The Economics of Welfare

Pigou, Arthur C.
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First Pub. Date
London: Macmillan and Co.
Pub. Date
4th edition.

Part I, Chapter II


§1. IN the preceding chapter economic welfare was taken broadly to consist in that group of satisfactions and dissatisfactions which can be brought into relation with a money measure. We have now to observe that this relation is not a direct one, but is mediated through desires and aversions. That is to say, the money which a person is prepared to offer for a thing measures directly, not the satisfaction he will get from the thing, but the intensity of his desire for it. This distinction, obvious when stated, has been somewhat obscured for English speaking students by the employment of the term utility—which naturally carries an association with satisfaction—to represent intensity of desire. Thus, when one thing is desired by a person more keenly than another, it is said to possess a greater utility to that person. Several writers have endeavoured to get rid of the confusion which this use of words generates by substituting for "utility" in the above sense some other term, such, for example, as "desirability." The term "desiredness" seems, however, to be preferable, because, since it cannot be taken to have any ethical implication, it is less ambiguous. I shall myself employ that term. The verbal issue is, however, a subordinate one. The substantial point is that we are entitled to use the comparative amounts of money which a person is prepared to offer for two different things as a test of the comparative satisfactions which these things will yield to him, only on condition that the ratio between the intensities of desire that he feels for the two is equal to the ratio between the amounts of satisfaction which their possession will yield to him. This condition, however, is not always fulfilled. By this statement I do not, of course, merely mean that people's expectations as to the satisfaction they will derive from different commodities are often erroneous. The point is that, even apart from this, the condition sometimes breaks down. Thus Sidgwick observes: "I do not judge pleasures [and the same thing obviously holds of satisfactions other than pleasures] to be greater and less exactly in proportion as they exercise more or less influence in stimulating the will to actions tending to sustain or produce them":*28 and again, "I do not think it ought to be assumed that intensity of immediate gratification is always in proportion to intensity of pre-existing desire."*29 This consideration obviously has great theoretical importance. When it is recollected that all comparisons between different taxes and different monopolies, which proceed by an analysis of their effects upon consumer's surplus, tacitly assume that demand price (the money measure of desire) is also the money measure of satisfaction, it is apparent that it may have great practical importance also. The question whether it has in actual fact great practical importance has, therefore, to be examined.


§2. In a broad general way we may, I think, safely answer this question in the negative. It is fair to suppose that most commodities, especially those of wide consumption that are required, as articles of food and clothing are, for direct personal use, will be wanted as a means to satisfaction, and will, consequently, be desired with intensities proportioned to the satisfactions they are expected to yield.*30 For the most general purposes of economic analysis, therefore, not much harm is likely to be done by the current practice of regarding money demand price indifferently as the measure of a desire and as the measure of the satisfaction felt when the desired thing is obtained. To this general conclusion, however, there is one very important exception.


§3. This exception has to do with people's attitude toward the future. Generally speaking, everybody prefers present pleasures or satisfactions of given magnitude to future pleasures or satisfactions of equal magnitude, even when the latter are perfectly certain to occur. But this preference for present pleasures does not—the idea is self-contradictory—imply that a present pleasure of given magnitude is any greater than a future pleasure of the same magnitude. It implies only that outer telescopic faculty is defective, and that we, therefore, see future pleasures, as it were, on a diminished scale. That this is the right explanation is proved by the fact that exactly the same diminution is experienced when, apart from our tendency to forget ungratifying incidents, we contemplate the past. Hence the existence of preference for present over equally certain future pleasures does not imply that any economic dissatisfaction would be suffered if future pleasures were substituted at full value for present ones. The non-satisfaction this year of a man's preference to consume this year rather than next year is balanced by the satisfaction of his preference next year to consume next year rather than to have consumed this year. Hence, there is nothing to set against the fact that, if we set out a series of exactly equal satisfactions—satisfactions, not objects that yield satisfactions—all of them absolutely certain to occur over a series of years beginning now, the desires which a man will entertain for these several satisfactions will not be equal, but will be represented by a scale of magnitudes continually diminishing as the years to which the satisfactions are allocated become more remote. This reveals a far-reaching economic disharmony. For it implies that people distribute their resources between the present, the near future and the remote future on the basis of a wholly irrational preference. When they have a choice between two satisfactions, they will not necessarily choose the larger of the two, but will often devote themselves to producing or obtaining a small one now in preference to a much larger one some years hence. The inevitable result is that efforts directed towards the remote future are starved relatively to those directed to the near future, while these in turn are starved relatively to efforts directed towards the present. Suppose, for example, that a person's telescopic faculty is such that he discounts future satisfactions, which are perfectly certain to occur, at the rate of 5 per cent per annum. Then, instead of being ready to work for next year, or a year ten years hence, so long as a given increment of effort will yield as much satisfaction as an equal increment devoted to work for the present, he will only work for next year so long as the yield of an increment of effort employed for that year is 1.05 times, and for ten years hence so long as it is (1.05)10 times, the yield of an increment employed for the present. It follows that the aggregate amount of economic satisfaction which people in fact enjoy is much less than it would be if their telescopic faculty were not perverted, but equal (certain) satisfactions were desired with equal intensity whatever the period at which they are destined to emerge.


§4. This, however, is not all. Since human life is limited, such fruits of work or saving as accrue after a considerable interval are not enjoyed by the person to whose efforts they are due. This means that the satisfaction with which his desire is connected is not his own satisfaction, but the satisfaction of somebody else, possibly an immediate successor whose interest he regards as nearly equivalent to his own, possibly somebody quite remote in blood or in time, about whom he scarcely cares at all. It follows that, even though our desires for equal satisfactions of our own occurring at different times were equal, our desire for future satisfaction would often be less intense than for present satisfaction, because it is very likely that the future satisfaction will not be our own. This discrepancy will be more important the more distant is the time at which the source of future satisfaction is likely to come into being; for every addition to the interval increases the chance of death, not merely to oneself, but also to children and near relatives and friends in whom one's interest is likely to be most keen.*31 No doubt, this obstacle to investment for distant returns is partly overcome by stock-exchange devices. If £100 invested now is expected to reappear after 50 years expanded at, say, 5 per cent compound interest, the man who originally provides the £100 may be able, after a year, to sell his title in the eventual fruit for £105; the man who buys from him may be able similarly to get his capital of £105 back with 5 per cent interest after one year; and so on. In these circumstances the fact that any one man would require a higher rate of interest per annum to induce him to lock up £100 for 50 years than he would to induce him to lock up the same sum for one year makes no difference. But, of course, in actual fact this device is of very narrow application. As regards investments, such as planting a forest or undertaking drainage development on one's own estate, which can only be accomplished privately, it is not applicable at all; and, even when investment is undertaken by a company, investors cannot seriously expect to find a smooth and continuous market for non-dividend paying securities.


§ 5. The practical way in which these discrepancies between desire and satisfaction work themselves out to the injury of economic welfare is by checking the creation of new capital and encouraging people to use up existing capital to such a degree that larger future advantages are sacrificed for smaller present ones. Always the chief effect is felt when the interval of time between action and consequence is long. Thus, of the check to investment, Giffen wrote: "Probably there are no works more beneficial to a community in the long run than those, like a tunnel between Ireland and Great Britain, which open an entirely new means of communication of strategical as well as of commercial value, but are not likely to pay the individual enterpriser in any short period of time." A number of other large undertakings, such as works of afforestation or water supply, the return to which is distant, are similarly handicapped by the slackness of desire towards distant satisfactions.*32 This same slackness of desire towards the future is also responsible for a tendency to wasteful exploitation of Nature's gifts. Sometimes people will win what they require by methods that destroy, as against the future, much more than they themselves obtain. Over-hasty exploitation of the best coal seams by methods that cover up and render unworkable for ever worse, but still valuable, seams;*33 fishing operations so conducted as to disregard breeding seasons, thus threatening certain species of fish with extinction;*34 farming operations so conducted as to exhaust the fertility of the soil, are all instances in point. There is also waste, in the sense of injury to the sum total of economic satisfaction, when one generation, though not destroying more actual stuff than it itself obtains, uses up for trivial purposes a natural product which is abundant now but which is likely to become scarce and not readily available, even for every important purposes, to future generations. This sort of waste is illustrated when enormous quantities of coal are employed in high-speed vessels in order to shorten in a small degree the time of a journey that is already short. We cut an hour off the time of our passage to New York at the cost of preventing, perhaps, one of our descendants from making the passage at all.


§ 6. In view of this "natural" tendency of people to devote too much of their resources to present service and too little to future service, any artificial interference on the part of Government in favour of that tendency is bound, unless it has compensating advantages on the side of distribution, to diminish economic welfare. Subject to that condition, therefore, all taxes which differentiate against saving, as compared with spending, must diminish economic welfare. Even without differentiation there will be too little saving: with it there will be much too little saving. Property taxes, where they exist, and death duties, obviously differentiate against saving. The English income tax, though it appears to be neutral, in fact, as is shown elsewhere, also does this*35 The foregoing analysis shows that there is a prima facie case for softening the differential element in these taxes. Proposals, therefore, for exempting saved income from income tax, balancing property taxes by heavy "indirect" taxes upon important objects of expenditure, exempting from local rates improvements contributed during the preceding twenty years, and so on, deserve to be carefully weighed. In the construction of a practical tax-system, however, considerations as to what is "fair" between people of different degrees of wealth and as to what is administratively feasible may compel us to accept arrangements which differentiate against savings in spite of our knowledge that such differentiation is in itself undesirable.*36


§ 7. Our analysis also suggests that economic welfare could be increased by some rightly chosen degree of differentiation in favour of saving. Nobody, of course, holds that the State should force its citizens to act as though so much objective wealth now and in the future were of exactly equal importance. In view of the uncertainty of productive developments, to say nothing of the mortality of nations and eventually of the human race itself, this would not, even in extremest theory, be sound policy. But there is wide agreement that the State should protect the interests of the future in some degree against the effects of our irrational discounting and of our preference for ourselves over our descendants. The whole movement for "conservation" in the United States is based on this conviction. It is the clear duty of Government, which is the trustee for unborn generations as well as for its present citizens, to watch over, and, if need be, by legislative enactment, to defend, the exhaustible natural resources of the country from rash and reckless spoliation. How far it should itself, either out of taxes, or out of State loans, or by the device of guaranteed interest, press resources into undertakings from which the business community, if left to itself, would hold aloof, is a more difficult problem. Plainly, if we assume adequate competence on the part of governments, there is a valid case for some artificial encouragement to investment, particularly to investments the return from which will only begin to appear after the lapse of many years. It must, however, be remembered that, so long as people are left free to decide for themselves how much work they will do, interference, by fiscal or any other means, with the way in which they employ the resources that their work yields to them may react to diminish the aggregate amount of this work and so of those resources. It does not follow, in short, that, because economic welfare would be increased if a man who now invests, say, one-tenth of his income, chose to invest one-half, therefore it would be increased if he were compelled by legislative decree, or induced by taxes and bounties, to make this change.

Notes for this chapter

Methods of Ethics, p. 126.
The Ethics of T.H. Green, etc., p. 340
Cf. my "Some Remarks on Utility," Economic Journal 1903, p. 58 et seq.
If k be the fraction of importance that I attach to a pound in the hands of my heirs as compared with myself, and ø(t) the probability that I shall be alive t years from now, certain pound to me or my heirs then attracts me now equally with a certain pound multiplied by {ø(t)+k(1-ø(t))} to me then. This obviously increased by anything that increases either ø(t) or k

If, through an anticipated change of fortune or temperament, one pound after t years is expected to be equivalent to (1- a) times one pound now, a certain {ø(t)+k(1-ø(t))} pounds of the then prevailing sort to me then attracts me now equally with a (1-a){ø(t)+k(1-ø(t))} pounds of the now prevailing sort to me then. Therefore, a certain pound to my heirs will be as persuasive to call out investment now as the above sum would be if I were certain to live for ever and always to be equally well off and the same in temperament.

In this connection the following passage from Knoop's Principles and Methods of Municipal Trade is of interest: "To secure an additional supply of water to a town, ten or more years of continuous work may easily be required. This means that for several years a large amount of capital will be unproductive, thus seriously affecting the profits of the undertaking and making boards of directors very chary about entering upon any large scheme.... It is almost inconceivable that a water company would have undertaken the great schemes by which Manchester draws its supply of water from Lake Thirlmere in Cumberland, a distances of some 96 miles; Liverpool its supply from Lake Vyrnwy in North Wales, a distance of some 78 miles; and Brighton its supply from the Elan Valley in Mid Wales, a distance of some 80 miles" (loc. cit. p. 38).
Cf. Chiozza-Money, The Triumph of Nationalisation, p. 199.
Cf. Sidgwick, Principles of Political Economy, p. 410.
Cf. my A Study in Public Finance, Part II. ch. x.
For example, the case against the imposition of equal taxation upon two men, each of whom spends £450 a year, but the first has an income of £1000 and the second an income of £500 a year is, from the point of view of equity, overwhelming.

Part I, Chapter III

End of Notes

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