The Economics of Welfare

By Arthur C. Pigou

WHEN a man sets out upon any course of inquiry, the object of his search may be either light or fruit—either knowledge for its own sake or knowledge for the sake of good things to which it leads. In various fields of study these two ideals play parts of varying importance. In the appeal made to our interest by nearly all the great modern sciences some stress is laid both upon the light-bearing and upon the fruit-bearing quality, but the proportions of the blend are different in different sciences. At one end of the scale stands the most general science of all, metaphysics, the science of reality. Of the student of that science it is, indeed, true that “he yet may bring some worthy thing for waiting souls to see”; but it must be light alone, it can hardly be fruit that he brings. Most nearly akin to the metaphysician is the student of the ultimate problems of physics. The corpuscular theory of matter is, hitherto, a bearer of light alone. Here, however, the other aspect is present in promise; for speculations about the structure of the atom may lead one day to the discovery of practical means for dissociating matter and for rendering available to human use the overwhelming resources of intra-atomic energy. In the science of biology the fruit-bearing aspect is more prominent. Recent studies upon heredity have, indeed, the highest theoretical interest; but no one can reflect upon that without at the same time reflecting upon the striking practical results to which they have already led in the culture of wheat, and upon the far-reaching, if hesitating, promise that they are beginning to offer for the better culture of mankind. In the sciences whose subject-matter is man as an individual there is the same variation of blending as in the natural sciences proper. In psychology the theoretic interest is dominant—particularly on that side of it which gives data to metaphysics; but psychology is also valued in some measure as a basis for the practical art of education. In human physiology, on the other hand, the theoretic interest, though present, is subordinate, and the science has long been valued mainly as a basis for the art of medicine. Last of all we come to those sciences that deal, not with individual men, but with groups of men; that body of infant sciences which some writers call sociology. Light on the laws that lie behind development in history, even light upon particular facts, has, in the opinion of many, high value for its own sake. But there will, I think, be general agreement that in the sciences of human society, be their appeal as bearers of light never so high, it is the promise of fruit and not of light that chiefly merits our regard. There is a celebrated, if somewhat too strenuous, passage in Macaulay’s Essay on History: “No past event has any intrinsic importance. The knowledge of it is valuable, only as it leads us to form just calculations with regard to the future. A history which does not serve this purpose, though it may be filled with battles, treaties and commotions, is as useless as the series of turnpike tickets collected by Sir Matthew Mite.” That paradox is partly true. If it were not for the hope that a scientific study of men’s social actions may lead, not necessarily directly or immediately, but at some time and in some way, to practical results in social improvement, not a few students of these actions would regard the time devoted to their study as time misspent. That is true of all social sciences, but especially true of economics. For economics “is a study of mankind in the ordinary business of life”; and it is not in the ordinary business of life that mankind is most interesting or inspiring. One who desired knowledge of man apart from the fruits of knowledge would seek it in the history of religious enthusiasm, of martyrdom, or of love; he would not seek it in the market-place. When we elect to watch the play of human motives that are ordinary—that are sometimes mean and dismal and ignoble—our impulse is not the philosopher’s impulse, knowledge for the sake of knowledge, but rather the physiologist’s, knowledge for the healing that knowledge may help to bring. Wonder, Carlyle declared, is the beginning of philosophy. It is not wonder, but rather the social enthusiasm which revolts from the sordidness of mean streets and the joylessness of withered lives, that is the beginning of economic science. Here, if in no other field, Comte’s great phrase holds good: “It is for the heart to suggest our problems; it is for the intellect to solve them…. The only position for which the intellect is primarily adapted is to be the servant of the social sympathies.”… [From the text]

Book Cover

First Pub. Date

1920

Publisher

London: Macmillan and Co.

Pub. Date

1932

Comments

4th edition.

Copyright

Part II, Chapter XIX

PURCHASERS’ ASSOCIATIONS

§ 1. THE results of the preceding chapters make it plain that, in many industries, neither simple competition, nor monopolistic competition, nor simple monopoly, nor discriminating monopoly will make the value of the marginal social net product there equal to the value of marginal social net products generally, and, therefore, that they will not maximise either the national dividend or economic welfare. It will have been noticed, however, that the systems so far investigated have all been systems under which goods are produced by one set of people and sold to another set. The failures of adjustment, to which they lead, have, therefore, all been dependent on this fact. Hence the question naturally arises: Could not these failures be eliminated by the device of voluntary groups of purchasers undertaking for themselves the supply of the goods and services they need?

§ 2. Now, the essence of a Purchasers’ Association, whether it is formed of the consumers of finished goods or of producers who will utilise their purchases in further production, is that its policy is directed to maximise aggregate purchaser’s benefit
minus aggregate costs. It must, therefore, call out just that quantity of output, which, except where others besides the purchasers of the commodity are affected by its production, will make the value of the marginal social net product of resources devoted to it equal to the value of the marginal social net product of resources in general. That is to say, other things being equal, it must eliminate, in great measure, the disharmonies belonging alike to monopoly and to simple competition. This
preliminary abstract statement does not, however, solve our problem. It is not enough to know that,
if other things are equal, Purchasers’ Associations will advantage the national dividend. Before we can infer anything from this about the effect of these Associations in actual life, we need to inquire how they compare with ordinary commercial businesses in crude economic efficiency; for it is clear that any advantages, which a Purchasers’ Association may possess in price policy, and, therefore, in respect of the distribution of resources among different occupations, are liable to be outweighed if it is inefficient on the productive side.

§ 3. As a prelude to this task, it is desirable to guard against certain confusions. First and most obviously, we need to rule out all appeals to the superior efficiency, in certain fields, of Purchasers’ Associations, as compared with the members of these Associations operating as isolated individuals. It is easy to point to services, which many persons need in small individual lots, but which can be produced much more economically in large lots. A good example is the service of marketing agricultural products of variable quality produced in small quantities by small farmers. For economical selling requires careful grading of qualities and a fairly continuous supply of each grade; and small farmers, who attempt individually to market their butter or their eggs, are not operating on a large enough scale to meet these requirements satisfactorily. Thus Mr. Rider Haggard writes of Denmark: “In 1882 what was called ‘peasant butter’ fetched 33 per cent less than first-class butter made on the big farms, but in 1894 the co-operative butter, which, of course, for the most part comes from the peasant farms, took more medals and prizes than that from the great farms, and what used to be called second and third class butter ceased to exist as a Danish commodity of commerce.”
*41 The fact, however, that, for this kind of reason, the manufacture of butter, the curing of bacon, and the marketing of eggs “afford a splendid opening for the application of co-operative principles,” is irrelevant to the present issue, since these things also afford a splendid opening for the
application of commercial principles.
*42 It is true that a Purchasers’ Association can work in this field much more cheaply than a single small farmer; but, exactly the same thing is true of an ordinary commercial firm, undertaking to sell the service of marketing to these farmers. Two examples are given by Sir R. H. Rew. “One is the French butter trade. This has been built up by the merchants in Normandy and Brittany—some of whom are Englishmen—who purchase the butter at the local markets from the individual farmers, and work it up in their blending houses. Another instance is the poultry trade in the Heathfield district of Sussex. There the system is that the fatteners, or ‘higglers’ as they are termed, purchase and collect the chickens from those who rear them; they are then duly fattened, killed, and prepared for market, and again collected by the carrier or railway agent, by whom they are forwarded to London and other markets. Both these are instances of complete organisation without co-operation.”
*43 Secondly, we must refrain from stressing unduly the history of English Co-operative Stores. The reason is that, when the device of Purchasers’ Associations was introduced into retail trading, it is very doubtful if the rival method was fairly represented. Partly in consequence of the imperfect competition between different shops, not all the economies that were available had been taken up.
*44 Even from their own point of view, “retailers
as a body kept far more shops than was necessary, spent far too much trouble and money in attracting a few customers, and then in taking care that those few customers paid them in the long run—the very long run—for those goods which they had bought on credit, or, in other words, had borrowed; and for all this they had to charge…. Retail trade was the one accessible business—Marshall was probably not thinking of house-keeping and domestic cooking as a business—in which there were great economies to be effected.”
*45 This view of the matter is fortified by Pareto’s observation, that retail shops were easily ousted by the competition, not only of
sociétés co-opératives, but also of
les grands magasins*46—to which should be added, in England, the very important multiple shops. A comparison between retail trading, as it stood when our consumers’ stores came into being, and these stores cannot, therefore, be accepted as a conclusive test of the relative merits of the industrial forms they represent. It is like a comparison between a member of one race whom there is some reason to suspect of being less healthy than the average of his compatriots and a thoroughly sound member of another. No great weight, therefore, can be attached to historical examples, and we are driven forward to an analytical study.
*47

§ 4. In attempting, from this point of view, to estimate the economic efficiency of Purchasers’ Associations, we may observe, first, that these Associations are, in structure, a form of Joint Stock Company. Like any other Joint Stock Company, a Purchasers’ Association is owned by shareholders, and is controlled by a manager under the supervision of a committee elected from among the shareholders. The alternatives to it are the private business and the ordinary commercial company. In attempting to compare its economic efficiency with theirs, we naturally look to the organisation
of the management. Under this head the Purchasers’ Association and the commercial company alike are inferior to the private business, just in so far as Boards of officials lack the opportunities for quick action and the stimulus of personal possession belonging to the private business.
*48 But the Purchasers’ Association is likely, in some degree, to make up for this deficiency through the ardour instilled into the manager and the committee by the fact that they are engaged in a service suited to evoke public spirit. The Purchasers’ Association may, in fact, utilise the altruistic motives, alongside of the egoistic, as a spur to industrial efficiency. Against this consideration, however, there has to be set a second. In so far as Purchasers’ Associations consist of poor persons, unaccustomed to large business, there is a danger that they may grudge adequate freedom to their managers and may discourage them by illiberal treatment in the matter of salaries. Furthermore, their committee-men are drawn from a more limited area, and are apt to possess less business experience than the directors of commercial companies. These conflicting influences will, of course, have different weights in different circumstances.

Secondly, when any section of a country’s industry is given over to monopolistic competition, ordinary commercial businesses are bound to engage in much wasteful expenditure on advertising, in the manner described in Chapter IX. § 14. In this respect Purchasers’ Associations are in a much more favourable position. When the services they provide consist of such things as the purchase of agricultural feeding stuffs or manures, or the work of wholesale trading, they are practically assured, without any direct effort on their part, of the whole demand of their members. When they provide the service of packing eggs, or curing bacon, or converting milk and cream into cheese and butter, their members may, indeed, sometimes be tempted by an offer of better terms to go elsewhere, but it is
possible for the Societies, by making “loyalty,” within limits, a condition of membership, in great measure to restrain such action without resort to advertisement. When they provide the service of retailing or of granting credit, the enforcement of loyalty by rule is, indeed, impracticable, and is not attempted; but even here loyalty will in fact be largely maintained through the members’ sense of proprietary interest in their own shop. Among non-members, no doubt, when it is desired to extend the range of any Association’s business, advertisement of one sort or another may be necessary. The Purchasers’ Association, however, has a considerable advantage over an ordinary Joint Stock Company, because it is able to offer to those who join it, not only cheap goods, but also a certain sense of part ownership in an important corporate institution. Such advertisement as it does undertake, therefore, is likely to prove more effective, and less of it is needed to achieve a given result. By so much its efficiency is,
ceteris paribus, greater than that of its rivals.

Thirdly, there is another way, besides the saving of advertisement costs, in which “loyalty” makes for economy. As was pointed out in Chapter XIV. § 3, it enables the work of a co-operative concern to be conducted steadily without those large fluctuations, to which private concerns are often subject and the presence of which inevitably involves cost. Thus the rule insisting upon loyalty as a condition of membership of co-operative bacon factories and creameries enables these establishments to count on a constant supply of raw material with greater confidence than private firms can do;
*49 and, in like manner, the practice of the English and Scotch
Wholesale Societies and of local Retail Associations, in concentrating the constant part of their demand upon their own productive departments and throwing the variable part upon outside traders, greatly lessens the fluctuations to which these productive departments are exposed. No doubt, the economies which co-operative concerns secure in this way have, from a national point of view, to be balanced against any diseconomies that may be caused to outside concerns by increased fluctuations thrown upon them; and so are not a net gain to the nation. To the co-operative concerns themselves, however, they are a net gain. Moreover, in so far as the aggregate demand or supply of a market is constant, and fluctuations in the parts are due to other causes than fluctuations in the whole, the introduction of steadiness in one part cannot increase, but necessarily diminishes, the fluctuations of other parts. Hence it is probable that a considerable part of the economies which co-operative concerns derive from loyalty represent a net increase in efficiency for the community as a whole as well as for themselves.

Fourthly, the relation that is set up between the various members of a Co-operative Society greatly facilitates the dissemination among them of knowledge about the best methods of production. Thus Sir Horace Plunkett observes of the work of the Irish Department of Agriculture: “It was only where the farmers were organised in properly representative societies that many of the lessons the Department had to teach could effectually reach the farming classes, or that many of the agricultural experiments intended for their guidance could be profitably carried out.”
*50 The root of the matter is reached by Mr. Fay when he writes: “Both the co-operative society and the firm are trading bodies, and they will not pay the farmers more than their milk is worth. But, whereas the firm’s remedy is to punish the farmer by the payment of low prices, the society’s remedy is to educate him so that he may command high ones.”
*51

Fifthly, when in any field of industry there is an element of bilateral monopoly, ordinary commercial businesses and their customers, respectively, are driven to expend energy, if not
money, after the manner described in Chapter IX. §§ 15-17, in attempts to get the better of one another. Where a Purchasers’ Association exists, this class of expenditure is likely to be reduced. In co-operative retail stores, as Marshall has observed, the proprietors, since they are also the customers, have no inducement to adulterate their goods, and costly precautions to prevent such adulteration are, therefore, unnecessary.
*52 The gain is no less clear in societies providing for their members the services of insurance and the retailing of loans. The insurance contract is conditional on some event happening to the buyer; the loan contract is conditional on the buyer’s promise to repay. In the one case the buyer may gain at the seller’s expense by simulating, or even by voluntarily bringing about, the event provided against; in the other he may gain by deliberately breaking, or by so acting as to render himself unable to perform, his promise. Now, it is, of course, true that individual buyers are able to gain by this class of conduct, not only when the relation of identity between buyers and sellers collectively does not exist, but also when it does exist. The point, however, is this. Under the Joint Stock form of industrial organisation the fraudulent or quasi-fraudulent conduct of one buyer does not matter to the other buyers, and can, therefore, only be guarded against by an elaborate and continuous system of inspection. Under the Purchasers’ Association form, however, the other buyers are directly injured by such conduct, and are, therefore, interested to prevent it. If, then, the Purchasers’ Association consists of neighbours, all will, incidentally and in the course of the ordinary conduct of life, constitute themselves voluntary and unpaid inspectors of each. In this way small local Purchasers’ Associations for the supply of insurance or the retailing of loans are, in effect, free from a substantial part, not merely of the nominal, but also of the real, costs that Joint Stock Companies attempting to furnish these services would be compelled to bear. In so far as people are less willing—apart altogether from the prospect of success—to try to defraud a Mutual Association than a commercial company, the gain under this head is increased.

§ 5. The various advantages that have been enumerated above
suggest that there is a wide field over which Purchasers’ Associations are likely to prove at least as efficient as any other form of business organisation: and in many important departments of industry they have proved their fitness by prosperous survival. This is true of the so-called supply associations often formed by farmers—associations, that is to say, which supply to their members the service of marketing from manufacturing firms such things as manure, seeds and agricultural machinery. It is true of the agricultural selling societies, which provide such services as the sorting, grading, selling and packing of eggs or of butter. It is true of the Co-operative Creameries, which play so important a part in Denmark and in Ireland, and whose services include a manufacturing as well as a marketing operation. Last but not least, it is true of that widespread organisation based on consumers’ stores, which provides for the retailing, wholesaling, and sometimes even the manufacturing, of staple household goods (including houses themselves) for large agglomerations of working people with fixed homes.

§ 6. Even, however, in departments of work where experience gives good hope of efficiency and success, it does not follow that Purchasers’ Associations will always come into being. Very poor people may lack the initiative and understanding needed to form one. Where the population is migratory, attempts are especially unlikely to be made—a circumstance which explains why co-operative stores “have seemed to shun capital and seafaring towns.” Better-to-do persons, while fully competent to develop Purchasers’ Associations, if they had the wish, may, in fact, not have the wish. With commodities on which they only spend a very small part of their income at rare intervals—commodities that are luxuries to the main body of purchasers—the possible savings may be too small to be worth while. Or again, even when they are worth while, it may be possible to get an equivalent advantage in some other less troublesome way. British tenant farmers, for example, with their traditional right to appeal to the squire in times of difficulty for a reduction of rent, are slow to overcome their native individualism for the (to them) relatively small advantages of co-operation with their neighbours. No doubt, encouragement may be given to them
by State action. Thus in Canada “in 1897 the Dominion Department of Agriculture established a system by means of which loans were made to farmers who undertook to organise themselves into Butter and Cheese Manufacturing Associations and to send their produce to Co-operative Creameries equipped by means of the loans. The Department undertook to organise the management of these creameries, and to manufacture and sell the butter for a fixed charge of four cents (2d.) per lb., an additional charge of one cent per lb. being made for the amortisation of the loans.”
*53 But this device is obviously of limited scope. Moreover, there are a number of very important sorts of work to which the Purchasers’ Association form of organization is not well suited. Whenever a large speculative element is present, whenever, in other words, much uncertainty has to be borne, this factor of production will not be readily forthcoming from organised purchasers. For, if capital has to be ventured at a hazard, the people who venture it will expect to exercise control, and to harvest the profits, more or less in proportion to their venture. Associations that raise capital at fixed interest and distribute surplus in accordance, not with investment, but with purchases, do not enable them to do this. The graded machinery of debentures, preference shares and ordinary shares furnished by Joint Stock Companies is much more satisfactory. In risky undertakings, therefore, Purchasers’ Associations will not work. Nor will they work as regards commodities and services for which economy demands centralised production, but of which the purchasers are spread over wide areas and make their purchases at irregular intervals. The idea, for instance, that the services now rendered by the cotton industry could be provided satisfactorily by any arrangement of Purchasers’ Associations is plainly fantastic. “In many cases the users or consumers of the service do not form a practicable constituency, apart from that of themselves as citizens, which could control the administration. The national railway service could hardly be governed by the votes of the incoherent mob of passengers who pour out of the termini of our great cities; or the characteristic municipal services by any other membership
than that of all the municipal electors.”
*54 We conclude, therefore, that, though the Purchasers’ Association, as a means of overcoming the evils of ordinary competitive and ordinary monopolistic industry, has, undoubtedly, an important part to play, the field open to it is limited in extent, and the study of further remedies is, therefore, still required.
*55

41.

Rural Denmark, pp. 195-6.

42.

In like manner, the charge that the development of Purchasers’ Associations on the part of groups of persons other than ultimate consumers may make possible monopolistic action against these consumers is irrelevant; for, so also may the development of commercial firms.

43.

Rew,
An Agricultural Faggot, p. 120.

44.

Care must be taken, however, not to treat as waste in the work of retailing those costs that are necessarily involved in the kind of retailing that the public chooses to ask for. “Imagine that every one intending to buy a pair of shoes or a suit of clothes was called on to send notice of his proposed purchase a week or two in advance, to give a preliminary account of the thing wanted, and then to accept an appointment for a stated place or time at which the purchases must be made. It is easy to see how the work of retailing could be systematised, how the selling force would be kept constantly employed, how stocks would be kept to the minimum. As things now stand, we pay heavily for the privilege of freedom in the use of our time, for vacillation and choice, for the maintenance of a stock and a staff adequate for all tastes and all emergencies. It is common to speak of the waste of competition; much of it is in reality the waste necessarily involved in liberty” (Taussig,
American Economic Review, vol. vi. No. 1 Supplement, 1916, p. 182).

45.

Marshall,
Inaugural Address to the Co-operative Congress, 1889, p. 8.

46.

Cf.
Cours d’économie politique, p. 274.

47.

It should be added that,
even if other things were equal, the payment of a dividend by a co-operative society trading at the same price as another concern would not prove greater efficiency of management; for, if, as is common, the society proceeded to a greater extent on a system of cash sales, the dividend would
pro tanto be simply payment to purchases of interest on their earlier discharge of indebtedness.

48.

In the United States, where the President of a company often holds a very large individual interest, it appears that he sometimes acts on behalf of the company, just as a private owner would do. “Generally speaking, the President of an American Corporation acts just as freely and energetically on behalf of his company as he would on his own behalf” (Knoop,
American Business Enterprise, p. 26). He only consults the directors when he wishes to do so.

49.

In the Danish co-operative bacon factories loyalty is generally enforced by a provision to the effect that members shall deliver all their saleable pigs (with certain specified exceptions) to the factory for a period of seven years, unless in the meantime they remove from the district (Rew,
An Agricultural Faggot, pp. 123.4). In like manner many Irish dairying societies provide that “any member who shall supply milk to any creamery other than that owned by the society for the space of three years from the date of his admission to membership, without the consent in writing of the Committee, shall forfeit his shares together with all the money credited thereon” (
Report on Co-operative Societies [Cd. 6045], 1912, p. xxxix). It will be noticed that in these classes of societies—and it is only in them that loyalty is enforced in the rules—the use of a considerable plant makes the maintenance of a steady demand a more important influence in eliminating cost than it would be in, say, an agricultural purchasing society.

50.

Ireland in the New Century, p. 241.

51.

Co-operation at Home and Abroad, p. 164.

52.

Cf. Inaugural Address to the Co-operative Congress, 1889, p. 7.

53.

Mavor,
Report on the Canadian North-West, p. 44.

54.

Webb,
A Constitution for the Socialistic Commonwealth, p. 252.

55.

For a full discussion of the various forms of co-operative activity,
vide Fay,
Co-operation at Home and Abroad. I am also indebted to Mr. Fay for useful criticism and suggestion in connection with this chapter.

Part II, Chapter XX