Monday, October 3, 2011

Market Failure Debate

A few days ago, Paul Krguman offered this quote on the issue of climate taxes:
At one level, this is all textbook economics. Externalities like pollution are one of the classic forms of market failure, and Econ 101 says that this failure should be remedied through pollution taxes or tradable emissions permits that get the price right. What Muller et al are doing is putting numbers to this basic proposition — and the numbers turn out to be big. So if you really believed in the logic of free markets, you’d be all in favor of pollution taxes, right?
Steven Landsburg responds:
Yes, that oversimplification is indeed sometimes taught in Econ 101. What Krugman doesn’t tell you is that it gets corrected in Econ 102, where students learn that taxing the source of an externality might or might not be efficient policy, depending on the available alternative remedies. It would, for example, be tragic to tax coal plants out of existence if it proved substantially cheaper to clean up their emissions after the fact, or to relocate the victims of those emissions.

I’m tempted to say that this is just Krugman being true to his principle that economics stopped advancing somewhere around the middle of the 20th century (something I certainly believe about music), so that just as Keynes had the last word on macroeconomics, Pigou had the last word on externalities. (Pigou, writing in 1920, is the source of the Econ 101 analysis; Ronald Coase, writing forty years later, advanced us to the level of Econ 102.) Except I know that Krugman knows better, because he once wrote a pretty good piece on green economics for the New York Times, where he made the Coasian argument tolerably well.
This is one of six points that Landsburg makes in response to Krugman's original post. Both are good to read because the entire exercise is a good excuse to think more about Coase.

The Krugman article on green economics that Landsburg likes "tolerably well" is here.

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