Tuesday, January 30, 2007

What's in a price? The great Pigovian flaw

The plan to nationalize the price of oil
One of the great flaws of Pigovianism is the role reversal imposed on prices. An example of how that flaw plays out appeared in Charles Krauthammer's recent piece for The Washington Post Group on energy policy. Along with other Pigovians on the Right, Krauthammer takes the gas tax plan right to its Pigovian root: Tax gas till it hits US$4 a gallon and then watch the market react. "Raise the price and people change their habits. It's the essence of capitalism." As I note in a column today (The new OPEC) posted at the No Pigou Club site, that's not at all the essence of capitalism. It's the essence of planning and statism.
Pigovian taxes turn the role of prices upside down. The proper view of prices in a market economy is that the price contains thousands of pieces of information about a product: the unmeasurable individual wants of millions of people, the costs of hundreds of inputs, the supply and demand circumstances at a point in time, assessments of future conditions, the relationship of all the prices for similar and competing products, etc. Price is part of a process, jam packed with unmeasurable information, not a fixture in time that just needs to be tweaked to get a desired result. Taxes are not prices.
The Pigovians throw all the real price information out, declare that it's all wrong and claim we need a new price that will incorporate the information we think should be in the price or would be in the price if people only knew what we know. The Pigovians plan to tear down the market price and all the information it contains and impose their own government-regulated price. They plan to nationalize the price gasoline and set prices to get the results they want rather than the results produced by the market.


Anonymous Mike Moffatt said...

That's absolute insane, Terence.

By your definition of "central planning", practically every good or service is centrally planned, due to the presence of the GST and PST.

By your logic there isn't a price in Canada that contains a single piece of information. That's insane.

2:25 PM  
Anonymous Lauren Landsburg said...

Mr. Moffatt misunderstands and inserts his own words into Corcoran's interesting and topical critique at the NoPigouClub:

Corcoran's post provides an example of the distinction between a government's taxing for the purpose of deterring behavior versus the government's taxing to raise revenue. Corcoran says:
Pigovian taxes turn the role of prices upside down.... Taxes are not prices.

Mr. Moffatt makes an entirely irrelevant remark:
By Mr. Corcoran's own definition, everything in our economy is the product of central planning. Why?"

Where in Mr. Corcoran's article is there any reference to, much less a definition, of "central planning"?

The definition of a Pigovian tax is that it is a tax for the sole purpose of deterring behavior as opposed to a tax for raising revenue.

Pardon me for suggesting a resource, but Mr. Moffatt might want to listen to a recent podcast interview with Greg Mankiw on the meaning of Pigovian taxes:
Greg Mankiw on Taxes, Keynes and Macroeconomics

Calling someone "insane" because you do not follow the references or intellectual arguments is not the ideal. Mr. Moffatt's background as a student at the U. of Rochester should perhaps have been training enough about how low it is to label one's intellectual opponents as "insane".

Lauren Landsburg
Library of Economics and Liberty

6:40 AM  
Anonymous Mike Moffatt said...

Hi Lauren,

My training at U of Rochester was enough to pass the Political Economy on the first try. With flying colours too, I might add.

I attended enough Friday morning bagel hours at U of Rochester to know what types of things are said about one's ideological opponents. To be fair, though, Bill Clinton wasn't in the room to hear what was being said about him. :)

11:11 AM  
Blogger Bernie said...

The more you tax gasoline
the less money that
gas industry companies,
employees of the gas industry,
and consumers of gas will have to invest in that industry
to improve the product.
These three groups are most likely
to invest substantial sums
relative to others in "their"

Investing creates improvements
that over time will result in
better quality and reduced prices.
That means gasoline technologies
that pollute half as much
AND costing half as much,
so the cycle can again be repeated.

Also less taxes and lower prices
means people will have increased wealth for themselves and therefore
work 10% less days per year and retire 5 years earlier, resulting in 20% less work related driving
and gas pollution.

The State is Satanic and every
thing they try to govern turns to ashes, and ends up achieving
the opposite goal
that was proclaimed.

Also, taxation is theft
so it is immoral.
Their are spiritual laws
in effect that curse the
projects that use
stolen money.

Anybody that advocates higher
taxes usually is on the
recipient end of the stolen
loot, directly or indirectly.
That's why they push it. BB

7:10 PM  
Anonymous Anonymous said...

Mr. Corcoran:

Pigovian taxes are not higher taxes; they are different taxes. Why do carbon tax opponents always fall back on the badly worn "big-government-trying-to-tax-us-to-death" slogan? It's really got nothing to do with it.

Assuming fixed expenditures and balanced budgets, total taxation is also fixed. An imposition of a carbon tax therefore necessitates reduction in other taxes. Why bring up increases in government expenditures? It just clouding the issue.

You are entirely right that capitalism isn't about defining a price to achieve a behaviour. But you are entirely wrong when you claim that "Pigovians throw all the real price information out". Pigovians are just requesting that all costs be reflected. Following that, the price is up to the market to decide as long as the producer pays a fee for his damage to the world (think of it as pre-paid litigation). What people do with that cost is up to them. They can buy fewer of something or more or none at all. But they need to see what they're doing in order to understand the decision they're making.

Nobody is trying to fix the price of gasoline. But we should make people pay if they damage our lives. The price of gasoline can be whatever it wants to be, provided somewhere in the supply chain, someone pays the CO2 disposal fee. That's part of the true cost.

Taxes are indeed not prices. They are costs. And costs are factored into prices by the powerful market.

I'd love for the free market ideal to fully apply here, but we're stuck with the communism of having a shared atmosphere. If we could own our own climate, I'd love to watch as you screw yours up for yourself. Sadly, that can't be. We're joined at the hip. You get the same climate I do, whether you're entitled to it or not. Basically: I think of you as a climate parasite. No offense.

Normally, when one person screws up someone else's life, they can sue. But those that emit CO2 with impunity school themselves like fish. I can't go and launch a suit against 6 Billion defendants... especially if there's to be 6 Billion such suits. Who'd be left for the jury?

We're stuck with a problem and our old ideologies need to be compromised so that they fit into the constraints imposed by reality. I feel for you, and I understand where you're coming from, but it just isn't going to work any other way.

Surely you wouldn't prefer government boondoggle "investments" in infrastructure and pet technologies. Surely you're not one of those guys you hear about still clinging to denial about global warming?

What path would you propose?

Jurgen Hissen

10:59 PM  
Blogger Bernie said...

Pigouvian taxes are higher taxes ( higher than zero ).
Pigovian taxes are also more taxes.
Why do carbon tax proponents always fall back on the badly worn
"big-government-taxes-are-beneficial" slogan? It's really got
nothing to do with it.

5:46 PM  
Blogger Francis St-Pierre said...

Mike : the GST adds a certain percentage to the price of all goods. So the price of something today and two years from now (assuming the tax level stays the same) both include the same percentage of tax.

A pigouvian plan that would "tax gas till it hits US$4 a gallon" is by its nature a tax that varies with the price of the good. IOW, the price of the good, including the tax, stays the same, while the percentage of tax in the total price changes.

The result is to leave actors of the market totally in the blank as to the real price of oil.

Hope this clarifies things.


4:07 PM  
Anonymous Philippe Mineau said...

Yes, there is a central flaw in your argument, Terence... and it has to do with information. You believe that a market price contains thousands of tidbits of information, and as such correctly represents its true cost - I agree in part, but disagree in one central aspect of your argument: you forget that most human beings ignore, discount and discredit information about the future.
Of course you are well aware that the amount of information a consumer has about a certain product will change his willingness to pay for it - usually the more a consumer knows the less he is willing to pay for a product / service.
Well, the central problem with polluting products is that the average consumer does NOT have the adequate amount of information to make a true estimate of its cost.
Why is this? The implications of pollution are in the extreme long term - something akin to smoking. You may do it for 50, 60 years, but you don't realize until it's too late the TRUE cost of your actions.
You know of course that humans inherently don't relate to their futures - we are animals, after all, and prone to seriously discounting the future.
Thus I would argue that because of our inherent natural limitations (not being able to clearly see the future, not realizing the long-term consequences of our actions) we will never possess the adequate information to correctly price gasoline. Thus the market fails, and I am doomed to struggle on with my asthma for the rest of my polluted life.

7:05 AM  
Blogger Karl said...

Opposition to Pigovianism is based on laissez-faire ideological dogma. The whole idea Pigou proposed is that sometimes the phenomenon of market failure arises, where a totally free-market outcome does not maximize social welfare or social utility. Whenever you have a market failure, mainstream economic theory generally accepts a legitimate role for corrective government intervention. (That's not to say that ALL market failures can be perfectly corrected, or that every attempt at correction will come without bureaucratic side effects.)

In the case of fossil fuels, prices do not reflect long-term trends in global scarcity and extraction costs, so that we end up overconsuming it without regard for the next generation, and the artificially low prices keep alternatives pushed out of the short- to medium-term marketplace. Price-increasing taxes curb consumption and make practical substitutes (renewable energy) more fairly competitive in markets, since the long-term scarcity market failure in fossil fuels gives them an unfair competitive advantage.

The NoPigou ideologues do not accept the premise that markets sometimes fail and that government can and should attempt to correct market failures. They are entitled to their free-market fundamentalist opinions, but that doesn't change the fact that I very strongly disagree with them.

Karl S. Bonner

6:15 PM  
Blogger Norton said...

I read about subsidies to Petroleum companies, such as research grants to drill. Would it be a free market if the government funded one industry and not the other?
I am a consumer. I feel like I don't have a choice in what I buy. My power comes from a monopoly, and they charge me whatever the government will allow them to charge.
So, do we really have a free market even now? How can we say that taxing carbon will be socialism, when we currently have socialism?
I challenge you to write a blog about cutting all subsidies to the petroleum industry.

6:03 PM  

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