There is a widespread feeling that the discipline of economics is not dealing enough with the problem of inequality, or that it is not doing so properly.
The questionnaire we submitted to the participants to Cologne Summer School (where we held a lecture) also confirmed this feeling: to the question "Do you think that the discipline of economics is dealing properly with inequality?" most students answered in the negative.
There is a precise historical reason behind this feeling: in fact, a certain strand of economic theory has relegated inequality to a secondary instance, or even asserted that there is no point in asking this problem.
A complete examination of distribution theories would have been too extensive to tackle, so in our presentation we have decided to focus on a precise moment in the history of economic thought, the one in which marginalist theory takes over from the theory of value, determining the decisive separation between the problem of production and that of distribution. In this vision of the economy, which we will outline in more detail in the next few lines, everyone receives what they deserve: wages are the just remuneration of labour, as interest is that of capital. In other words, we have tried to explain the reason for economics' apparent lack of interest in the problem of income distribution, which is another way of looking at the issue of inequality.
The starting point are so-called classical economists: Adam Smith, David Ricardo, Robert Malthus. These economists were active between the mid-18th and late 19th century, when economics started to acquire its own autonomy as a discipline, detaching itself from ethics, philosophy and sometimes religion.
Just as, in the natural sciences, the discoveries of classical physics had led to the hope that the world could be explained by mathematical formulae, so the dream began to be nurtured that laws of the same kind could also exist in the succession of human events. The impact of this revolution in thought, coupled with the unfolding of the hitherto unseen power of the industrial revolution, led some scholars to question the causes of the difference in wealth between nations and individuals.
Summarising the thinking of these economists is no easy task, not only because of the diversity of their positions, but also because they embraced a wide variety of themes in their thinking. What is relevant to our story is that the classical economists, albeit in different ways, had theories of distribution and addressed the problem of inequality.
These economists were engaged in investigating how the surplus formed by economic action is distributed among the agents operating in the economy. In this sense, they had developed theories of income distribution, albeit of a functional type, so much so that Ricardo would state that 'to determine the laws which regulate this distribution, is the principal problem of the Political Economy'1(Ricardo,1821, Preface, p. 5). Connected to this problem was that of establishing what the value of goods was, a concept prior to price, which would thus represent a phenomenal form of it.
In a different way and with different arguments, for classical economists one of the pivotal problems was to establish the origin of the value (and then the price) of commodities. The search for a theory of value was to be the main problem that kept the classical economists busy (which they in turn inherited from earlier thinkers) and which was to constitute the theoretical framework of reference until the first half of the 19th century. In particular, the labour theory of value, developed differently by Smith and Ricardo, enshrined the link between the value of a commodity and the labour required to obtain it.
After classical economists
In the mid-nineteenth century, three different ideas helped to radically change the conceptual apparatus of classical economists. These ideas form the pieces of a jigsaw puzzle that will help us see how the problem of income distribution (and thus inequality) is no longer the central problem of economics.
The first is the marginalist revolution, the second is the search for general economic equilibrium and the third is the Pareto efficiency concept. These are ideas developed by different figures in the history of economic thought, but which over time found a common synthesis in what would become the neoclassical economic paradigm.
The marginalist revolution is perhaps the first real conceptual revolution in the history of economic thought. Three different thinkers in three different countries (Léon Walras, William Stanley Jevons and Carl Menger), without communicating, arrived at the same idea: by recovering the concept of utility from the utilitarian tradition and combining it with the theories of infinitesimal calculus, they developed the idea that the value of goods corresponds to the value that each of us associates with an incremental unit of a given good. Man, the economic agent, thus becomes homo oeconomicus, an agent who maximises his own utility (echoes of Bentham are evident here). The quantity of labour is therefore no longer the determining factor in determining the value (and price) of a commodity.
The marginal utility approach will become the core of all subsequent economic analysis, and it is the basic method still applied today. This change in the approach to economics, which is not by chance called a 'revolution', is also sanctioned by the transformation of the discipline's name: the influential British economist Alfred Marshall (1842-1924) stopped using the term 'political economy' to refer to the still fledgling discipline of economics, and coined the term 'economics'. In 1932, Lionel Robbins (1898 - 1984), from the Marshallian tradition, would define economics as the science that studies human behaviour in relation to the alternative allocation of scarce resources. No room for fairness, but also and above all for value judgements. Robbins' explicit intention is precisely to eliminate everything that is not immediately referable to a calculation.
Let us take a step back to deal with the second piece of the puzzle. In fact, one of the three authors of the marginalist revolution also developed another idea destined to change the history of economics. The most famous contribution of Léon Walras (1834 - 1910) is that he laid the foundation for the theory of general economic equilibrium.
Walras was fascinated by classical physics and he imagined the economy as a system of interconnected markets that could be represented by a system of equations. The solution of each equation would represent the price that manages to equalise supply and demand. The solution of the system would then be a vector of equilibrium prices, such that each market would be in equilibrium. Walras would never be able to overcome the mathematical difficulties inherent in the enterprise, but the appeal of the idea of general economic equilibrium would generate a very prolific line of research, culminating in Gérard Debreu's proof of the existence of equilibrium in 1959 and continuing with other notable contributions.
What is relevant to our story is that the idea of general economic equilibrium is accompanied by another, more implicit, but very powerful idea: that everything can be conceived of as a market, even that which could not be marketed until then (e.g. labour). The conceptual scheme of supply and demand began to appear as a convenient framework for structuring economic problems.
The economy then began to take shape as a set of interconnected markets, populated by agents maximising marginal utility, in which prices were the phenomenal form of this manifestation. And yet there was still a problem: that of efficiency. How could the efficiency of such a configured system be judged?
This is where the third piece of the puzzle comes into play, the concept of Pareto-efficiency. This concept was developed by the economist and sociologist Vilfredo Pareto (1848-1923) - who clearly did not call it that... According to this concept, a situation is Pareto-efficient (or efficient in the Pareto sense) if it is not possible to increase the welfare of any of the actors involved, except by reducing the welfare of some of them.
The concept of Pareto-efficiency will be central to a particular branch of economics that is very relevant to our history: welfare economics. Conventionally born in 1932 with Arthur Cecil Pigou's (1877-1959) book 'Economics of Welfare', welfare economics seeks to assess whether or not economic situations approach a social optimum. The history of welfare economics is dense and troubled, studded with rival and diametrically opposed approaches centred on the conflict between positive and normative analysis.
The two fundamental theorems of welfare economics develop in the sense of this discipline, crystallising the modus operandi that welfare economics would uniformly adopt:
First fundamental theorem of welfare economics:
A perfectly competitive market system is capable of Pareto optimum allocation.
Second fundamental theorem of welfare economics:
By appropriately modifying the initial distribution of resources among individuals and then leaving it to the operation of the market to realise the efficient allocation of resources, it is possible to achieve a different optimal situation than that realised with the initial distribution of resources.
These two theorems bind the theory of economic equilibrium to a judgement of efficiency, but not of fairness, and sanction the theoretical justification for laissez-faire policies. As shown by a famous two-agent, two-goods diagram used in basic microeconomics courses (the Edgeworth box), Pareto-efficient allocations are also those in which one agent has all the goods and the other has nothing.
Squaring the circle
The neoclassical paradigm, of which we have illustrated some of the main axes, then adds to the analysis of the consumer the analysis of the enterprise, with entirely analogous structures hinging on maximisation: the enterprise maximises profits, or minimises costs, an operation analogous to the former as proven by Paul Samuelson. Marginality enters here as marginal factor productivity: wages and interest are the remuneration of the respective factors of production.
Thus wages are the remuneration of the labour factor, just as interest is the remuneration of the capital factor. The picture is thus complete: economics describes a world regulated by markets, where the consumer maximises his utility, just as the enterprise maximises profits. Pareto efficiency and the two theorems of welfare economics provide scope for adjustment of equilibrium configurations through modification of agents' initial endowments, but it is not the economist's job to deal with questions of distributive justice. Economics looks at efficiency, guaranteed by markets that tend towards equilibrium, everything else is the business of politicians and sociologists.
Economics, but also politics
Neoclassical economics is the hegemonic, or mainstream, paradigm now taught in all the universities of the world. What is less well known is that this conceptual framework has also been the basis for the formulation of many neo-liberal policies, such as those mentioned in the first part of the article. And it is here that the apparent disinterest of economics in the issue of distribution becomes apparent even to the uninitiated. Confidence in the market has led to disinterest (often perhaps self-interested) in redistributive policies, relegated only to the modification of initial allocations as dictated by the second theorem of welfare economics.
Interestingly, in the neoclassical paradigm there are no conflicts, especially class conflicts. The principle of marginal productivity guarantees the efficiency of factor remuneration, whereby everyone gets what they deserve according to the laws established by the market.
Piero Sraffa (1898-1983), one of the most important Italian intellectuals of the 20th century, demonstrated in his book Production of Commodities by means of Commodities (1960) that, on the contrary, at the core of neoclassical theory remains the conflict between wages and profits. This is a bursting result, also because it is demonstrated with absolute mathematical rigour, and precisely because of its potentially devastating scope for the dominant theory worthy of a real damnatio memoriae, especially in Italy. Sraffa's result is potentially so explosive that Claudio Napoleoni, an Italian economist active in the 20th century, asserted that Sraffa....
...forces us to start all over again.
What is to be done?
In contemporary economic theory, in the face of a succession of often planetary economic crises such as that of 2008, there are two contrasting phenomena. On the one hand there is the consolidation of the mainstream paradigm - especially in universities and also thanks to the publication mechanism of academic articles - and on the other hand there is the blossoming of so-called heterodox theories that put the issue of inequality at the centre of their discourses.
While on the one hand the limitations of the neoclassical paradigm emerge with increasing clarity, on the other hand there is a kind of closure of this paradigm, which raises its defences in the face of attacks from theories that blame it for not paying enough attention to issues such as environmental sustainability and inequality.
It should be noted, however, that even in mainstream theory there has been a progressive recognition of the centrality of the problem of equity in the distribution of resources, not least due to the awarding of the Bank of Sweden's prize for economic science in memory of Alfred Nobel (mistakenly called the 'Nobel Prize for Economics') to Abhijit Banerjee, Esther Duflo and Michael Kremer, whose research has focused precisely on the problem of inequality.