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Is RIO policy Pigovian Welfare Economics?

Hector McNeill1

Pigou’s "The Economics of Welfare" (1920) developed Marshall’s concept of externalities. These are the costs imposed or benefits conferred on others that are not accounted for by the person who creates these costs or benefits.

Pigou proposed that negative externalities (costs imposed) could be discouraged by a tax, and positive externalities could be encouraged by subsidy.

In the early 1960s Ronald Coase suggested that taxes and subsidies are not necessary if those creating and affected by externalities could negotiate solutions. But then the W3 has changed all of this providing a hybrid solution that is more efficient and closer to the incentive mechanisms proposed to achieve RIO policy objectives.

RIO-Real Incomes Objective

The way in which the Real Incomes Approach to Economics proposes to implement RIO is to create incentives for companies to create a positive externality in the form of enhanced general real incomes. Since the macroeconomic impact represents the sum total of the contributions of all economic units to this externality, it is important to sustain the effect if this incentive to secure policy traction.

This is based on providing incentives for two important types of real income enhancing moves associated with:

  • Price setting designed to lower unit output prices to penetrate the market
  • Using the increased production to raise process productivity (learning curve) and to invest in improved technologies to safeguard margins

The policy instruments consist of:
  • A coefficient which measures the relative movements in aggregate unit costs and unit prices over a period known as the Price Performance Ratio (PPR)) which is under the control of enterprise management
  • A levy, the Price Performance Levy (PPL) which uses the PPR value to calculate the amount to be paid.
Since the PPR very much depends upon price setting and investments which impact unit costs, it is possible for enterprises to minimize their PPL deduction down to zero or close to zero. This would reflect a maximization of the real incomes externality effect and result in an income bonus to the company.

Pigovian taxes

Arthur Cecil Pigou

Arthur Pigou first set out his Pigovian Tax proposals in his book "Welfare Economics". Pigovian (Pigouvian) tax was proposed to discourage activities that have adverse side effects for society. Adverse side effects include environmental pollution, strains on public health care from the sale of tobacco products, and any other side effects that have an external, negative impact.

Ronald Coase, criticised Pigou's approach because he proposed that transaction cost theory involving the direct negotiation between seller and buyer was a more efficient method and that Pigou's externality theory was not efficient. Although people appeared to be swayed by Coase's logic Pigovian taxes are prevalent today in the form of carbon emissions tax (Carbon trading) and taxes or surcharges placed on plastic bags. These taxes redistribute those costs back to the producer and/or user that generate the negative externality.

Ludwig von Mises suggested Pigovian taxes face a "calculation and knowledge problem" because", he suggested, governments cannot issue the correct Pigovian tax without knowing in advance what the most efficient outcome is. This would require knowing the precise amount of the externality cost imposed by the producer, as well as the correct price and output for the specific market. If lawmakers overestimate the external costs involved, Pigovian taxes cause more harm than good.

Positive externalities

When the Reagan administration applied lower marginal taxation in the first application of so-called supply side economics, some of the logic was that with higher disposable incomes more would be invested leading to more lower cost production. Without any thought having been given to the externalities of this process which include a declining marginal propensity to invest. Supply side economics provided a once off marginal tax benefit which is a momentary incentive which will lead to an attenuated impact and loss of policy traction. As a result it can be seen that although supply side did have a small impact on productivity the overall reduction in prices was the result of exceptionally high interest rates that resulted in many home and farm land mortgages failing and a reduction in circulating money from employed population segments. As a result the policy had no traction.

The RIO-Real Income Policy provides a continual incentive whose impact is under the control of enterprises so the result is effective traction. Since the determination of PPR and PPL rests with the company, and this operation has no connection to government revenue-seeking through taxation, Ludvig von Mises' calculation and knowledge problem does not exist. In the same way Coase's transactional tax is a rational observation but not correct in terms of throwing doubt on the efficiency of the levy.

The general sematic time-bound issue2

The validity of many criticisms of applications such as Pigovian taxes can only be assessed in terms of the time when they were made. Coase and Mises made observations and critiques that were time-bound by the state-of-the-art and practice in communications and information technology. With the rapid rise of the W3 and the digitization revolution during the last 25 years Coase's and Mises' observations are no longer valid. The result is that today economic theory and practice needs to be evaluated applying computer-based decision analysis models before releasing them on the world making use of advanced information technology and telecommunications to provide unobtrusive but well-informed oversight and management.

1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.

2 Time-binding is a concept developed by Alfred Korzybsky, as part of his General Semantics theory; the relative validity of any statement needs to be assessed in relation to the time it was made. This is an important element in Locational State Theory (LST) in assessing the quality of data sets in terms of their validity and range of appropriate application.

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