The Greatest Externality Story (N)ever Told
This article critiques current undergraduate economics textbooksâ€™ treatment of externalities. Despite a tremendous scholarly pushback since 1920 to Pigouâ€™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 handâ€™s unintended and emergent consequences as a positive externality, (c) emphasizes negative relative to positive externalities, (d) ignores Coaseâ€™s critique of Pigouvian tax â€œsolutions,â€ and (e) presents policy â€œsolutionsâ€ to negative externalities that ignore inframarginal external benefits that may render â€œsolutionsâ€ harmful to social welfare. Aside from attention to â€œThe Coase Theoremâ€ (excerpted from only about four pages of Coaseâ€™s voluminous writings), the typical textbook today discusses little of the scholarly critique that emerged in response to Pigouâ€™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.