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Pigou on war finance and welfare.


This paper reviews A. C. Pigou's contributions to policy discussions pertaining to war finance across three distinct periods: the early phase of World War I from 1915 to 1916; the final phase of World War I from 1917 to 1918; and the post-war phase from 1919 to 1925. We establish that the distribution of the fiscal burden of war finances was a major theme of Pigou in the early phase of the War, but, as the end of the conflict drew near his focus shifted to the sustainability of public debt and proposals to reduce that debt. In the post war phase, his reflections shifted to the necessary elements of future political, fiscal and economic stability. We conclude by suggesting the grounding for his analysis of policy issues during each of these three phases can be traced back to his major pre-war work, Wealth and Welfare.


Accepted 25 July 2016


Britain; taxation; borrowing; capital levy

The economic wreckage now going forward, immense and unprecedented though it be, is to my mind trivial and insignificant in comparison with the human and moral wreckage--the mangled bodies of men and the shattered fabric of ideals, with which it is so fatally accompanied. It is not the business of this conference to discuss these things, and I do not propose to discuss them. But it is not right that we should come to debate our lesser economic problems without a memory and a word for their terrible setting of blood.

A. C. Pigou, (1916d, 4) 27 July 1916, Conference on the Reorganisation of Industry.

1. Introduction

Between 1915 and 1925, Arthur Cecil Pigou was perhaps the most active scholar in investigating the implications of World War I for the British economy. (1) During that period he set about writing a number of substantial works on the economics of war, which, significantly, encompassed the actual bellicose years of World War I as well as the subsequent post-bellicose years when public finances specifically, and the macroeconomy more generally, still operated under the shadow of that war. Pigou systematically analysed the disputed policy questions of the day-primarily concerning the extent that war related expenditures should be funded by debt or taxation-by largely applying criteria from his pre-existing theoretical work.

The purpose of this paper is to reveal the particular welfare issues that attracted Pigou's attention across three distinct periods-the early phase of the war (1915-16); the final phase of the war (1917-1918); and the post war phase (1919-1925)--and to follow William J. Barber (1991) by suggesting how his analysis of public finance issues in each of those periods was grounded in fundamental aspects of Wealth and Welfare. (2) In the early war years, we find that Pigou was concerned about the distribution of the burden of funding the war, advocating heavier taxation on the well-to-do. In the late war years, Pigou's concern with the distribution of the burden of war finance takes a back seat to the more basic issue of the sustainability of the public debt; and his writings on the proposed capital levy are interpreted in that context. In the after war years, Pigou reflected seriously on the economic elements of future political stability, including the diminution of economic influences that lead governments to contemplate war, and the restoration of stability to fiscal and economic conditions with a view to establishing the pre-conditions for Britain to return to the gold standard. It is the contention in this paper that, when the very different fiscal and economic circumstances that governments confronted in these three periods are recognised, the relationship between Wealth and Welfare and Pigou's analysis of particular fiscal issues emerges distinctly and clearly in each of the three phases of his writing.

In the light of these introductory remarks, this paper is structured as follows. Section 2 focuses on Pigou's writings from the early war years, when he reflected on the best way to fund the escalating war budgets while still having regard for the distribution of the burden of war finance within the community. Section 3 concerns his papers published during the late phase of the war, between 1917 and 1918, which deal with the nature of Britain's inflation and his reasons for supporting a capital levy. Section 4 deals with the post war period and considers the reasons for Pigou's back down on the capital levy as well as his thoughts on 'stability' and Britain wining the peace in an economic sense. The paper concludes in Section 5 with a discussion of how the emphasis of Pigou's discussion of war finance in each phase of the war underlined a different core definitional condition of economic welfare, the three of which Pigou had documented in his pre-war Wealth and Welfare.

2. The First Phase of the War: Distribution of the Burden of War

Pigou's preliminary inroad into war finance came with the paper "Sources and Methods of Paying for the War", in the 1915 July issue of the Contemporary Review. According to him, the actual costs of the military engagement, that is, the real resources directed to the war effort, could be drawn either from the future or the present. In that regard, future production is affected when inventories are used up; the capital stock is run without proper maintenance or replacement; people refrain from new investments; property owned abroad is sold to foreigners, and, lastly, when debt is funded from loans obtained overseas. With respect to resources drawn from the present, Pigou indicates that they can be obtained by either increasing the overall level of production, which would involve longer working hours and less strikes, or by reducing the share of production dedicated to private consumption, which would require voluntary abstinence by private individuals. As for the particular financing instruments, which have implications for whether the burden is imposed in the present or the future, (3) Pigou highlights foreign loans, extra taxation, domestic loans, and an increased fiduciary issue of currency notes. In relation to the last point, the monetization of public debt by increasing the supply of fiat money had the potential to contract real consumption, owing to the consequent inflation, and, in this way, release real resources to be appropriated by the government (Pigou 1915). (4)

The particular method chosen by the government to pay for its expenditures has, however, a distributive effect that can influence how the burden of the war is parcelled out over time. Although war loans tend to make the resources for private capital accumulation more scarce, Pigou notes that an excess of fiduciary inflation or of indirect taxes could be far more damaging to the economy by deteriorating the living standard of poor families and, therefore, putting them at greater risk of reduced productive capacity in the long run. This proposition, which had been raised in different parts of Wealth and Welfare (5), is worded by Pigou as follows:
This point is of very great importance. It shows that methods of
financing the war which mean large contributions by the poor, though
they are likely to diminish the material capital of the country less
than other methods, may, nevertheless, be more hurtful than other
methods to the accumulation of capital in the widest sense, and,
therefore, to the productivity of the country in future years. (Pigou
1915, 717)

A similar line of reasoning was further explored by Pigou in the paper "The Distribution of the Burden of the War Charges", in the July 1916 issue of the Contemporary Review. This time, though, he puts forth a case for a heavier taxation of the well-to-do people using the assumptions of diminishing marginal utility and its comparability among individuals, on which he had based his plea for income redistribution in Wealth and Welfare (Pigou 1912, 2-31, Part II, Part III, chap. IX). Based on these hypotheses, Pigou had advanced in that book a full research program stating that economic welfare could be increased in three different ways, namely: first, by an expansion in the national dividend for a given distribution of income; second, by a more even distribution of income, provided the national dividend is not diminished; and, lastly, by attenuating the intensity of business cycles, since for the representative man more utility is lost during the depression than is gained in the prosperity phase for commensurate variations of income (Pigou 1912, 14-32, 401-407). In the 1916 paper, Pigou holds that the proposal for increasing taxes in equal proportion for everybody, popular in some quarters, would be intrinsically unfair, since a shilling taken from the poor occasions a loss of utility greater than the one experienced by a rich person deprived of that same shilling. Still, the decision of conferring priority on domestic loans benefits mostly affluent investors, given that the interest rate on public bonds has to be higher than the existing alternatives to the private sector, while a significant portion of the loans is taken up by rich individuals out of funds borrowed from the banks (Pigou 1916a).

From the above papers and two lectures delivered that same year, Pigou composed in 1916 a short book, The Economy and Finance of the War, whose overall content can be placed under four heads: (i) the temporal incidence of war costs, (ii) the foreign exchanges, (iii) the distributive effects of the financial policy, and (iv) the post--war economic reconstruction. On the first issue, Pigou observes that since individuals have a marked preference for present vis-a-vis future enjoyments, direct interference by the government to coordinate private choices is inevitable in time of war to preserve a minimum level of capital formation and to discourage luxury spending. (6) Restrictions on the importation of consumable goods, the adoption of food rationing and the introduction of duties on consumption goods would go a long way toward inducing society to draw upon the present in meeting the war necessities. Restrictions on investment, on the other hand, such as the prohibition of placing capital abroad or on certain kinds of activities, set up by the Treasury early in the war, would have a contrary effect (Pigou 1916b, 48-52; see also Pigou 1917a). (7)

In regard to 'the exchanges', Pigou identifies Britain's trade deficit as one of the crucial economic problems in prosecuting the war. British imports of food, munitions and raw materials had grown considerably to attend war needs and her exports had fallen heavily as a result of the shortage of labour and capital. Pigou's first solution to this problem would comprise cutting back ordinary imports to a minimum while diverting labour and capital to produce more exportable goods. The second one would require the transference of gold and the selling of assets held abroad. Here, however, Pigou makes it clear that the first of the above options was the better of the two, giving voice to his hope that the war could be finished before long due to the large stock of Britain's capital held abroad.
If they [authorities] have the fortitude to do this, they will have at
their command, when the critical moment comes, a powerful strategical
reserve. By conserving it till then, and then throwing it into the
scale, they may, if fortunate and wise, bring about the end of the war
(Pigou 1916b, 63-64).

But again, Pigou became preoccupied with the distributive aspects of the government's financial policy. In addition to replicating the arguments on distribution that he had outlined in his previous papers on the subject, he adds three new reasons for taxing the more well-off in society. First, he alerted readers to the existence of a limit on taxing the poor, and, since such limit had presumably been reached, no major additional revenue could be reaped from this particular source. Second, a strict loan policy alone would mainly benefit wealthy creditors of the government, since they would earn a higher real interest rate on their bonds when deflation comes about after the war. Lastly, paying off the national debt, built by indiscriminate borrowing, would necessitate heavier taxes most likely to be weight, to a large extent, on the shoulders of the poorest segments of the nation (Pigou 1916c, 66-83). (8)

Reflecting a combination of stoic realism and guarded optimism for the future at the time, Pigou dedicates the book's last section to the aftermath of the war. The transition to peace, in his estimation, was bound to be seriously complicated by the demobilization of large contingents of men from military service and the deficiency of savings to attend domestic and, especially, foreign demands for capital from war torn countries in Europe. The resulting imbalance between the demand for and the supplies of capital and labour would put pressure on interest rates to rise and wages to fall, thereby further worsening the distribution of income. Nevertheless, Pigou foresees an industrial boom on the horizon, powered by the unrestrained enthusiasm of producers and merchants with the peacetime recovery of civilian demand. That prosperity, though, he cautioned, inspired by his own depiction of expectations-fuelled business cycles in Wealth and Welfare (Pigou 1912, 453-466) (9), should be moderated by the authorities through some kind of credit restriction in order to attenuate the pessimism to be triggered by the subsequent slowdown in sales.
It is practically certain that, to make good the havoc and the waste of
war, there will be a strong industrial boom. This boom, if history is
any guide, will generate in many minds an unreasoning sense of optimism
leading to much wild investment. The result, some years afterwards,
will be failures, crisis and depression. If this danger is to be
obviated or mitigated, it is imperative that the Government and the
banks should so act as to restrain and keep within reasonable limits
the initial peace boom. (Pigou 1916b, 88)

3. The Final Phase of the War: The Sustainability of Public Finances

As the war dragged on into 1917, Pigou's confidence in a rapid end to the conflict must have evaporated. Reginald McKenna, Chancellor of the Exchequer (1915-1916), who had mounted a relatively modest attempt to funding a more substantial part of the ever growing government spending through the introduction of new measures for taxation and import duties, was replaced by Andrew Bonar Law (1917-1919), and the new Chancellor went back to Lloyd George's former loan strategy to meet the fiscal burden of war related expenditures (Dauton 2002, 36-59; Peden 2000, 73-127; Mallet and George 1929, 68-174), while the monetization of public debt continued to grow. (10) Inflation, as Pigou had feared, soared during the late war years. The Ministry of Labour's cost of living index, which was set to 100 in July 1914, reached 165 in January 1917 and 220 in December 1918, similar variations registered for The Economist index over the same period (Morgan 1952, 267-285).

In December 1917, an important paper by Pigou entitled 'Inflation' was published in The Economic Journal, analysing the sources of the ongoing price rises in Britain. In general terms, Pigou sustains that any typical country operating under the international gold standard could be considered small when compared to all the other countries adopting that same standard. More specifically, what happens in a single country has a small effect over the world, while world scale events have a large influence on the economic situation of any single country. Bearing in mind that the gold standard is a system of fixed exchange rates, Pigou observes that prices increase and gold flows out of the country if a government issues too much money, while commodities flow in the opposite direction to gold until a new equilibrium is reached, with slightly higher prices all around. Britain had effectively evaded this mechanism during the war due, first, to the nation selling foreign securities abroad to pay for its excess imports and; second, to the great risks of transferring gold across the oceans during a state of naval warfare. This last factor particularly meant that Britain's domestic inflation had had a negligible impact on the world at large, while the worldwide rise in shipping and insurance charges had hit the country hard.

By comparing retail food prices in the US, Canada and Britain, Pigou concludes that much of the increase in British prices was actually due to external causes. This interpretation would be important in his future analysis of Britain's return to gold at the pre-war parity, as discussed further in Section 4. In his words:
On the whole, therefore, it would seem fair to conclude that perhaps
four-fifths of the [price level] rise that has taken place in this
country has been, in a loose sense, 'inevitable'; and that
responsibility cannot properly be thrown upon our monetary and banking
arrangements for more than the remaining one-fifth. (Pigou 1917b, 464)

Right after the Armistice, in December 1918, Pigou published another significant paper in The Economic Journal entitled 'Government Control in War and Peace'. The reason for its relevance lies in the fact that it provides a glimpse of how he assessed the impact of the war on the role of the state under normal conditions. In Wealth and Welfare, Pigou had already set out a strong case for public intervention in the economy in three different circumstances. First, when social costs are distinct from private costs, which may require remedies such as: the regulation of unbalanced contracts; the taxation of certain activities with harmful effects on third parties; or some form of control over monopolies. A second instance of state intervention admitted by Pigou comprised the redistribution of income by means of progressive taxation and the provision of public goods to the poor, as well by the establishment of a minimum national standard of living. Lastly, industrial fluctuations could be mitigated by a mandatory insurance for wage earners and by the undertaking of public works for the unemployed in times of economic distress (Pigou 1912, 246-289, 346-398, 408-422, 476-488). (11)

The unprecedented scale of state command over the economy during the war did not cause Pigou to abandon his convictions about the role of the government in the economy. Specifically, he continues to believe that, apart from the three cases mentioned above, the government interference in the economy, at least in principle, would decrease the national dividend and would, consequently, reduce economic welfare (Pigou 1912: 104-108). But notwithstanding this, he clearly recognises that the scope of government activity was necessarily extended to undertake war related activities. In his 1918 paper, Pigou stresses that Government war time controls need to unwind, but during the period of war governments must: take full control of some strategic industries to speed up the manufacture and delivery of munitions and all sorts of goods to the troops; ration food, among people, and raw materials, among industries, to divert real economic resources from civil to military activities; and control prices to contain the effects of increased spending in time of war (Pigou 1918b).

But after a number of years of war and the increased extent of government control, Pigou's attention shifted firmly towards policy measures to a return to fiscal sustainability. By way of contrast, it should be noted that Britain's domestic debt had jumped tenfold from [pounds sterling]649.7 million in 1913 to [pounds sterling]6552.9 million in 1919 (Mallet and George 1929: 411), while interest on debt servicing charges had reached [pounds sterling]320 million in 1920 (Feinstein 1972: T31), an amount which accounted for almost one third of the whole central government revenue. Wartime calls for heavier taxation were commonly accompanied by the suggestion of some type of wealth confiscation, most frequently during the debates over the war budgets. That was the case on 22 April 1918, when, following a financial statement by the Chancellor of the Exchequer Bonar Law, Mr. Sydney Arnold (1918) urged the imposition of a levy, to be charged in two instalments, one right after the war and the other one two years later, each of them of 12 per cent on private owned capital, idea that aroused immediate and fierce opposition. The controversy continued well into the 1920s, the taxation of capital being incorporated into the Labour platform for the 1924 election (on the Parliamentary debates, see Hirst and Allen 1926, 28, 224-233, 265-275; for the broader discussion of the issue by the British society, see Dauton 1996).

The July 1918 edition of The Economic Journal included contributions in favour of the proposal, with Pigou leading the group with the article 'A Special Levy to Discharge the War Debt'. He accepts that paying off the debt would mean just the transfer of purchasing power from one group of citizens to another within the country, irrespective of the transfer taking place in the present or in the future. But he nevertheless identifies three main reasons for adopting the levy. First, the taxation of income in its current form discriminated against saving because 'spent' income-such as consumption expenditure-is taxed once, whereas income set aside for investment is taxed twice, once as income (e.g. wage) and later as the interest on savings (i.e. yield on the investment). (12) Second, each additional increase in the tax burden is more likely to make the labouring classes to work longer, while some investors might indulge in extra consumption and others divert their savings to investments abroad. Third, high taxes hurt the competitiveness of domestic industry and may lower its productivity. Lastly, in view of the probable outlook of a post-war deflation, nominal incomes would fall while interest charges on the debt would stay unaltered, generating a need for increased duties and rates on existing taxes.

Pigou does admit the proposition that the introduction of a levy could generate fears among investors that other similar levies may be introduced in the future, but at the time that concern was not decisive in his thinking. He even dismisses the need for assessing immaterial capital, that is, human professional skills, due to its alleged small proportional value when set against other forms of capital, instead recommending that the taxation of miscellaneous forms of personal wealth to be taxed as death duties when they came to be handed down to others (Pigou 1918a).

The next issue of The Economic Journal, from September 1918, brought a series of papers against the levy. William R. Scott (1918), for example, contends that the sums to be gathered from the owners of immaterial capital (such as skilled workers and creators of intellectual capital), as well as from small business and holdings, would most likely have to be received in instalments, being equivalent therefore to an increase in the income-tax. Mitchell (1918), for his turn, considers the introduction of a levy such a drastic measure that he suggested that the government should raise indirect taxes on common luxuries such as drink, tobacco and entertainment. George B. Shaw (1918) points out that it would result impossible to 'realize' any form of fixed or intellectual capital, even slamming Pigou's proposal as a 'crazy delusion', (13) particularly after a war that had devoured so many of the nation's sons and so much of her wealth.

4. The Post-War Years from 1919 to 1925: the Restoration of Stability

During the immediate post war years, Pigou was still very concerned about the issues of sustainability related to a high level of public debt. This is evident from his return to the question of the capital levy in A Capital Levy and a Levy on War Wealth (1920). It was, by and large, an attempt to address criticisms levelled against the idea of using the nation's private capital to liquidate the public debt. Specifically, he reported a correspondence between the deflation that will be necessary for Britain to return to the gold standard at or near the pre-war parity; and the erosion of the nominal value of the income tax base that would have to be exploited to meet the debt services charges that the British Government has saddled itself with during the war.
Hence, while the prices of things in terms of gold may fall through
currency causes [credit restriction], the price of gold in terms of
sterling will almost certainly fall. This means that the prices of
things in terms of sterling will probably fall before long to some
extent, and may fall to a considerable extent. If, however, a fall of
prices due to currency causes comes about, the money representation of
any given amount of real income must fall correspondingly. Hence, in
order to raise a given money revenue to meet debt charges, the
Government will have to impose rates of taxation higher-perhaps much
higher than are required now. (Pigou 1920b, 21)

A levy on capital would reduce public debt and diminish the extent to which the contracting nominal value of the income tax base has to be exploited. The counter issue is that the introduction of the levy may lead to the flight of capital and, indirectly, contribute to a reduction in real income. Pigou's point, however, was that expectation of a flight of capital resulting from a capital levy is exaggerated because that uncertainty associated with the potential levy was already a source of fear. Following the introduction of such a levy the business community would, in Pigou's view of 1920, feel that the uncertainty has been removed-the matter has been definitely settled and, therefore, would have less reason to fear a future riddled with high taxes. With regard to a possible increase in government's expenditures after the debt ceased to cripple the budget, Pigou, in accordance with his views on state intervention, argues that such assumption does not consider that many types of public spending may be worth taking and that they could have just been avoided until then due to the lack of sufficient revenue (Pigou 1920b, 24-26). In the remainder of the book, Pigou recognizes the problems raised by the critics about the practical aspects of the levy proposal, but he systematically downplays all of them for having supposedly little impact on revenue, as in the case of immaterial capital, or for its being less prejudicial than the existing tax load (Pigou 1920b, Part II, chaps. III-V).

But by 1925, Pigou changed his mind on the capital levy because he came to appreciate that it would, indeed, have a significant repercussion on government revenue. On 20 March 1924, the Labour Chancellor of the Exchequer Phillip Snowden (22 Jan-3 Nov 1924) appointed a Committee to assess the national debt and the tax system, with Lord Colwyn as the chairman. Pigou gave testimony to that Committee on 3 March 1925, revealing that he was now concerned about the effect of a capital levy on business expectations, which lead him to explicitly declare a preference for the orthodox sinking fund arrangements funded from general taxation, although with a higher rate of debt redemption. More specifically, Pigou explained that he had fought for the levy straight after the war due to the negative impact of the prevailing high taxes on industry, personal exertion and savings, but never as a mechanism to redistribute wealth. (14) Of course, this confirms the shift in emphasis from Pigou's writings in the early war phase, which focus on analysis the distributive consequences of war time fiscal measures, to that of the end of war phase when sustainability comes to the fore. But he also highlights the loss of confidence from expectations that the arrangement could be repeated in future; its negative impact on business expectations in a depressed conjuncture and, last of all, the effect of the levy in reducing the revenue of the income-tax, as sufficient reasons to set the whole idea aside (Pigou 1925, 436-437).
Though, of course, I realised from the outset that a special levy used
in repayment of internal debt would cause Income Tax, Super-tax, and
Death Duties on any given scale to yield less revenue afterwards, I
have not, until within the last year, realised how very large a
proportion of a levy at steeply progressive rates ... would be used up
in repairing ravages in the future revenue consequent upon the levy
itself (Pigou 1925, 437). (15)

Nahid Aslanbeigui and Guy Oakes (2012, 139-142; 2015, 108-110) have presented the case for the view that Pigou's change of mind on the capital levy is an illustration of the 'historicity' of his approach to policy analysis. That is, in the years after the war, issues associated with the incentive to work across the entire workforce became more significant than they were during the period of the war, when a large part of the workforce was engaged in military service. In view of this, Pigou changed his mind.

All of Pigou's earlier works on war related issues were brought together in 1921 into a single volume entitled The Political Economy of War, with almost three hundred pages and twenty-nine chapters. But, consistent with his post war focus on stability, Pigou also includes a chapter (III) on 'The Economic Causes of War', in which he points out that whatever might be the particular fact triggering a war, this incident always ignites a pile of material that had been accumulating on account of two main psychological predispositions: first, the desire for domination, and second, the desire for gain. Be that a boy bullying his colleagues at school or a European nation colonizing other peoples' countries, both cases display the same longing for the exercise of raw power over individuals or nationalities. The desire for domination ensues from this deep-rooted psychological propensity and is at the very origin of the wars of independence and liberty conducted by oppressed peoples. The trap into which modern ruling powers had fallen, lamented Pigou, was that none of them wanted to slacken their grip over the subjugated territories for fear of either losing the supply of colonial soldiers or having these regions conquered by rival powers (Pigou 1921, 16-19).

The second factor stressed by Pigou as fuelling war-namely, the desire for gain--drives governments to set up areas of protective tariffs under their control in order to counterbalance similar initiatives introduced by other governments. At the same time, exporters, traders and importers of raw materials from the colonies form a coalition of interests that pushes the government toward political imperialism. In this quest for domination, these individuals are helped by financiers seeking profitable concessions in undeveloped regions of the world, either by granting loans to suspect rulers or by exploiting natural resources through disguised types of forced labour. Governments are then dragged into a ferocious contest for spheres of influence or the direct annexation of weaker countries in order to reap undue gains for some of their nationals. In the background, armament makers bribe governments and disseminate war scares with a view of promoting a widespread military race. Pigou is the most emphatic when talking about this whole process.
Thus, the rivalry of the traders and financiers of different nations
leads to a contest among their governments for 'places in the sun'. In
this contest allies and associates are helpful, and so the area of
contest is extended. In the background of it all stands military power.
No government wants to fight for a sphere of influence or a concession
for its nationals, but every government knows that, unless there is
some point at which people believe that it will fight, its diplomacy
will be relatively ineffective. (Pigou 1921, 22)

Increasing free trade would, in Pigou's opinion, be the only effective way to build an international environment less prone to tensions and disputes. Consequently, he advocates in favour of the suppression of all protective policies toward the 'mother country' in undeveloped regions, opening those economies to trade with the community of nations. In this assessment, European powers have a moral obligation to prevent activities of their own nationals that freely exploit the most fragile regions of the globe. Pigou argues that wherever possible control over the armaments industry would contribute in large measure to preserving world peace. Lastly, he underlines the importance of international cooperation under the auspices of the League of Nations, with a view to enhancing free trade, as this may contribute to a substantial mitigation in the state of rivalry among nations (Pigou 1921, 22-27).

The second issue that Pigou focuses on is the return to fiscal and economic stability while still in the shadow of war. To his mind, the experience of Britain during the course of the war suggested that governments were not to be trusted with ensuring fiscal and economic stability. The improvement in the international sphere contemplated by Pigou, therefore, involved the reconstruction of the international gold standard system, which had been shattered by the war and the subsequent remapping of Europe. (16) In early 1918, Pigou was appointed a member of the Committee on Currency and Foreign Exchanges after the War, the so-called Cunliffe Committee, after its chairman, Lord Cunliffe, then Governor of the Bank of England. The Committee indicated the immediate cessation of any further borrowing by the British government, the reduction of its indebtedness and the limitation of the note issue as necessary conditions for getting sterling back to its $4.86 pre-war parity with the dollar. Otherwise, the Committee on Currency and Foreign Exchanges (1918, 5-7) reported, Britain would lose her prominence as an international financial centre, jeopardizing in the wake of that disaster its industry and foreign trade.

In The Political Economy of War, chapter XV, The Aftermath in Currency, Pigou elaborates his thinking on monetary regimes. He observes that the wide range of fluctuations in exchange rates were a major obstacle to the revival of trade in Europe. He does admit that stable exchanges could be achieved through central bank intervention to alter the interest rate, but he explains also that governments were, as a rule, still too feeble to be trusted to monitor and enforce this momentous task. '[I]n the present state of the world, governments are not strong enough, nor yet sufficiently trusted, for a system of this kind to be likely to work. Something less directly dependent upon the conduct of politicians is needed' (Pigou 1921, 168). In view of this, Pigou favours a post war return to free gold convertibility by the international community, but the next issue was whether to maintain the bank note-gold convertibility rate at the pre-war standard, or to set a different bank note-gold convertibility rate.

To address this question, Pigou's first step is to estimate the exchange rate in terms of purchasing power parity, which he calls the 'proper' exchange rate, and see how far that is below the pre-war parity. Differences between the proper and the actual exchange rate would be due to accidental influences. However, when those accidental differences derive from 'the commotion of war', such as uncertainty of post war exchange rate regimes and temporarily weak trade patterns, they come to exert a systematic force that reduces the actual exchange rate below the proper exchange rate for substantial periods. As the effect of those accidental influences in Britain was, in Pigou's assessment, much less pronounced than in other European nations, he concludes that Britain had the capacity to go back to the pre-war parity as long as British-United States exchange rate was within 20% of the pre-war gold exchange parity (Pigou 1921, 177). But to return to pre-war parity from that position, Pigou recognises that Britain would have to restrict currency note issues and use credit policy to increase interest rates, even though this would involve significant economic distress and hardship.
The process to be gone through on the return journey to pre-war parity
is not a smooth one either for employers, whose dividends will fall, or
for wage-earners, whose employment will be threatened. Moreover, the
successful accomplishment of it involves afterwards the payment of
interest on war loans in a currency much more valuable than that in
which a large part of them was subscribed. (Pigou 1921, 176-177)

Pigou justifies undergoing this economic distress on at least two explicit grounds (Pigou 1921, 174). First, to set a new lower parity would reduce the international community's confidence in the financial probity of the devaluating currency. Second, although a return to the pre-war parity would, as noted above, create hardship for taxpayers, a return to a lower parity would adversely affect creditors who lent money to the government on a fixed interest basis before the war (or early in the war), as they would be repaid with money that has a lower value than that which they lent to the government. (17)

In 1924 Pigou was appointed a member of the Committee on the Currency and Bank Note Issues, subsequently referred to as the Chamberlain-Bradbury Committee. That Committee's final report-submitted to the Chancellor of the Exchequer, Winston Churchill, in February 1925-recommended that Britain make a rapid return to the gold standard, a policy which became effective from 28 April 1925, the date of Churchill's budget speech. Along with some warnings of a premature return to gold which were voiced by a few witnesses, the worries about the perverse effects of receding prices that Pigou had articulated in his 1921 book must have crossed his mind as he served on the Chamberlain-Bradbury Committee. Indeed, he actually wrote the September 1924 draft of the Committee's report, which recommended that a decision to return to gold be held over because there was time to do so, as the legislated prohibition on the free export of gold did not expire until 31 December 1925 (Moggridge 1969, 32-35). (18)

Pigou's position on government action in the economy has already been presented, but on his 1921 reflections on the war, particularly in chapter XVIII, The Aftermath of Government Control, he broadens the scope for state action to increase the nation's capacity for defence. In Britain, as he points out, a large fleet proved to be fundamental to the war effort, not because of its easy conversion to military needs, as had happened in the past, but because of its capacity to move large volumes of essential supplies during the war. If the shipping industry ever reaches a condition of stress, writes Pigou, then the government should come to its rescue through the provision of special bounties and other stimulus in order to assure the readiness of a large merchant marine. Protection and artificial encouragement may also be provided to industries producing crucial materials and substances for armaments, the same applying for key industries like magneto-making and optical glasses. Lastly, a system of national granaries should be built to keep a large store of grain capable to attend the society's needs for at least one whole year.

5. Concluding Remarks

In Wealth and Welfare, Pigou indicates that a probable increase in economic welfare will be associated with three conditions: one, a ceteris paribus increase in the size of the national dividend; two, a ceteris paribus increase in the absolute share of the national dividend accruing to the poor; and three, a ceteris paribus diminution in the variability of the national dividend (Pigou 1912, 66). The influence of Wealth and Welfare on Pigou's writing on war finance is most evident because in each of the three phases of his writing on war related matters, he placed emphasis on one of these three welfare improving conditions-although the focus is turned around to minimising the welfare losses from actions related to war financing.

In early-mid phase of the war, Pigou's second welfare condition, that is, the discussion of minimising the burden of war financing on the poor is the war time equivalent of the second welfare condition (increase in the absolute share of the national dividend accruing to the poor). At the end of the war, Pigou's focus on the sustainability of public finances is the war time equivalent of welfare condition one (increase in the size of the national dividend). For example, the discussion of the capital levy to reduce the burden of public debt is couched in terms of the impact that it will have on revenue. Will tax bases-income-be harmed or not? His reflections on that issue, and his change of mind, all turn on the how to reduce levels of unsustainable public debt with the minimum of impact on the national dividend. Pigou's writings in the post war phase primarily deal with the third welfare conditions (diminution in the variability of the national dividend). Part IV of Wealth and Welfare treats the third welfare criterion and deals in some detail with variability in price levels-which Britain confronted at the end of the war and in its aftermath, with inflation being followed by the 'doldrums'-and advocates money being 'authoritatively regulated in the interests of stability' [Pigou 1912, 437-438]. It is the pursuit of stability that drives much of Pigou's discussion in this post war phase. His interest in Britain's return to the gold standard is seen in that context-and in the context of his loss of faith on the efficacy government action in defence of stability.

Of course, Pigou's deep concern over the burden of war expenditures bourn by the poor never disappeared. It is just that his apprehension over the magnitude of the debt and interest problems for the British budget became progressively more prominent-and discussion of the distributive consequences of different devices for funding the war became less urgent-in Pigou's writings as the war progressed. Also, his treatment of taxation and debt decisions during the war always take place against the backdrop of the breakdown of the gold standard and the introduction of currency notes. The consequent monetization of public debt in the face of war accentuated the fiscal problem that the Government faced-and Pigou's discussion of political economy after the war soon turned to creating the conditions to return to gold, in part as a means of de-institutionalising the monetization of public debt that had developed during the war.

Finally, it should perhaps be noted that Pigou's reflections on stability also had an international aspect, with European economic recovery being conditioned on the reinvigoration of free trade among nations through the cessation of political imperialism and protectionism, on the one hand, and the revival of the international gold standard system, on the other.


(1.) J. M. Keynes was, like Pigou, also very active in matters of war finance, but during the war itself, his rather important activities were, by-and-large, undertaken through internal Treasury policy documents that were not in the public domain e.g. Treasury memoranda, notes and briefings for the Chancellor of the Exchequer (see Johnson 1971). Of course, that situation was reversed after the war in a most dramatically manner through the publication of his hugely successful The Economic Consequences of the Peace (Keynes 1919).

(2.) William J. Barber (1991) was the first historian of economics to underline the significant link between Pigou's economic analysis of the war and his earlier contributions to the theory of welfare economics.

(3.) Pigou appears to be of the view that, when raising a given amount of revenue, a tax-loan policy creates the illusion that the tax burden is lower than in the case in which taxes fund that revenue exclusively.

(4.) Here, Pigou does not include cuts in the government's ordinary spending, a point scarcely brought up during the early phase of the war. The notable exceptions were Hobhouse (1915), and Lord Middleton, who, on 6 July 1915, at the House of the Lords, called for the utmost economy in peace services (Hirst and Allen 1926, 76-79). Two years later, on 6 July 1917, the uncontrolled growth of national expenditure was finally questioned at the Commons by Colonel Godfrey Collins, and a Special Committee was set up to review the matter (Mallet and George 1929, 133-134). The Committee's final report, issued in 1918, identified excessively liberal payments being made, the existence of redundant staff in several departments and bad accounting practices as a rule, so it strongly advised a more active scrutiny of government's expenditures by the Commons thereafter (Committee on National Expenditure 1918, 108-149).

(5.) Pigou made use of this proposition extensively in Wealth and Welfare when arguing in favor of transferences to the poor in order to improve their health, education and housing, resulting thus in stronger bodies and trained minds that would bring about an increase in productivity (Pigou 1912, 54-65, 343-345, 355-364, 393-398). Alfred Marshall, Pigou's mentor, had already maintained that a well-fed and educated population was the best investment a nation could undertake to promote the growth of wealth (Marshall 1920, 220-236).

(6.) The idea received further elaboration in The Economics of Welfare, published in 1920, where Pigou pins down the deficiency in telescopic faculty, that is, the circumstance that people see future pleasures in a diminished scale as compared with pleasures of the same intensity at the present, as limiting investments and pressing for the overuse of the available capital stock. In view of this particularity of the human nature, he prescribed that the government should intervene in the economy to stimulate savings and to preserve existing resources for future generations (Pigou 1920a, Part I, chap. II).

(7.) The London Stock Exchange had been closed on 31 July 1914 and reopened only in 4 January 1915. On the following 19 January, the Treasury determined that new issues of capital would be conditioned on its previous authorization based on considerations of 'national interest'. Empire issues would be approved only in cases of urgency and special circumstances, while foreign issues would normally be not allowed (Burk 1982, 86-89; Morgan 1952, 261-266).

(8.) In a letter to the editor of The Times, in 1917, Pigou explains how a policy of taxes was supposed to work as against loans: "The difference is that on the borrowing plan these persons [bondholders] are, and under the tax plan they are not, promised a high rate of interest at the expenses of the tax-payers in the future" (Pigou 1917b).

(9.) As stated in Wealth and Welfare: "Experience suggests that, apart altogether from the financial ties, by which different business men are bound together, there exists among them a certain measure of psychological interdependence. A change of tone in one part of the business world diffuses itself, in a quite unreasoning manner, over other and wholly disconnected parts" (Pigou 1912, 460).

(10.) McKenna's Rule of public finance sustained that ordinary peacetime revenue should be enough to pay for normal expenditures, the interest charges on the public debt and for the sinking fund (Nason and Vahey 2007). McKenna's war budgets, besides increasing the income-tax, the super-tax and reducing the exemption limit, introduced the excess profits duty and raised the import duties for cars and films. Those measures, though, had just marginal effect in covering the government war expenditures, which amounted in those years to over four times the tax revenue (Mallet and George 1929, 64-119). McKenna was actually afraid that given the unequal distribution of taxes under the prevailing system, further advances in taxation would harm the less favoured classes. 'I know there are advocates of heroic taxation ..., but I am not sure that these persons are fully apprised of the immense difficulty which large classes amongst us have today in maintaining not the pre-war standard of their life, but such a standard of life as is necessary in their circumstances for the maintenance of efficiency' (McKenna in Dauton 2002, 42).

(11.) For a broader approach to the relation between the state and the economy, as formulated by Pigou in a lecture to the London School of Economics in 1934, see 'State Action and Laissez-Faire' (Pigou 1935, 107-128).

(12.) The suggestion that saving is taxed twice was championed by Irving Fisher, in the first decade of the twentieth century, and by Luigi Einaudi, in the second decade of the same century; with Marshall and Pigou being among the few prominent economic theorists to accept that proposition (Fossati 2013).

(13.) One of our referees has kindly pointed out that Pigou interpreted Shaw's criticism as drawing attention to the folly of introducing a 'brain tax'.

(14.) In a paper published the year before in The Quarterly Journal of Economics, 'The Burden of War and Future Generations', Pigou recalls though that the loan policy had been mostly financed by savings, hurting thus future generations by reducing the capital stock available to them, and also that the poor would be taxed to pay for the service the national debt, held mostly by rich people, worsening thus income distribution and future welfare (Pigou 1919).

(15.) Aslanbeigui and Oakes (2015, 110) note that, on this matter, Pigou was influenced by Sir Josiah Stamp (1924), which reports on the fiscal implications of changes in wealth and income. The Committee's final report, released in 1927, followed Pigou's line of reasoning by concluding that there was no clear evidence supporting the alleged benefits of a capital levy: 'Certainly, whether regarded as a means of lightening the annual burden of industry, or as a means of reducing indirect taxes and increasing expenditure on social objects, it [the levy] would, in our opinion, yield physical results quite disproportionate to the magnitude of the operation' (Committee on National Debt and Taxation 1927, 293).

(16.) In his Memorandum on Credit, Currency and Exchange Fluctuations, prepared for the 1920 Brussels International Financial Conference, Pigou devises a scheme of short term relief to distressed occupied regions through the issue of bonds by the responsible authorities of each country. The funds were only to be used to finance the acquisition of food, agricultural implements, material for factories and equipment; and only on condition of the benefited governments centralizing the exchanges, incurring in no military spending and forbidding the import of luxuries and the sending of capital abroad (Pigou 1920c, 4-7).

(17.) Pigou may have also noticed the then current deep recession in former Allied countries after the US cut short the supply of dollars to Europe (see Eichengreen [1992, 100-107]; Samuelson and Hagen 1943). In the paper 'Unemployment', published in 1922 in The Contemporary Review, he attributes the unemployment of the time to the dislocations in world trade caused by the war, as well as to the excessive optimism with the prospective demand from European countries in peacetime, which pushed British merchants and bankers to pile up large inventories of commodities at increased prices. As wages finally caught up with inflation and banks raised interest rates, sales receded, prices fell, and a wave of pessimism settled in (Pigou 1922).

(18.) The present authors have recently examined Pigou's understanding of the real purpose of the Chamberlain-Bradbury Committee (Arthmar and McLure 2015); as well as his specific contributions to that Committee in the light of testimony given at the forum by Reginald McKenna (Arthmar and McLure 2016), the latter of which notes that McKenna and Pigou were concerned that tight credit policy to force the exchange rate up to that of the gold standard, and to maintain it there, could adversely affect real economic activity and the real value of tax bases.


We acknowledge Annalisa Rosselli, Yukihiro Ikeda, Michael Ambrosi and the other participants at the 4th ESHET-JSHET Conference on 'War in the history of economic thought: the economists and the question of war', convened at the Otaru University of Commerce, Otaru, Japan, on 11-13 September 2015, where an earlier draft of this paper was first presented. We also thank the two referees for their comments (one of whom provided highly critical feedback that proved very helpful).

Disclosure statement

The authors report no conflict of interest. They alone are responsible for the content and the writing of this article.


CAPES [10972/13-7]; FAPES [0750/2015]; CNPq [307080/2012-9].

Notes on the contributors

Rogerio Arthmar is a researcher in the fields of the history of economic thought and economic history, focusing mainly on classical economics, the international gold standard and the economic theory of the interwar years.

Michael McLure specialises in the history of economic thought, especially as it pertains to Arthur Cecil Pigou and Vilfredo Pareto. He was co-editor of the History of Economics Review from 2007 to 2011 and was one of the five editors of the critical and variorum edition of Pareto's Manual of Political Economy (2014 OUP).


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Rogerio Arthmar (a) and Michael McLure (b)

(a)Department of Economics, Universidade Federal do Espirito Santo, Vitoria, Brazil; (b)Economics Program, Business School, The University of Western Australia, Perth, Australia

CONTACT Rogerio Arthmar * * Department of Economics, Universidade Federal do Espirito Santo, Vit6ria, Brazil; Michael Mclure * michael.m * Economics Program, Business School, The University of Western Australia, Perth, Australia
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