Neoclassical Economics and Its Method
If classical political economy did not refrain from moral evaluations of studied phenomena, neoclassical economics radically changed the relationship between economic theory and ethics. Neoclassical economics started as a result of the Marginal Revolution of the 1870s when several scholarsāW. Jevons in England, K. Menger in Austria, and L. Walras in Switzerlandāindependently of each other published their ideas about new mathematical analysis of economic decisions of consumers and producers and new mathematical analysis of market equilibrium. They did what was absent in classical economicsāthey tried to describe functions connecting basic variables of economic activity, i.e. the amount of consumed goods and the satisfaction from this consumption, the amount of used factors of production and the quantity of goods produced with these factors. They tried to study the mathematic characteristics of these functions and the behavior of actors (consumers and producers) who deal with these functions. From the very beginning, they assumed the rationality of actorsāthat consumers and producers seek maximum utility or profitāand it generally looked quite consistent with classical economics, because Smith, Ricardo, and Mill also assumed that people try to make rational choices to improve their welfare. Now this analysis was clothed in the mathematical language of calculus, e.g. finding the maximum of target functions, describing conditions of optimality, and so on. Although in mathematics there are several methods to describe and find the maximum, the language of marginal analysis (marginal utility, marginal costs, marginal product, etc.) could be quite effectively applied to an explanation of the behavior of consumers and producers with simple geometrical diagrams and with minimal mathematics; that is why the approach was popularized in this language and the revolution in the method was called Marginal. All pioneers of this approach explicitly understood this as a new scientific approach to economic theory, which could be very accurate and eligible for logical proof as with any other science.
At the same time, economists started distinguishing positive economic theory, normative economic theory, and economic policy as three different branches of economic science. This tripartite structure was suggested by John Neville Keynes in the book āThe scope and method of political economyā (1890), written in an attempt to clarify the methodological muddle of the economic theory of the late nineteenth century. Keynes distinguished positive economic science, normative economic science, and the third part which he called the āart of political economyā, dealing with the development of economic policy. Importantly, Keynes asserted the danger of confusing them in one research.
The problem whether political economy is to be regarded as a positive science, or as a normative science, or as an art, or as a combination of these, is to a certain extent a question merely of nomenclature and classification. It is, nevertheless, important to distinguish economic enquiries according as they belong to the three departments respectively; and it is also important to make clear their mutual relations. Confusion between them is common and has been the source of many mischievous errors . (Keynes 1890, p. 22)
How had normative economic science been developed? Historically, it took the form of welfare economicsāas a study of how some economic events influence society, which should help to shape the economic policy of the state. Logically, normative economics should cooperate with moral philosophy, but this cooperation did not happen. It seems that moral philosophy then did not look like a science which might be helpful. The majority of economists were fond of their new scientific methodology and avoided the moral philosophy domain as something alien. As a result, neoclassical economics had been developing for a long time with no explicit connection with ethical theory. All neoclassical economists intuitively belong to Utilitarianism and assumed that the maximization of happiness of the greatest number was a good purpose for economic policy. But this position was not an outcome of deep study of moral philosophy and a conscious choice of Utilitarianism as a superior moral theory. We may guess that even if Bentham and Mill had never existed, economists would invent a self-made variant of Utilitarianism during the Marginal Revolution . The reason for this is quite obviousāthe utility of consumers is the final result of economic activity in neoclassical economics and the idea of maximization is central to the whole paradigm. The conclusion that the total utility of society should also be maximized was inevitable in this situation.
Neoclassical theory faced the same fundamental problems as all Utilitarian thinkers: (1) how to measure happiness (utility); (2) how to compare the utility of various people; and (3) whether it is permissible to interchange the utility of one person for the utility of another. Some pioneers of the Marginal Revolution believed that marginal utility could be measured and at least in theory we could use some imaginary units to put on diagrams and equations. This approach was later called the theory of cardinal utility. However, many believed that in a scientific economic theory we could not measure utility and compare the utility of various people. For example, William Stanley Jevons (1835ā1882) devoted the first chapter of his book āThe Theory of Political Economyā (1871) to a new methodology of economics claiming that if we want to make economics a science, it should be a mathematical science. The chapter included a section āMeasurement of Feeling and Motivesā where Jevons rejected the possibility of interpersonal utility comparisons because all people have different capabilities to experience psychological feelings from the same goods. So, although marginal utility analysis works well with one mind it cannot tell us much when we need to compare the utilities of various people.
Soon a solution for the measurability problem was developed and this led to a revolution inside neoclassical economicsāthe development of ordinal utility, which allowed evaluating goods without measurement. The key instrument of this analysisāthe indifference curveāwas suggested by Francis Ysidro Edgeworth (1845ā1926) in his book āMathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciencesā (1881). This idea was developed further by Italian engineer and economist Vilfredo Pareto (1848ā1923) in his textbook āManual of Political Economyā (1906). Pareto used the indifference curve to replace cardinal utility with ordinal utility, which required only comparisons of utility but not their measurement in absolute units. Therefore, maximization of utility may be now analyzed graphically with the help of indifference curves developed by F. Edgeworth. Beside this, Pareto introduced the concept of efficiency, which was later named after him as Pareto efficiency and which meant that it was impossible to reallocate any resource to increase the utility of one person and not to decrease the utility of another. Graphically, this idea is usually illustrated by a production possibility frontier or a bargaining curve. Since then, in economic theory the idea of efficiency may be easily and accurately separated from the idea of justice. We could say that positive economics should deal with the latter, and normative economics with the former. However, as we will see below, the normative branch of economics developed under the strong influence of positive methodology and tried to limit itself to efficiency issues.
Cambridge Tradition in Welfare Economics
Although in the beginning of the twentieth century all economists were aware that measuring or comparing interpersonal utilities represented a serious methodological problem, some economists did not give up and continued to suggest that it was possible. They believed that indifference curves and mathematical analysis were only āmachineryā (in Pigouās words) and essentially the economic theory still could make some approximate propositions about comparing and interchanging utilities.
The legendary Cambridge economist Alfred Marshall (1842ā1924), who is best known for his aggregation of neoclassical economics in three volumes of āPrinciples of Economicsā (1890) where the new science first got his scientific-sounding name (like Physics or Mathematics ), assumed that it was permissible to compare and interchange utilities because it was just a common sense.
It would naturally be assumed that a shillingās worth of gratification to one Englishman might be taken as equivalent with a shillingās worth to another ā¦ until cause to the contrary were shown. (Principles of Economics, Book III, chapter VI, paragraph 12)
ā¦ the utility, or the benefit, that is measured in the poorer manās mind by twopence is greater than that measured by it in the richer manās mindā¦ (Principles of Economics, Book III, Chapter III, paragraph 11)
In 1914 his disciple Arthur Cecil Pigou (1877ā1959) published a large essay āWealth and Welfareā where he introduced the concept of āeconomic welfareā and tried to explore its connection with total welfare or happiness of the people. This book seems to be the first in the neoclassical tradition ...