Consummation, Consecration, and Destruction of the Invisible Hand: Neoclassical Welfare Economics - Part 24

The polluting of water and the practice of strip mining may destroy valuable social resources and disrupt the ecological balance of an entire geographical region in which people must live. But in the “invisible hand” world of the neoclassical utilitarians, each person is concerned only with his or her own actions, and, of course, the general welfare is promoted by all selfish actions.

With the recognition of the pervasiveness of externalities, the tax-subsidy solution is clearly seen as the fantasy that it is. This solution would require literally hundreds of millions of taxes and subsidies (in the United States alone). Moreover, the imposition of any single tax or subsidy would undoubtedly create totally new externalities because it would create new patterns of envy and sympathy. This envy and sympathy would constitute new externalities for which there would have to be new taxes and subsidies. The process would go on forever, with an infinitude of taxes and subsidies never getting us any closer to that most elusive of all individualistic, utilitarian chimeras — Pareto optimality.

But the more reactionary element of orthodox neoclassical theorists, the Austrian and Chicago schools (which we will discuss in Chapter 17), has never accepted the principle of discretionary government intervention into any of the market processes. Therefore, for many years they simply ignored externalities. In the late 1950s and early 1960s, however, they devised new formulations of their doctrines that permitted them to enter the debates on externalities that came into vogue in the late 1960s, when even orthodox theorists could no longer ignore the degradation of the environment by American capitalism. During the decade of the 1960s, the Chicago School theorists formulated a policy recommendation to deal with externalities. This formulation has remained unchanged to the present time.

The policy of the Chicago School neoclassicists was to create new property rights to pollute the environment and then to create new markets in which these rights to pollute could be freely bought and sold.22 Presumably such trade would continue to the point where the marginal utility to the polluter of another dollar's added pollution would just equal the marginal disutility to the sufferers from the pollution. At this point, it would be impossible to effect a Pareto improvement by either increasing or decreasing pollution, and a new, laissez-faire, competitive Pareto optimum with pollution included would be attained.

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