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The Science of Economics

The “proper” methodological approach to economics as a branch of study was not obvious at the beginning (and may still not be). In the second half of the nineteenth century, the impressive progress that was apparently being made in the field we now call micro-economics stimulated various economists to discuss the methodological foundations of economics. One result was that economists began to propound theories of the philosophy of (social) science, adopting from and adding to the developments of that philosophical field in the natural sciences.

Keynes undertook an analysis of these issues in The Scope and Method of Political Economy (1891). He distinguished between two schools: the theoretical, abstract and deductive and the ethical, realistic and inductive. Id., pp.9–10. Adam Smith had engaged in both approaches. Malthus had continued the inductive tendencies of Smith, while David Ricardo had developed the deductive approaches. However, even Alfred Marshall stressed the need for inductive as well as deductive analysis and rejected the idea of a comprehensive, axiom-based theory: “The function then of analysis and deduction in economics is not to forge a few long chains of reasoning, but to forge rightly many short chains and single connecting links.” Marshall, Principles of Economics, p.781.

Deductive theories

Deductive systems have strong appeal, presumably in part because they seem scientific. But, it is also clear that such theories can be immensely flexible, general and powerful. The use of deductive systems also has the advantage of allowing work to be done in pieces. Certain aspects of what might become an all-inclusive theory could be developed independently, with the expectation that the pieces could ultimately be put together into a sweeping whole.

Part of the differences in approach by practicing economists reflected different views of what it was that economics was supposed to explain. What became the marginal utility school (the deductive theorists) asserted that the goal was to understand—or, the subject of economics was—the allocation of scarce resources among competing ends. The other school focused on the historical and institutional underpinnings of economic development. See, Sherman R. Krupp, “Types of Controversy in Economics,” in Krupp (ed.), The Structure of Economic Science (1966), p.42.

Keynes’ prejudice was clear. He admired abstract reasoning. Keynes was impressed by the scientific method of economic theory and believed that, because of it, economics was decidedly superior to the other social sciences, especially sociology. See, e.g., The Scope and Method of Political Economy, pp.110, 134. (The criticism of sociology seems not to be a result of negative reactions to sociologists but to the concept of sociology as being the overarching or all-encompassing study of human activities.) Other economists, in the following decades, were to espouse the same view. The belief was that economists were developing ‘“a body of ‘pure theory’ the possession of which distinguishes Economics from the other social sciences.” T.W. Hutchinson, The Significance and Basic Postulates of Economic Theory (1938), p.3.

In the English-speaking world, in the end, mainstream economics came to focus on explanatory models based upon the model of classical mechanics.⁶ As classical economics evolved into neo-classical theory, economics assumed the mantel (almost) of a real science. Its proponents and admirers marveled at the elaborate graphical presentations that appeared to generate definitive and clear results, putting to shame the subjective narrative methodologies of the other social science. For example, once value (or price) is defined as the intersection of supply and demand and one hypothesizes that both supply and demand over various quantities and prices are functions that can be depicted as curves (sloping opposite directions), then mathematical techniques can be utilized to explore various possible characteristics of those curves and make “predictions” of the results that would occur if those characteristics obtained in the real world. In other words, the theories constructed about relationships in the world lent themselves to mathematical representation. If such cases, the power and versatility of mathematics could be used to investigate those relationships and to make predictions about events.

The first effort to state economic theory in the form of a system of axioms and deductions is attributed to Nassau William Senior, writing in the 1830s. “To Senior belongs the signal honor of having been the first to make the attempt to state, consciously and explicitly, the postulates that are necessary and sufficient in order to build up—it is misleading to say to ‘deduce’—that little analytical apparatus commonly known as economic theory, or, to put it differently, to provide for it an axiomatic basis.” Schumpeter, A History of Economic Analysis, pp.575–76. Senior described the analytical work of the economist as follows: “his premises consist of a very few general propositions, the result of observation, or consciousness, and scarcely requiring proof, or even formal statement, which almost every man, as soon as he hears them, admits as familiar to his thoughts, or at least as included in his previous knowledge; and his inferences are nearly as general, and, if he has reasoned correctly, as certain, as his premises.” Nassau William Senior, Political Economy (1836), pp.2–3.

This attitude is reminiscent of the “necessary truths” that allegedly exist a priori to experience. The methodological approach was certainly believed to be sound: if the premises are true, then logical deductions from them will also be true. Today, of course, there is considerable appropriate skepticism about the obviousness and, indeed, the truth of the initial premises that economists were utilizing. Indeed, a century after Senior published his treatise, Lord Robbins described economics in very similar terms: "The propositions of economic theory, like all scientific theory, are obviously deductions from a series of postulates. And the chief of these postulates are all assumptions involving in some way simple and indisputable facts of experience relative to the way in which the scarcity of goods…actually shows itself in the world of reality… . But while it is important to realize how many are the subsidiary assumptions which necessarily arise as our theory becomes more and more complicated ( i.e., market structure, etc.), it is equally important to realize how widely applicable are the main assumptions on which it rests." The Nature and Significance of Economic Science (1935), p.158.⁷

Robbins was not alone. Interest in the methodological issues blossomed in the first half of the twentieth century, with rather elaborate and excited tributes written about the scientific status of economics. See, e.g., T.W. Hutchinson, The Significance and Basic Postulates of Economic Theory (1938) and, to be discussed in some detail below, Milton Friedman, “The Methodology of Positive Economics,” in Essays in Positive Economics (1953). Hutchinson wrote that deductive economic theory was constructed on the model of mechanical equilibrium, which generated “a body of ‘pure theory’ the possession of which distinguishes Economics from the other social sciences.” The Significance and Basic Postulates of Economic Theory, p.3.

Pareto optimality

Let us explore an illustration. Assume that an economy is in the position in which no changes could be made that would result in making any person better off without making at least someone else worse off. Such a situation became known as Pareto optimality, named after the Italian engineer and economist Vilfredo Pareto (1848–1923), who published his Manual of Political Economy in 1906. This definition of an optimum seems “scientific” or, at least, objective.

In addition, it avoids any attempt at the comparative valuing of benefits for different people. For example, one would not assert that a change would benefit society, as a matter of economics, if one person sacrificed so that 100 people could benefit. Similarly, the satisfaction of a human vice is not assigned less weight than the satisfaction of a fundamental human need.

This approach had one clear virtue: How could anyone disagree with a reallocation of resources that made one person better off without disadvantaging anyone else? If this standard were actually sufficient to resolve some of society’s important questions, that is, to enable a choice between policies to be made, then one could hardly complain. However, to the contrary, this standard is simply irrelevant with respect to most of the really important and pressing policy issues facing most societies—issues involving questions of justice and fairness, the establishment of priorities among or weighting of competing goals, the value of human life (or animal lives), etc.

Of course, many of these issues are decidedly outside of the defined scope of economics, but others have been excluded by choice. For example, traditional economics consciously refuses to rank or value individual choices. Instead, not only are people presumed to be the best (or only) judge of what pleases them, but no judgment is made about the relative merits of such pleasures (at least as long as the indulgence does not hurt anyone else). For this reason, the gross domestic product of a nation reflects the sum of the market prices of all of the goods and services produced. No differentiation is made between products that promote health and those that undermine it; no different weighting is made for expenditures that add to wealth or productivity and current consumption of luxuries. Thus, comparable GDPs can represent very different levels of economic wellbeing. At a more prosaic level, as has been frequently observed, if two caregivers simply take care of each other’s wards in exchange for payment (in amounts that can even cancel each other out), rather than stay at home caring for their own, GDP is increased. Yet, there is no actual increase in real output (indeed, there may be time lost in commuting, additional expenses and more taxes paid because of the creation of recognizable income). There is an increase in economic activity only because economic activity is defined to include the exchange of services but not the self-provision of them.

This last example could, in theory, be corrected for, with substantial problems of data collection. But, the other examples reflect the decision by economists to avoid value judgments, allegedly, in part, in order to be more scientific.

Problems and controversies

The Great Depression raised significant questions about economists’ understanding of the macro-operations of economies and of the role of money, but the theoretical model of the determination of price and output came to be subject to sharp criticisms as well. Part of the reason for some of the passion reflected in the attacks were the apparent normative implications of the theory (some of which are discussed below in the subsection "Economic 'morality'"), coupled with the claims that it was a science resembling Newtonian physics.

Micro-economics appeared to demonstrate that the most efficient allocation of scarce resources would occur in conditions of perfect competition. When equilibrium was reached, the allocation would be such that any change would result in a reduction in total output. Of course, the particular equilibrium in question would depend upon the initial conditions, including the distribution of wealth and resources. Other initial conditions would lead to different results. Thus, economists would argue that free exchange and open markets, with certain caveats developed over time, would lead to the most efficient allocation of resources. However, some would call the caveats “minor” qualifications; others would say that the caveats reflect almost everything that matters, rendering the general theory almost or totally useless or, even, dangerous.

This theoretical structure was built upon a large number of propositions or postulates that appeared to have factual content (that is, they could be true or false). The results are deduced from those postulates. Attacks on the theory often challenged specific postulates. The resulting debates are quite interesting and informative.

I think that the nature of the methodological issues that arose can be illustrated better—or, at least, certainly more concretely—by an example. The example I use here is the controversy over the theory of the firm.