The Greatest Externality Story (N)ever Told

This article critiques current undergraduate economics textbooks’ treatment of externalities. Despite a tremendous scholarly pushback since 1920 to Pigou’s path-breaking writings, modern textbook authors fail to synthesize important critiques and extensions of externality theory and policy. The typical textbook treatment (a) does not distinguish pecuniary from technological externalities, (b) is silent about the invisible hand’s unintended and emergent consequences as a positive externality, (c) emphasizes negative relative to positive externalities, (d) ignores Coase’s critique of Pigouvian tax “solutions,†and (e) presents policy “solutions†to negative externalities that ignore inframarginal external benefits that may render “solutions†harmful to social welfare. Aside from attention to “The Coase Theorem†(excerpted from only about four pages of Coase’s voluminous writings), the typical textbook today discusses little of the scholarly critique that emerged in response to Pigou’s anti-market polemic. Imparting economics students with Pigouvian biases is potentially harmful to both them and society because it leaves them ill-prepared to critically assess policy proposals that are alleged to solve externality problems.