Pareto and the Italian Neoclassical Economists

6.5.1. From cardinal utility to ordinalism

Vilfredo Pareto, a member of a family which included eminent politicians as well as revolutionaries, succeeded Walras into the chair of economics at the University of Lausanne, where he published his Cours d^,economie politique in 1896-7.

Here, for reasons of space, we will focus only on Pareto’s funda­mental contributions to economic theory: the foundation of the ordinalist statute and, in relation to this, the formulation of the Paretian criterion of optimality.

However, we should not overlook Pareto’s contribution to general­equilibrium theory. According to J. Hicks, ‘his famous theory of General Equilibrium is nothing else but a more elegant restatement of the doctrines of Walras’ (Value and Capital, p. 12)—an opinion shared by most people, but not completely true, considering that in the first volume of the Cours, the theory of general equilibrium is enriched by a section on monopolies (while Walras dealt with monopoly only in the 41st lesson, in his treatment of Cournot, without integrating it into the theory of general equilibrium). Not only this, but in the Manuale, Pareto gave numerous hints about what was later to be called monopolistic competition.

We have already mentioned that with the advent of the marginalist revolution there was a radical reformulation of the terms of economic dis­course.

The cornerstone of this construction is the theory of rational consumer behaviour, a theory that the early marginalists founded on the hypothesis that consumers are able to order their own needs. Gossen’s famous First Law (so it was called by Pantaleoni in 1889) stated, in Georgescu-Roegen’s for­mulation: ‘If an enjoyment is experienced uninterruptedly, the corresponding intensity of pleasure decreases continuously until satiety is ultimately reached, at which point the intensity becomes nil’ (‘H. H. Gossen’, 1983, p. lxxx). After having defined the utility of a good as its ability to satisfy needs, the early marginalists went on directly to postulate the existence of a function that associates a measure of total utility with the quantities of goods. Furthermore it was assumed that the increment in utility corres­ponding to each extra quantity consumed gradually decreases. This is the principle of decreasing marginal utility.

Now, the whole of this brilliant construction is based on one crucial assumption: that the utility an individual derives from the consumption of a good is a quantity that can be measured cardinally. Edgeworth, in Math­ematical Psychics, had strenuously defended the cardinal measurement of utility. Deeply influenced by the discoveries of E. T. Fechner and E. H. Weber in experimental psychology, he even argued that satisfaction can be meas­ured in terms of its atoms by means of a type of ‘hedonimeter’.

Precisely because utility is identified in an intrinsic quality of objects (the property of generating happiness by satisfying needs), goods possess a utility as an intrinsic property. Happiness and welfare are objective, just as the health of a person is not subjective, as with the pleasure received from eating a good meal.

Towards the end of the nineteenth century another conception of utility gained ground, first cautiously and then with increasing authority: utility as an expression of preferences and therefore of individual choices. Pareto’s contribution to this change in the notion of utility was decisive. In the Cours, the Italian economist coined the term ‘ophelimity’, from the Greek ophelos (pleasant), in order to denote ‘the attribute of a thing capable of satisfying a need or a desire, legitimate or not’ (p. 3). The main reason Pareto gave for his terminological innovation was that of distinguishing the property of an object desired by an individual, its ophelimity, from the property of an object which is beneficial to society, its utility. For example, a weapon belongs to the first but not to the second category, whereas air and light, while useful to the human race, do not give ophelimity. This meaning of utility was used by Pareto in his monumental Trattato. The difference between utility and ophelimity is therefore the difference between ‘socially useful’ and ‘desired’. For the individual, ‘socially useful’ is what leads to physical health or, more generally, material welfare, le bien-etre materiel. Unpleasant medicine is useful for the patient, but it does not bring him ophelimity.

In the applications Pareto considered ophelimity as a quantitative attribute. In this way he managed to demonstrate the famous theorem on the maximum ophelimity of the consumer. It is not clear whether Pareto considered ophelimity as a cardinal quantity in general. However he even­tually became convinced that it was not necessary to be able to measure it for carrying out consumer theory. In a letter to Maffeo Pantaleoni of 28 December 1899, he put forward the argument that an individual (or a group) always chooses, among the accessible alternatives, that which is preferable to all the other alternatives.

In this way the question whether utility or ophelimity are measurable became irrelevant. In the appendix to the French edition of the Manuale, Pareto showed that it is possible to assign arbitrary (but increasing) indexes to the indifference curves; he thought, in this way, that he had succeeded in moving from utility to ophelimity, and from the latter to ordinal indexes, thus liberating economic theory from every ‘metaphysical’ element.

In conclusion, already at the end of the century there were two distinct notions of utility in the literature, both known to all the pioneers of ordinal- ism, and especially to Pareto. And, by this time, almost everybody realized that, for the purposes of the theory of prices, there was no need whatsoever to use a cardinal measurement of utility. Fisher had already made this clear in his Mathematical Investigations.

The implications of this new point of view were extremely important. On the one hand, utility only referred to the preference ordering of the individual; on the other, preferences were defined with respect to a situation of choice. In this way, the foundation of utility was placed in the virtual behaviour of an individual who has to choose. This behaviour is defined only in terms of certain conditions of consistency. All references to happiness and individual satisfaction of needs disappear, while the underlying motivations for the choices lose their importance.

6.5.2. Pareto’s criterion and the new welfare economics

Once the notion of cardinal utility had been abandoned, it became obvious that there is no possibility of making interpersonal comparisons of utility. How is it possible to make judgements on alternative policy measures when individual utilities can be neither compared nor summed? As we have already mentioned, the criterion proposed by Bentham was the maximization of the sum of individual utilities, a criterion that found its widest application in Pigou’s work. But once cardinality was abandoned it became necessary to find another rule in order to be able to advance social-welfare propositions.

The new criterion was discovered by Pareto: the efficiency of an allocation is maximum when it is impossible to increase one economic magnitude without decreasing another. In the specific case of social welfare, Pareto’s criterion takes on the well-known formulation according to which a certain economic configuration is optimal when it is impossible to improve the welfare of an individual without worsening that of another. Such a criterion allows for the evaluation of alternative social states without any need whatsoever to use interpersonal comparisons of utility or welfare. All that is needed is to determine if each individual improves or worsens his own condition.

Walras was the first to put forward explicitly, even if in a rather unclear way, the idea that the best possible allocation of resources occurs when all goods are exchanged on perfectly competitive markets. This idea anticipated a crucial aspect of Pareto’s criterion of social optimum: the principle of unanimous evaluations of the allocations. With the assertion that, in com­petitive equilibrium, all agents reach the maximum satisfaction, however this is defined, Walras had implicitly maintained that an evaluation of alternative allocations is only meaningful if there is complete consensus about it. Now, Pareto introduced a notion of social optimum which is compatible with the principle of unanimous evaluations—a notion that succeeded in crowning Walras’s project, in that it proved the superiority of competitive markets with respect to other market structures. It was in ‘Il massimo di utilita dato dalla libera concorrenza’ (1894) that Pareto put forward for the first time his notion of social optimum: this is an allocation that cannot be modified in order to increase the welfare of everybody. In other words, a social state is Pareto-optimal if and only if there is no other alternative state in which at least one individual is better off and nobody else worse off. On the other hand, a social state x is Pareto-superior to a social state y if and only if at least one individual is better off in x than in y without any other individual being worse off in x than in y.

Now, provided it exists, is a Pareto optimum unique? Clearly not! An allocation to which no other is unanimously preferred is not necessarily the allocation unanimously preferred. There can be a multiplicity of Pareto optima, none of which is comparable with the others on the basis of the unanimity criterion. Pareto’s fundamental result is the demonstration that each allocation associated with a competitive equilibrium is a social optimum in the above sense. If the allocation associated with a competitive equilibrium were unanimously preferred to any other possible allocation, then it would be possible to state that an equilibrium different from the competitive one is socially inferior to it. Yet it is not possible to assert the superiority, in general, of the competitive market structure, contrary to Walras’s idea. However, Pareto demonstrated the superiority of perfect competition over monopoly. He then tried to compare it with other market structures, but did not obtain significant results.

6.5.3. Barone, Pantaleoni, and the ‘ Paretaio'

Pareto, in spite of his despotic and intolerant attitude towards the ideas of others, managed to surround himself with some of the best economic minds of his time, giving life to the famous ‘Lausanne School’. In Italy, the dif­fusion of marginalism was the work of two illustrious members of the school, Enrico Barone and Maffeo Pantaleoni.

Enrico Barone was a singular economist. He spent the years of his youth and early maturity in the army, and published some excellent works on military history. With the passing of time he showed a growing interest in economics, an interest that in 1906 culminated with his resignation from the army to dedicate himself full-time to science.

As early as 1894, thanks to his friendship with Pantaleoni and Pareto, he collaborated on the prestigious Giornale degli Economisti, and many col­leagues, including Walras, predicted a brilliant career for him. However, during the decade after his death the prevailing opinion was that he had, at least in part, betrayed these expectations, and that this was due, perhaps, to the excessive heterogeneity of his interests. In any case, it is certain that his most famous work, the article ‘Il ministro della produzione nello stato collettivista’ (1908) had to wait until 1935, the year of the publication of the English translation, thanks to Hayek’s interest, for all its importance and originality to be recognized. In this article Barone raised the question whether a planner in a ‘socialist’ state, using a Walrasian general-equilibrium system, could obtain the same results as a decentralized economy based on private property. The answer was that the equations describing the two systems are formally equivalent, and that the only obstacle for the planner is one of computational complexity, a problem that in the competitive context is theoretically resolved by resorting to the auctioneer. All this is argued without any reference to the theory of utility, while the equivalence of the allocative results between the two systems is demonstrated with a pioneering use of Pareto optimality. Samuelson, in the Foundations (1947), recognized the importance of Barone’s contribution in establishing the correct use of Pareto optimality as a criterion of economic efficiency.

Although his work played an important role in the debate between the supporters of the centrally planned economy and those of the market eco­nomy, Barone believed that the ideological element was absent from it. Above all, he was interested in the possibilities offered by mathematics in the search for a solution to many practical problems. Paradoxically, from this point of view, his most important work was a failure because he came to negative conclusions about the practical possibility of central planning based on the Walrasian theoretical system.

Other works of Barone also deserve attention, for example his studies on the theory of distribution and the problem of the exhaustion of the product, which we have already mentioned; but especially those in the field of public finance. Also in this field he was able to use Pareto’s theories, above all his distribution law. He used this law to explain how the burden of taxation should be shared among the tax payers. Even though he was aware that the Pareto Law may not be stable, he defended it as a heuristic device to solve the thorny question of taxation. His relative lack of interest in theory itself meant that, when the first misunderstandings between Pareto and Walras arose, he stayed on the fence and tried to act as peacemaker, which only led him to be partially misunderstood by both.

Even today it is not possible to say how much Barone’s ideas have con­tributed to the formulation and consolidation of the systems of thought of his two mentors, who were certainly not very generous in acknowledging their intellectual debts, while Barone tended to be exactly the opposite. Perhaps a major re-evaluation of his thought still has to be accomplished.

Let us now turn to Maffeo Pantaleoni, also a singular personality but for very different reasons. He had a fiery and volatile character and his furious opposition to any form of restriction on intellectual freedom brought him more than a few enemies. Nevertheless, he was a supporter of the Fascist regime, and shared a great many of Pareto’s ideological prejudices.

Pantaleoni’s greatest merit may lie in his spreading within the Italian cultural world the ‘new ideas’ of Walras and Pareto and, more generally, the marginalist approach to economics. However, it is important to note that, from the methodological point of view, Pantaleoni was nearer to Marshall than Walras. More than one generation of Italian economists was educated with his extremely successful textbook: Principii di Economia Pura (1889).

229 Particularly important were his applications of marginalist analysis to some classic problems of public finance, such as the financing of public spending and the theory of optimal taxation. Pantaleoni was never dogmatic in his use of the marginalist categories, and his refined eclecticism often led him to anticipate the arguments of many of the most widespread modern heterodox theories.

Unlike Barone, the mathematical element never played a determinant role in his work. He believed economic reasoning to be endowed with an auto­nomous strength, which meant that any reference to ‘more noble’ disciplines was superfluous. The discipline that inspired Pantaleoni was not mechanics, but rather sociology, a science that studies diverse and complex causal fac­tors and the complicated social-interaction patterns in which they are combined.

We must also mention here Ugo Mazzola, author of I dati scientifici della finanza pubblica (1890), a book judged by Pantaleoni as a ‘lasting con­tribution’ to the foundation of financial science, and one which was to exercise a strong influence on Wicksell’s theoretical work. Mazzola was a student of Francesco Ferrara and a fervent admirer of the theories of Jevons and Menger. He was the first economist who came to understand the nature of public goods and describe their characteristics. He distinguished indi­vidual needs from collective needs and argued that it was the state’s responsibility to satisfy the latter. This was conceived as a co-operative of citizens aimed at producing certain services at lower costs than those borne by private business.

In 1912, Pasquale Jannaccone published an article, ‘Il ‘‘paretaio’’’, stig­matizing the prevailing tendency among Italian economists to follow in an uncritical way the methodological canons of the Lausanne School. As a matter of fact, the Italian economists in the first decades of the century were all, in one way or another, followers of Pareto and Pantaleoni. Yet, they concentrated their interest on applications of partial-equilibrium analysis, which they judged more likely to come to grips with reality and to produce results of practical value.