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Externalities 4. Steven Cheung: The Myth of Social Cost

This is the fourth of a series examining the moral dimensions of economic “externalities”, the spillover or incidental side effects in market activity.

The series is available in expanded form, with an introductory chapter and updated essays, as an e-book to facilitate reading and annotating: https://nmichaelbrennen.com/shop/.

In the 1978 collection of essays “The Myth of Social Cost,” Steven Cheung – a long time friend of Ronald Coase – and other contributors continued the critique of Pigovian welfare economics along the Coasean lines.  The authors covered a variety of topics, and my summary necessarily only touches certain relevant points.

A central issue in the various analyses is the definition of property rights.  Inadequately defined property rights can create transaction costs.  Cheung argued that “to say that transaction costs are zero is identical to declaring the existence of private property rights” (53, emphasis original.)  As an example regarding air and water pollution, C.K. Rowley noted that “the ‘property’ rights to pollute or not to pollute may never have been determined;” without a clear delimitation of property, there can be no market exchanges to internalize the external, uncompensated costs.  Following an argument by Frank Knight, Cheung pointed out that in one of Pigou’s early examples (one involving two publicly owned roads, removed from later versions of Pigou’s work) Pigou had missed that, were the roads private, the private solution to optimally balancing traffic on the roads is exactly what a Pigovian tax would have accomplished (Cheung, 42; Knight, 587.)

Cheung formulated hypotheses and then tested them against data collected in research (10.)  Cheung rejected some welfare economics arguments on the grounds that “Using imaginary ‘facts’ to support imaginary policies seems habitual in the Pigovian tradition” (55;) Cheung rejected Pigou’s analysis of tenant farming and of J.E. Meade’s analysis of beekeeping based on actual research and collected data (section VI.)  J. Burton stated that Pigou’s contributions were based on “armchair theorizing rather than empirical investigation” (72.)

J. Burton summarized arguments against Pigou’s assumptions of State intervention.  Pigou assumed that the cost of administering government interventions is zero.  Where prices work in the market as a relatively cheap source of information, a government has no low cost equivalent method of gaining the distributed information across many agents to manage marginal, and hence dynamic, supply and demand.  Not only could the cost of government administered correctives to externalities frequently exceed the gains to society, there may be spillover effects from the intervention itself. Finally, as a public choice critique, political agents are not impartial nor independent; they have their own goals that are frequently directly linked to election cycles.

If one accepts these arguments, the Pigovian welfare economics approach not only may not solve the problems it attempts to address, it may well make them worse.

Considering the Coasean analysis of liability assignments when settling a dispute, Cheung further noted that the economic outcomes of different rights assignments will result in different wealth distributions.  Assigning the right to emit smoke to a factory owner and assigning the right of the nearby citizen to clean air, then assessing the market transactions necessary in each assignment to settle the differences, will result in different economic outcomes.  The economic assessment of each may be very different than how others view them normatively, though both reflect the reciprocal nature of externalities; as Cheung noted, “what is ‘fair’ to one party is always ‘unfair’ to the other (45.)  This is consistent with Dahlman’s argument (considered in a previous blog post in this series) that one’s value judgments determine how one understands its economics.

From an ethical view, Cheung acknowledged that “On ethics, economic theory must remain silent” (21.)  He presented an interesting argument supporting economic efficiency as an effective policy tool.  He   A public policy is assessed by normative value judgments, which are not open to theoretical proof.  Cheung saw economics as a ‘positive’ science (his quotes) that can determine whether economic activities are efficient.  Thus the transition from positive economic analysis to normative policy argument “requires only the inference that efficient allocation of resources is desirable to society” (21.)  He argued that such an inference is easy to draw and easy for most economists to accept.  Here I think Cheung must have had neoclassical economists in mind, rather than Marxist or progressive economists.

Note that Cheung argued specifically in the direction from economic analysis to normative policy; in my reading of the work I did not note any assessment of normative policy directing specific economic activities.  Given his emphasis on empirical research, it seems consistent that he would want to weigh the effectiveness of the policy on the assessed economic outcomes of its implementation.  Dahlman’s conclusion does seem to entail that Cheung’s argument from economic efficiency to policy would only hold for those who accept that a goal of policy should be economic efficiency, as defined by neoclassical economics.  In contrast, it is frequently the case that policy dictates economic activities precisely because the goal is to alter, on moral grounds, a perceived neoclassical economic outcome, without regard to the unanticipated side effects of market intervention.

Cheung, Steven. “The Myth of Social Cost.”  Hobart Paper 82. London: The Institute of Economic Affairshttp://www.iea.org.uk/sites/default/files/publications/files/THE%20MYTH%20OF%20SOCIAL%20COST.pdf

Knight, Frank. “Some Fallacies in the Interpretation of Social Cost.”  The Quarterly Journal of Economics, Vol. 38, No. 4 (Aug., 1924.)  pp. 582-606.  JSTOR: http://www.jstor.org/stable/1884592

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