Editor's Choice

The Information Value of Pigouvian Pricing

I recently read an article in the journal Economics and Philosophy, written by Lisa Herzog, which has nothing whatsoever to do with environmental economics but nonetheless I think has interesting implications for it and for Pigouvian pricing in particular.  

In case you are unfamiliar with it, the journal Economics and Philosophy is a scholarly journal publishing articles on topics related to (wait for it) economics and philosophy.  And, often, the philosophy of economics.  This is an area that I have become interested in recently, influenced no doubt by my years as an undergraduate philosophy major.  

In the article, Herzog addresses and basically dismantles Hayek’s model of the price mechanism in markets as being an efficient way of processing and distilling information necessary for buyers and sellers.  Hayek’s idea is basically that the world is a complicated place, and markets have lots of complicated information about costs, benefits, demands, etc.  But, once markets determine a price for something, that price contains all of the information that buyers and sellers need to make their optimal decision. Herzog quotes Hayek: markets process “dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.” 

Herzog’s argument is that Hayek is ignoring important pieces of knowledge that buyers and sellers need to make morally informed choices and that are missing from the price signal.  Without this information, or “epistemic infrastructures, market participants do not act as morally responsible agents: when acting in such markets, it often seems fair to say that they do not know what they are doing.”  The motivating example is buying clothes made in sweatshops overseas.  The price mechanism contains lots of information about production and transportation costs, etc., but it is missing important moral information, like the conditions of the workers and their outside opportunities.  Without this information buyers cannot make morally complete (and therefore optimal) decisions.

What does this have to do with environmental economics?  Of course, when there are negative externalities (like pollution), the unregulated market price will not reflect those externalities and thus will not provide buyers and sellers the necessary information to make optimal choices.  This is not new; this is Pigou, and even the most die-hard Hayekian would admit that market failures like externalities need to be incorporated somehow into the price signal to achieve efficiency. (Aside: maybe it’s not actually Pigou, according to this working paper by my colleague Spencer Banzhaf.) 

But I think there is a deeper and less obvious point than that.  Supposing that there is a Pigouvian price on pollution that accounts for its negative externalities.  Does this price still contain the necessary “epistemic infrastructure” for all buyers and sellers to make morally responsible decisions?  If the Pigouvian price is “right” then it accounts for the spillover costs, but it’s not obvious that these costs are all that is morally necessary to make informed choices.   Just like with sweatshops, there potentially are moral considerations above and beyond any cost considerations (even spillover costs) that need to be incorporated.  It it not clear that a Pigouvian price would incorporate any of this. 

Anyways, some Pigouvian price on pollution is still no doubt better than no Pigouvian price on pollution, but there is potentially a strong argument to be made here based on Herzog’s article that any Pigouvian price can’t get us enough information to make morally optimal choices.