Pigou Economics Essay

The debate between Ronald Coase and Authur Pigou is still going strong some 50 years after Coase wrote his criticism of Pigou’s theory of social costs and externalities. Since the debate’s inception, much studies have taken place and ground made on both sides of the issue, yet not much common ground has been established. One thing that is clear is that there are external costs imposed on parties outside of a transaction in certain situations. These externalities create inefficiencies in the market since they are costs or benefits outside of the original transaction. How to correct for these inefficiencies remains the topic of debate. The Pigou followers believe that these inefficiencies can be corrected by government in the form of taxes or subsides; however, Coase followers believe that these inefficiencies are best handled through market forces. Both have pros and cons to their applications and can be extremely situationally dependent, but which theory works best?

One particular transaction in which externalities are involved is that of driving. When a person, who pays for the right to drive through registration a license fees, decides to drive someplace there are many other costs involved to drivers and pedestrians around him than what are accounted for in the original transaction. The transaction between government and drivers pays for roadways, law enforcement, maintenance, etc. The costs not included in this transaction are pollution, road congestion, hazards for walking to work, etc. In 2003, London policy makers recognized these externalities and instituted a Pigouvean tax to account for them. The tax institutes a ten pound per day charge to drive through certain parts of London during certain times of the day. After this externality was accounted for with the institution of this tax, there were drastic changes in behavior. There was a 15% increase in the amount of bus trips, 30 % more trips by bicycle, and an overall increase in use of public transportation by 55%.

The improvements made by this government tax are substantial, but Coase would probably not be in support of this policy. He viewed externalities a reciprocal cost. I this particular case, Coase would view the problem as follows, drivers being allowed to drive unrestricted prevents others from enjoying clean air, safety, and more open roads. On the opposite end, if people were able to enjoy clean air, safety, and open roads then drivers would be restricted in their driving behavior. In order to maximize efficiency, the people who enjoy clean air, safety, and uncongested roads would have to pay other drivers to stay off the road, provided this payment is less than the benefits of the transaction. Coase also claims that this transaction must take place through market forces rather then government for maximized efficiency. Transaction costs in this instance, paying enough drivers to stay off the road and enforcing that they do, may be too high for this to take place within the free market. Ultimately, for this situation, government may be the only viable option.

The biggest facto to determining the optimal strategy, whether Coase’s or Pigou’s, is transaction costs. There are many instances when government may hold a comparative advantage to reducing transaction costs than the private market. When dealing with an issue that requires large scale enforcement, government is likely to hold an edge over anything that can be done in the private sector. However, it is not always true that these top down strategies are more effective at maximizing efficiency in markets. There are many cases where the private market, with its easier and cheaper access to information is better suited to maximize transactions. Government will always be required to uphold property rights, but ultimately transaction costs will be the deciding factor in determining whether a Pigouvean or Coasean approach will lead to the more favorable and efficient outcome.