Thread by @LaurentFranckx

This year, we will celebrate the 100th anniversary of one of the most important works ever in the field of economics: Pigou's "The economics of welfare" /
britannica.com/biography/Arth…

If that doesn't ring a bell, Pigou laid the theoretical foundations of what we would now call "pollution taxes". Following this work, the whole idea of protecting the environment, even if it increases the cost of doing business, is completely mainstream in economics. /

The theoretical foundation is the concept of "externality": Alfred Marshall, Pigou's predecessor, had already understood that some costs & benefits of economic activities do not go to the entity undertaking that activity. /

What Marshall had in mind were mostly what we would now call "agglomeration benefits": agglomerations provide not just bigger markets, but also skilled labour and specialised services (finance, legal services etc) , and thus an increase in economic activity in an /

agglomeration will benefit all. Pigou's innovation consisted in understanding how pollution could be understood as a negative externality: a firm discharging effluents in a river will for instance reduce the profits of a downstream fishery /

As a result, the combined profits of the factory and the fisheries will be smaller than if the factory and the fisheries would have one single owner who would maximize joint profits /

For instance, the joint owner would install pollution control devices that would allow the factory to continue operations without damaging the fisheries (or with smaller damages). /

For several reasons, such a merging of activities would not always be practical, so what Pigou proposed was for the government to step in and to create a price signal that would make the factory owner act as if he would maximize the joint profits: the pollution tax /

And thus the field of the economic analysis of instrument choice in environmental policy was borne. In the 1960s, "tradable permits" were added to the toolbox (even though they were "imported" from political science). The most important advantage of pigovian taxes and tradable/

permits is that, compared to traditional command-and-control systems, they allow to reach any environmental target at a lower cost to society: private agents will indeed chose the combination of abatement techniques (reducing the scale of their operations, changing the fuel /

mix, installing scrubbers etc) that minimizes their costs. It is an illusion to think that a central planner has the specialist knowledge that would be needed to achieve this. /

Of course, 100 years later, the impact on policy has been disappointing, to say the least. Nevertheless, tradable permits have played a key role in reducing "acid rain" in the US at a very low economic cost, and are central to the EU's climate policy (even if there have /

been some teething problems). Hopefully, in the next 100 years, these ideas will move from the mainstream of scientific thought to the mainstream of practice. /