risks that may be catastrophic to “trip” or breach. While you generally cannot have too much of a positive externality – a “free good thing” – too much of certain unwanted harms may induce systemic failure.
Externalities exist because markets have an incomplete grasp of what humans value. Markets work off prices and not everything has – or can have – a price. As such, marketed values – or prices – exist amidst a broader “value field” of things that humans care about and which have an influence on our wellbeing.
Pigou’s proposition was an inconvenient truth for economics. It suggested that there are real limits to what conventional economics might say about matters of human value and, hence, to how far markets might serve human wellbeing. The inconvenience of his idea may be why Pigou is not better known – seemingly more tolerated, than celebrated.