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 III


§ 1. GENERALLY speaking, economic causes act upon the economic welfare of any country, not directly, but through the making and using of that objective counterpart of economic welfare which economists call the national dividend or national income. Just as economic welfare is that part of total welfare which can be brought directly or indirectly into relation with a money measure, so the national dividend is that part of the objective income of the community, including, of course, income derived from abroad, which can be measured in money. The two concepts, economic welfare and the national dividend, are thus co-ordinate, in such wise that any description of the content of one of them implies a corresponding description of the content of the other. In the preceding chapter it was shown that the concept of economic welfare is essentially elastic. The same measure of elasticity belongs to the concept of the national dividend. It is only possible to define this concept precisely by introducing an arbitrary line into the continuum presented by nature. It is entirely plain that the national dividend is composed in the last resort of a number of objective services, some of which are embodied in commodities, while others are rendered direct. These things are most conveniently described as goods—whether immediately perishable or durable—and services, it being, of course, understood that a service that has already been counted in the form of the piano or loaf of bread, which it has helped to make, must not be counted again in its own right as a service. It is not, however, entirely plain which part of the stream of services, or goods and services, that flows annually into being can usefully be included under the title of the national dividend. That is the question which has now to be discussed.


§ 2. The answer which first suggests itself is that those goods and services should be included (double-counting, of course, being avoided), and only those, that are actually sold for money. This plan, it would seem, must place us in the best possible position for making use of the monetary measuring rod. Unfortunately, however, for the symmetry of this arrangement, some of the services which would be excluded under it are intimately connected, and even interwoven, with some of the included services. The bought and the unbought kinds do not differ from one another in any fundamental respect, and frequently an unbought service is transformed into a bought one, and vice versa. This leads to a number of violent paradoxes. Thus, if a man hires a house and furniture belonging to somebody else, the services he obtains from them enter into the national dividend, as we are here provisionally defining it, but, if he receives the house and furniture as a gift and continues to occupy it, they do so no longer. Again, if a farmer sells the produce of his farm and buys the food he needs for his family in the market, a considerable amount of produce enters into the national dividend which would cease to enter into it if, instead of buying things in the market, he held back part of his own meat and vegetables and consumed them on the farm. Again, the philanthropic work done by unpaid organiser, Church workers and Sunday school teachers, the scientific work of disinterested experimenters, and the political work of many among the leisured classes, which at present do not enter or, when there is a nominal payment, enter at much less than their real worth, into the national dividend, would enter into it if those people undertook to pay salaries to one another. Thus, for example, the Act providing for the payment of members of Parliament increased the national dividend by services valued at some £250,000. Yet again, the services rendered by women enter into the dividend when they are rendered in exchange for wages, whether in the factory or in the home, but do not enter into it when they are rendered by mothers and wives gratuitously to their own families. Thus, if a man marries his housekeeper or his cook, the national dividend is diminished. These things are paradoxes. It is a paradox also that, when Poor Law or Factory Regulations divert women workers from factory work or paid home-work to unpaid home-work, in attendance on their children, preparation of the family meals, repair of the family clothes, thoughtful expenditure of housekeeping money, and so on, the national dividend, on our definition, suffers a loss against which there is to be set no compensating gain.*37 It is a paradox, lastly, that the frequent desecration of natural beauty through the hunt for coal or gold, or through the more blatant forms of commercial advertisement, must, on our definition, leave the national dividend intact, though, if it had been practicable, as it is in some exceptional circumstances, to make a charge for viewing scenery, it would not have done so.*38


§ 3. Reflection upon these objections makes it plain that they are of a type that could be urged in some degree against any definition of the national dividend except one that coincided in range with the whole annual flow of goods and services. But to adopt a definition so wide as that would be tantamount to abandoning dependence upon the measuring rod of money. We are bound, therefore, either to dispense altogether with any formal definition or to fall back upon a compromise. The former policy, though there is more to be said for it than is sometimes allowed, would certainly arouse distrust, even though it led to no confusion. The latter, therefore, seems on the whole to be preferable. The method I propose to adopt is as follows. First, in accordance with the precedent set by Marshall, I shall take, as the standard meaning of the term national dividend, that suggested by the practice of the British Income Tax Commissioners. I, therefore, include everything that people buy with money income, together with the services that a man obtains from a house owned and inhabited by himself. But "the services which a person renders to himself and those which he renders gratuitously to members of his family or friends; the benefits which he derives from using his own personal goods [such as furniture and clothes], or public property such as toll-free bridges, are not reckoned as parts of the national dividend, but are left to be accounted for separately."*39 Secondly, while constructing in this way my standard definition of the national dividend, I reserve full liberty, with proper warning, to use the term in a wider sense on all occasions when the discussion of any problem would be impeded or injured by a pedantic adherence to the standard use. There is, no doubt, a good deal that is unsatisfactory about this compromise. Unfortunately, however, the conditions are such that nothing better appears to be available.


§4. The above conclusion does not complete the solution of our problem. Given the general class of things which are relevant to the national dividend, a further issue has to be faced. For the dividend may be conceived in two sharply contrasted ways: as the flow of goods and services which is produced during the year, or as the flow which passes during the year into the hands of ultimate consumers. Marshall adopts the former of these alternatives. He writes: "The labour and capital of the country, acting on its natural resources, produce annually a certain net aggregate of commodities, material and immaterial, including services of all kinds. This is the true net annual income or revenue of the country, or the national dividend."*40 Naturally, since in every year plant and equipment wear out and decay, what is produced must mean what is produced on the whole when allowance has been made for this process of attrition. To make this clear, Marshall adds elsewhere: "If we look chiefly at the income of a country, we must allow for the depreciation of the sources from which it is derived."*41 In concrete terms, his conception of the dividend includes an inventory of all the new things that are made, and of all the services not embodied in things that are rendered, accompanied, as a negative element, by an inventory of all the decay and demolition that the stock of capital undergoes. Anyone, on the other hand, who had been so far convinced by Professor Fisher*42 as to hold with him that savings are, in no circumstances, income, would identify the national dividend with those goods and services, and those only, that come into the hands of ultimate consumers.*43 According to this view, Marshall's national dividend represents, not the dividend that actually is realised, but the dividend that would be realised if the country's capital were maintained and no more than maintained. In a stationary state, where the creation of new machinery and plant in any industry exactly balances, and no more than balances, loss by wear and tear, these two things would be materially equivalent. The dividend on either definition would consist simply of the flow of goods and services entering into the hands of ultimate consumers; for all new materials at earlier stages in the productive process that came into factories and shops would be exactly balanced by the corresponding materials that left them in worked-up products; and all newly created machinery and plant would exactly take the place, and no more than take the place, of corresponding machinery and plant that became worn out during the year. In practice, however, the industry of a country is hardly ever in this kind of stationary state. Hence it is extremely rare for the two versions of the national dividend to be materially equivalent, and it is impossible for them to be analytically equivalent. The question how the choice between them should fall is, therefore, an important one.


§ 5. The answer to it, as I conceive the matter, turns upon the purpose for which we intend the conception to be used. If we are interested in the comparative amounts of economic welfare which a community obtains over a long series of years, and are looking for an objective index with which this series of amounts can be suitably correlated, then, no doubt, the conception which I have attributed to Professor Fisher's hypothetical follower is the proper one. It is also much more relevant than the other when we are considering how much a country is able to provide over a limited number of years for the conduct of a war; because, for this purpose, we want to know what is the utmost amount that can be squeezed out and "consumed," and we do not premise that capital must be maintained intact. The major part of this volume, however, is concerned, not with war, but with peace, and not with measurement, but with causation. The general form of our questions will be: "What effect on economic welfare as a whole is produced by such and such a cause operating on the economic circumstances of 1920?" Now it is agreed that the cause operates through the dividend, and that direct statements of its effects must refer to the dividend. Let us consider, therefore, the results that follow from the adoption of those two conceptions respectively. On Fisher's follower's plan, we have to set down the difference made by the cause to the dividend, not merely of 1920, but of every year following 1920; for, if the cause induces new savings, it is only through a statement covering all subsequent years that its effect on the dividend, as conceived by Fisher's follower, can be properly estimated. Thus, on his showing, if a large new factory is built in 1920, not the capital establishment of that factory, but only the flow of services rendered by it in 1920, should be reckoned in the dividend of 1920; and the aggregate effects of the creation of the factory cannot be measured without reference to the national dividend of a long series of years. On Marshall's plan this inconvenient elaboration is dispensed with. When we have stated the effect produced on the dividend, in his sense, for the year 1920, we have implicitly included the effects, so far as they can be anticipated, on the consumption both of 1920 and of all subsequent years; for these effects are reflected back in the capital establishment provided for the factory. The immediate effect on consumption is measured by the alteration in the 1920 dividend as conceived by Fisher's follower. But it is through total consumption, and not through immediate consumption, that economic welfare and economic causes are linked together. Consequently, Marshall's definition of the national dividend is likely, on the whole, to prove more useful than the other, and I propose in what follows to adopt it. The entity—also, of course, an important one—which Fisher's follower calls by that name, we may speak of as the national income of consumption goods, or, more briefly, consumption income.


§ 6. We have thus achieved a definition which, unsatisfactory as it is, is still reasonably precise, of the concrete content of the national dividend. This definition carries with it certain plain implications as to the way in which that dividend must be evaluated. The first and most obvious of these is that, when the value of a finished product is counted, the value of materials employed in making that product must not be counted also. In the British Census of production of 1907 this form of double counting was carefully avoided. The Director described his method as follows: The result of deducting the total cost of materials used, and the amount paid to other firms for work given out, from the value of the gross output for any one industry or group of industries is to give a figure which may, for convenience, be called the "net output" of the industry or the group. This figure "expresses completely and without duplication the total amount by which the value (at works) of the products of the industry or the group, taken as a whole, exceeded the value (at works) of the materials purchased from outside, i.e. it represents the value added to the materials in the course of manufacture. This sum constitutes for any industry the fund from which wages, salaries, rent, royalties, rates, taxes, depreciation, and all other similar charges, have to be defrayed, as well as profits."*44 When, however, it is desired to evaluate the national dividend as a whole, these allowances are not sufficient. There is no real difference between the flour, which is used up in making bread, and bread-making machinery, which is used up and worn out in the process of effecting the conversion. If adding together the flour and the bread in summing the national dividend involves double counting, so also does adding together the machinery and the bread. "Logically," as Marshall observes, "we ought to deduct the looms which a weaving factory buys as well as its yarn. Again, if the factory itself was reckoned as a product of the building trade, its value should be deducted from the output (over a term of years) of the weaving trade. Similarly with regard to farm buildings. Farm houses ought certainly not to be counted, nor for some purposes any houses used in trade."*45 In a broad general way these considerations can be taken into account by subtracting from the sum of the values of the net products of various industries, as defined in the Census of Production, the value of the annual depreciation, which signifies the annual cost of renewal and repair of all kinds of machinery and plant.*46 Thus, if a particular sort of machinery wears out in ten years—Professor Taussig's estimate for the average life of machinery in a cotton mill*47—the value of the national dividend over ten years will fall short of the value of the aggregated net product by the value of this machinery.*48 Again in so far as any sort of crop wastes the productive powers of the soil, the value of the dividend will fall short of the value of the aggregated net product by the cost of returning to the soil those chemical ingredients that it removes.*49 Yet again, when minerals are dug out of the ground, a deduction should be made equal to the excess of the value which the minerals used during the year had in their original situation—theoretically represented by the royalties paid on their working—over the value which whatever is left of them possesses to the country after they have been used. If "using" means exporting in exchange for imports that are not used as capital, this latter value is zero. If, on the other hand, it means inducing Nature miraculously to transmute the mineral into something possessing greater value than it had in the mine, then, in order to obtain the value of the national dividend from the value of the aggregated net product, we shall need to add, and not to subtract, something. This is sufficient for our present purpose. More delicate issues concerning the precise significance of the notion "maintaining capital intact" are treated in detail in the next chapter.


§ 7. It remains to consider the relation between the national dividend as thus evaluated—an addition, of course, being made for the value of income received from abroad—and the money income accruing to the community. On the face of things we should expect these two sums to be substantially equal, just as we should expect a man's receipts and his expenditure (including investments) to be equal. With proper account-keeping this clearly ought to be so. In order that it may be so, however, it is necessary for the money income of the community to be so defined as to exclude all income that is obtained by one person as a gift against which no service entering into the inventory of the national dividend is rendered—all allowances, for example, received by children from their parents. In like manner, if A sells existing property or property rights to B for £1000, the £1000, if already counted as a part of B's income, must not be counted as a part of A's income also. These points are, of course, well understood. But certain further implications are less fully realised. Thus the incomes constituted by old-age pensions and special war pensions must be excluded; though ordinary civil service pensions are properly included, "because these may be said to be equivalent to salaries, and the pension system is only an alternative to paying a higher salary to those rendering existing services and leaving them to look after their own superannuation allowance."*50 There must also be excluded all income received by native creditors of the State in interest on loans that have been employed "unproductively," i.e. in such a way that they do not, as loans to build railways would do, themselves lead to the production of services which are sold for money and thus enter into the national dividend as evaluated in money. This means that the income received as interest on war loan must be excluded. Nor is it possible to overthrow this conclusion by suggesting that the money spent on the war has really been "productive," because it indirectly prevented invasion and the destruction of material capital that is now producing goods sold for money; for whatever product war expenditure may have been responsible for in this way—and a similar argument applies to expenditure on school buildings—is already counted in the income earned by the material capital. Yet again, it would seem that income obtained by force or fraud, against which no real service has been rendered, ought not to be counted. There are, furthermore, certain difficulties about payments made to Government. The moneys that governing authorities, whether central or local, receive in net profits on services rendered by them, e.g. the profits of the Post Office or of a municipal tramway service, should clearly be counted. What the Treasury receives in income tax or death duties should, on the other hand, clearly not be counted, because this income, which has already been reckoned as such in private hands, is not passed to the Treasury in payment for any services rendered by it, but is merely transferred to it as an agent for the tax-payers. What the Treasury receives in (the now abolished) excess-profit duty and corporation tax, as operated in England, stands, however, on a different footing. It should be counted, because the incomes of companies and individuals were reckoned as what was left after these taxes had been paid, so that, if the income represented by them had not been counted when in the hands of the Treasury, it would not have been counted at all.*51 Finally, the main part of what the Treasury receives in customs and excise duties ought, paradoxical as it may seem, to be counted, in spite of the fact that it is already counted when in the hands of the tax-payers and that it is not paid against any service. The reason is that the prices of the taxed articles are pushed up (we may suppose) by nearly the amount of the duties, and that, therefore, unless the aggregate money income of the country is reckoned in such a way that it is pushed up correspondingly, this aggregate money income dividend by prices, that is to say, the real income of the country, would necessarily appear to be diminished by the imposition of these duties even though it were in fact the same as before.*52 When the nominal money income of the country has been "corrected" in these various ways, what is left should approximate fairly closely to the value of the national dividend (inclusive of incomes from abroad) estimated on the plan set out above.*53

Notes for this chapter

It would be wrong to infer from the above that the large entry of women into industry during the war was associated with an approximately equal loss of work outside industry. For, first, a great deal of war work was undertaken by women who previously did little work of any kind; secondly, the place of women who entered industry was taken largely by other women who had previously done little—for example, many mistresses in servant-keeping houses themselves took the place of a servant; and, thirdly, owing to the absence of husbands and sons at the war, the domestic work, which women would have had to do if they had not gone into industry, would have been much less than in normal times.
The Advertisement Regulation Act, 1907, allows local authorities to frame by-laws designed to prevent open-air advertising from affecting prejudicially the natural beauty of a landscape or the amenities of a public park or pleasure promenade. It is not, we may note in this connection, a decisive argument against underground, and in favour of overhead, systems of tramway power wires that they are more expensive. The London County Council deliberately chose the more expensive underground variety for aesthetic reasons.
Marshall, Principles of Economics, p. 524.
Ibid, p. 523
Marshall, Principles of Economics, p. 80.
Professor Fisher himself takes the position that the national dividend, or income, consists solely of services as received by ultimate consumers, whether from their material or from their human environment. Thus a piano or an overcoat made for me this year is not a part of this year's income, but an addition to capital. Only the services rendered to me during this year by these things are income (The Nature of Capital and Income, pp. 104 et seq.). This way of looking at the matter is obviously very attractive from a mathematical point of view. But the wide departure which it makes from the ordinary use of language involves disadvantages which seem to outweigh the gain in logical clarity. It is easy to fall into inconsistencies if we refuse to follow Professor Fisher's way; but it is not necessary to do so. So long as we do not do so, the choice of definitions is a matter, not of principles, but of convenience.
For consistency it would be necessary to exempt new houses that are built to be occupied by their owners from the category of income and to place them in that of capital, if a money valuation of their annual rental value is included in income.
[Cd. 6320], p. 8.
Marshall, Principles of Economics, p. 614 n.
CF. Flux, statistical Journal, 1913, p. 559.
Quarterly Journal' of Economics, 1908, p.342. The report of the Census of Production, 1907, sanctions the view that an average life of ten years may reasonably be assigned to buildings and plant in general (Report, p. 35).
In industries where large individual items of assets need replacement at fairly long intervals, it is usual to meet this need by the accumulation of a depreciation fund built up by annual instalments during the life of the wasting asset. For machinery which wears out in about equal quantities every year, Professor Young argues that, provided the renewals and repairs required every year are duly furnished, capital will be maintained intact by that fact alone, and no depreciation fund is necessary (Quarterly Journal of Economics, 1914, pp. 630 et seq.). It is true that by this method, when the plant has been running for some time, the capital is maintained in any one year at the level at which it stood in the preceding year. But Professor Young himself shows that, in static conditions, when a plant has been established for some time, it will normally be about half worn out (loc. cit. p. 632). If half-worn-out plant, that is to say, plant half-way through its normal life—is technically of the same efficiency as new plant, this fact does not injure his conclusion. But, in so far as the efficiency of plant diminishes with age, the case is otherwise. If the capital is to be maintained at the level at which it stood when first invested, it is necessary, not merely to provide renewals and repairs as needed, but also to maintain a permanent depreciation fund, to balance the difference between the values of a wholly new plant and of one the constituents of which are, on the average, half-way through their effective life. (Cf. also a discussion between Professor Young and Mr. J. S. Davis under the title "Depreciation and Rate Control" in the Quarterly Journal of Economics, Feb. 1915.)
Professor Carver writes of the United States: "Taking the country over, it is probable that, other things equal, if the farmers had been compelled to buy fertilisers to maintain the fertility of their soil without depletion, the whole industry would have become bankrupt... The average farmer had never (up to about 1887) counted the partial exhaustion of the soil as a part of the cost of his crop" (Sketch of American Agriculture, p. 70.) Against this capital loss, however, must be set the capital gain due to the settlement of the land.
Stamp, Wealth and Taxable Capacity, p. 57.
Cf. Stamp, Wealth and Taxable Capacity, pp. 55-6.
The reason why it is only claimed that the main part, not the whole, of what the Treasury receives under this head should be counted as income is (1) that commodity taxes may not always raise prices by their full amount, and (2) that they may indirectly cause production to contract.
It should be noticed, however, that one paradox still remains uncorrected by the qualifications set out in the text. If a service, for which hitherto fees have been charged to business men, the fees being of a sort that it is lawful to deduct as a business expense before incomes are reckoned, comes to be provided for and to be paid for by an addition to income tax, the money income of the country is increased, though the real income is unchanged (cf. Stamp, Wealth and Taxable Capacity, pp. 52-3). The only way to get rid of this paradox would be to allow business men to deduct the cost of any services which, if paid for by fees, would count as a business expense, whether in fact they are paid for by fees or not.

Part I, Chapter IV

End of Notes

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