The Philosophy of Economics

A paper presented at the School of Economic Science Justice and Equity Conference 2010

Dr. Peter Bowman, London, UK

The philosophy of economics stands in relation to economics as jurisprudence to law and the philosophy of science to physical sciences. It seeks to identify and then question the validity of the assumptions on which the subject is based. It also seeks to delineate the proper scope of the subject and formulate the questions that set the direction of the subject. Should economics, for instance, concern itself primarily with the production of wealth or with the distribution of wealth? Since economics is a social science aspects of the philosophy of science will come within the philosophy of economics. The physical sciences have been concerned primarily with the discovery and application of natural laws. Is this also the goal of economics? Finally it is the task of the philosophy of economics to identify and question the values associated with the basic assumptions of the subject. It compares the benefits of different ethical systems. It recognizes that the system of economics followed by a society determines in practice the way people lead their lives. To what extent does a particular system of economics facilitate the realisation of mankind’s highest aspirations?


1. Introduction

The philosophy of economics[1] is now a well-established sub-discipline within philosophy. It stands in relation to economics as jurisprudence to law and the philosophy of science to the physical sciences. The aim of this paper is to provide an introductory survey of the field[2] in the context of the particular question of what the role of justice is in economics.

The chief task of he philosophy of economics is to identify the assumptions upon which the subject is based and then to examine them in the light of reason to determine their validity and truthfulness. A suitable framework for this endeavour is the dialectical method expounded by Plato in Books VI and VII of The Republic[3]. Arithmetic, geometry, astronomy and harmony are presented as suitable subjects in the education of the future guardians of the state under consideration in that dialogue. The rationale for this is that all these have the capacity to uplift since they have a structure based on hypotheses, the study of which takes the student out of the visible world of the senses to the higher realm of the “intelligible world”. However, Socrates presents the view that these subjects are not sufficient in themselves. An additional component, namely, dialectic is also required. In this subject the hypotheses of the other subjects are taken as a starting point. Rather than descending to the visible world there is an ascent to the higher intelligible world, a realm of principle, one with a greater degree of truth. The ultimate aim is to unite with the Highest Good itself. To arrive there was not the end of the processs. There was also the requirement to return to the lower realms and illuminate them with the philosophical insights gained.

It is the intention here to apply this Socratic method of dialectic to economics. Three areas will be covered. Firstly, there is the question of what the proper scope of the subject is. Secondly there is the question of the methodology of economics. How does it acquire its knowledge? What is the status of that knowledge and particularly to what extent are the methods of the physical sciences appropriate in this subject? Finally, the ethical basis of economics will be addressed.

2. The Direction of Economics

At present there is no universally agreed definition of economics that establishes its scope unambiguously. Rather than comparing the different ones that are presently in vogue the issue will be addressed by considering the way the subject has developed historically. In its present form economics has emerged relatively recently. It began as “political economy,” a branch of moral philosophy. The recent appearance of Adam Smith’s profile on our banknotes indicates his status as the acknowledged and respected founding father of the subject. For economics to rank as a subject worthy of study Smith recognised that it needed to go beyond the observation of the merely obvious and superficial aspects of commerce. What he wanted to pursue were the causes of the unintended consequences of the actions of individuals in their pursuit of wealth. Why, for example, should the effect of the importing of large quantities of silver into a country by merchants not have the effect of making everyone materially better off instead of raising the price of all other commodities? Hence the first part of the title of his ground-breaking work “An inquiry into the causes of the Wealth of Nations.[4]

As the industrial revolution gained momentum in the late eighteenth and early nineteenth centuries there was an undoubted increase in prosperity but the most obvious unintended consequence of this was that the newly created wealth was not evenly distributed throughout the population. It became concentrated in the hands of a few with the consequence that a large proportion of the population was condemned to poverty with its accompanying misery. To David Ricardo (1772 – 1823), one of the most influential economists of the generation following Adam Smith, the main question facing the subject was that of the distribution of wealth between the owners of the three main factors of production land, labour and capital,[5] the concern being with the mechanics of the process rather than the justice of it. Under the influence of Thomas Malthus[6] he formulated laws which condemned the workers to unending poverty and which also carried the implication that this was a natural state of affairs.

From this point political economy developed in three different directions. Each developed its own sense of the scope of the subject.  In two of these the question of distributive justice was addressed but in very different ways. Karl Marx gave a full and cogent analysis of what he saw as the exploitation of workers by the owners of capital. His solution was formulated in terms of a dynamic evolving model of the economy rather than the static view of the classicists. It called for the establishment of a new social order with the worker receiving a just return for his labour. Attempts to achieve this through revolutionary struggle proved to be unsuccessful in the long term. As a peaceful alternative the socialist movement sought a compromise in which the worst social effects of the injustices of the industrialisation were offset through state intervention without addressing their causes.

Meanwhile, in the United States, Henry George[7] adapted the concepts of classical economics in such a way as to clearly expose the fundamental causes of the injustices of the “capitalist” system identifying it with the private appropriation of public benefits generated by an economy with an advanced division of labour. Even though his ideas were well received and strongly advocated by some English liberals, including Winston Churchill,[8]at the beginning of the twentieth century they have still yet to be fully tested in practice.

The third direction, which came to be the mainstream, completely avoided the question of distributive justice and so also departed from the quest for the discovery of the fundamental laws governing economies as a whole implied in Smith’s Wealth of Nations.  Instead the focus became the private individual’s pursuit of wealth. Conveniently supported by Jeremy Bentham’s utilitarian ethics the subject that was political economy was transformed into the science of optimising consumption.

3. Methodology

The label of “science” was a convenient one to associate with this development since it disguised the essential immorality of the pursuit with a sheen of amorality associated with that word as applied to subjects such as physics and chemistry which, unlike economics, were not concerned directly with human nature.

J. S. Mill[9], a brilliant philosopher and logician as well as economist, took on the task of providing this redefined subject with a creditable scientific methodology. He recognised that the main practical difficulty facing it was the problem of distinguishing the effect of a single variable in the complex situations that pertained in society where a number of factors were always acting simultaneously. The first step he took to deal with this was to separate out from the rest those aspects of man’s activities that were connected with the pursuit of wealth, thus creating what he called the “separate science” of economics. He recognised that, of course, there were many other facets to human life, but for the purpose of analysis he considered it necessary to study this aspect in isolation. This hugely significant step seems to have been quietly accepted without much comment but it had huge ramifications, not just for the subject of economics, but for the whole direction of development of western culture where, as the importance of economics considerations have increased there has been a consequent devaluing of those aspects of human life not related to wealth accumulation.

In the physical sciences Mill recognised that the availability of the special conditions of the laboratory meant that a method a posteriori could be used to discover the effect of changing a single variable in a particular defined system, say for example, the temperature at which a chemical reaction takes place. From the results of a series of experiments the method of induction could be used to formulate a general law of the effect of temperature on chemical reactions. This in turn could then be tested by further experiments.

In economics, where the special conditions of the laboratory were not available the situation was too complex for this method to be applied with any rigour. Mill proposed a method a priori. In this method general assumptions were established by a process of reasoning based upon experience. On this basis testable predictions could be made. However, what was put under test were not the general assumptions themselves but rather their applicability to particular circumstances.

As an example he took the question of whether a despotic ruler was likely to abuse his power and use it to suppress the population under his rule rather than provide for their welfare. The method a posteriori would tackle this by studying particular cases from history, for example, and then seek to make a generalisation based upon these. The method a priori, on the other hand, would look at human nature in general and one’s own inner tendencies in particular and make an inference on that basis which could then be tested by looking at a particular instance.

Mill used another example from physical science of the tides to further illustrate the method. That tides are caused by the gravitational effect of the moon is an a priori assumption. To predict the time of high tide in a particular location would require additional information about the area and additional assumptions. If the prediction turned out to be wrong it would not negate the concept of gravity but only the assumptions made about that particular case.

As economics developed in its neo-classical form in the latter part of the nineteenth and early twentieth century it largely followed the method a priori. Sophisticated abstract models were developed by a process of reasoning and, increasingly, by the use of mathematical ideas. Meanwhile, in the physical sciences, under the influence of a developing philosophy of science, quite a different direction had been taken.[10] Looked at very simply two schools concerning the goals of science could be discerned. On the one hand there were scientific realists. They held that science should not only enable reliable predictions about the particular phenomenon under investigation to be made but should also produce meaningful explanations of phenomena which enable us to discover new truths about the world. On the other hand, for instrumentalists the emphasis was mainly on just developing tools to make reliable predictions. For some of them this was because the emphasis was on the practical application of science whereas for others it was because of a scepticism about finding fundamental “truths”. During the early twentieth century, under the influence of the philosophy of logical positivism, the instrumentalist view gained a lot of support, particularly in physics and there was a strong suspicion of attributing meaning and significance to anything abstract.

In the wake of this, by the middle of that century, economists began to get guilty feelings about their a priori methods. In particular Milton Friedman[11]strongly advocated the instrumentalist approach in economics. He declared that the prime concern should be to find fits of data and that the ‘realism of assumptions’ was not important. The correlation that he found between prices and money supply over a twenty-year period provided the empirical basis of his monetarist approach to regulating the economy[12]. Although it received a lot of criticism from other economists it found favour with politicians in Britain and the US where it gave rise to the use of interest rates as the main tool to control inflation.

This approach amounts to a dismissal of the Platonic dialectical method advocated at the beginning of this essay as of no value. Hausman wittily and satirically revealed the flawed thinking behind it in his essay Why look under the hood?[13]  He summarises Friedman’s basic argument as the assertion that what makes a hypothesis good is only whether it provides meaningful predictions and so the only test of the validity of such a hypothesis is that it does provide such predictions. Hence, any other analysis of the hypothesis is irrelevant. Hausman compares this with buying a second hand car. It is like saying that since the qualities of a good second hand car are that it drives safely, economically and comfortably then the only test of whether it is a good second hand car is to take it on a test run and see if it does drive safely, economically and comfortably. To get a mechanic to look under the hood (bonnet) and check the various mechanical components is of no use!

Underlying Friedman’s instrumental approach to economics was the distinction he attributed to John Neville Keynes[14] (Juhn Maynard’s father) between a positive and normative science. The former, Keynes suggested, deals with facts, with what is, whereas the latter deals with values, with what ought to be. On that basis Friedman argued that “positive economics is in principle independent of any particular ethical position or normative judgements.” Before questioning the validity of this assumption one additional aspect of the methodology of positive economics will be considered and that is the extent to which it should be a mathematical science.

Given the success of mathematically based physics following the work of Isaac Newton and others it was not surprising that economists found it attractive to use it as a model for their own science. William Stanley Jevons articulated the basic assumption behind this approach in his Theory of Political Economy of 1871.[15]

‘It is clear that Economics, if it is to be a science at all, must be a mathematical science… Many persons seem to think that the physical sciences form the proper sphere of mathematical method, and that the moral sciences demand some other method – I know not what. My theory of Economics, however, is purely mathematical in character. To me it seems that our science must be mathematical because it deals with quantities.

However, in his essay Can Mathematics be used successfully in Economics[16] Donald Gillies, Professor of Philosophy of Science and Mathematics at King’s College cogently points out that there is a fundamental and significant difference between the quantities used in economics compared with those used in physics. The latter, he points out, are things such as the mass of a falling body, its velocity and air resistance, that are estimates of exact quantities which actually exist. By contrast, the quantities used in economics, for example such things as money supply, rate of inflation, level of unemployment, or more arcane examples such as “brand value” and “goodwill” are what he terms “operational numbers”. They do not correspond to existent quantities but are the result of an attempt to deal in a convenient way with what are essentially qualitative phenomena. As such their numerical values depend as much on the convention used to define them as upon the thing in itself. Hence, to a certain extent they are arbitrary and so it follows that the relationships found between them may have no real significance.

Gillies goes on to point out that not all good science is necessarily mathematically based and that it was perhaps inappropriate that economics chose to model itself on the analytical methods of mathematical physics. As an example of good non-mathematical science he points to the research into disease pioneered by Pasteur in the late nineteenth century that led to the germ theory. This was a very successful endeavour. It paved the way for the development not only of a number of cures but also of preventative strategies. Key to this was a major shift in understanding which went beyond the instrumentalist approach and enabled a wide range of application of the new discoveries. The basic research had no reliance on mathematics but was still a diligent enquiry into the cause of a phenomenon in a complex system. This suggests a more appropriate model for economic science and one more suitable to pursue Smith’s original direction of determining those causes of economic phenomena which, if properly understood, could enable the unintended consequences of actions to be anticipated.

4 Economics and Ethics

The division of economics into positive and normative branches was an attempt to separate the facts from the values so that at least in part the subject could become a mathematically based science independent of any ethical basis. However, what separates economics from the physical sciences is that it deals with human actions and the nature of humans so that any full explanation of a human action requires a reference to its inner motives as well as the external appearance. The nature of these inner motives is such that they are subject to evaluation, to praise or condemnation and thus have an ethical basis.

In Essay on the Nature and Significance of Economic Science Lionel Robbins[17] defined economics in as the science which studies human behaviour as a relationship between ends and scarce means that have alternative uses. It thus moved economics in the direction of the science of individual choice, consumer choice, and is now widely accepted and influential. Thus, when supermarkets are attacked because of the way their low prices force the producers who want to stay in business to ethically questionable practices such as factory farming of animals and sweatshop labour for clothing,[18] their reply is that they are driven by the requirement to satisfy customer preferences. Recently in the UK the same idea has appeared in the political arena where providing choice has been at the basis of reform in health and education. Although positive economics makes the claim that this is based on a system that is value free and therefore amoral rather than immoral, when its development is traced back it is becomes clear that its ethical basis has been ignored rather than removed.

The “preference satisfaction” basis of neo-classical economics has its roots in the utilitarian ethics of Jeremy Bentham. According to moral philosophy this belongs to one of the three recognised ethical structures known as consequentialism. The essential attribute of this ethical system is that the qualities of actions are judged by their consequences. The right action is judged as the one with the best outcome. Hence one should do what maximises the total good. In utilitarianism the outcome that matters is individual welfare or well-being which Bentham and Mill equated with the mental state of happiness. Utility was the property of objects that caused this mental state. The price one was prepared to pay for something gave an indication of its utility. Over the nineteenth century the concept received some refinement which made it more compatible with the methods of the positive sciences that economics was endeavouring to imitate. W. S. Jevons in the UK, Karl Menger in Austria and J. B. Clark in the US almost at the same time came up with the idea of marginal utility.

On a hot, sunny day ice creams have a high utility and one would probably be prepared to pay a high price for one. After the happiness gained from consuming the first the second will be less inviting but one still might be tempted if the price was lower. For each succeeding one the utility is lower until by the sixth or seventh it may even have a negative utility. It is this marginal utility, the utility of the next item that is significant rather than the utility of the commodity as a whole.

Francis Edgeworth then suggested that whereas utility as the provision of happiness could not actually be objectively measured the relative utility of two things such as an ice cream and a cold drink could be validly compared. To formalise this he introduced the idea of preference. This concept could be extended to build up an order of preferences that could be transformed into a mathematical entity called a utility function. All that remained was to shoe-horn human beings into the theory. This was done by adapting the meaning of the term “rational”. In the choices they made people were assumed to act rationally and rationality was defined in terms of conforming to certain technical requirements of being “transitive” and “complete.”  Essentially this meant that their preferences corresponded to a consistent pre-established order and they always chose in accordance with these preferences. In this way, with the additional assumption that people prefer more to less the normative ideal of “maximising utility” under a given set of constraints could be replaced by the positive notion of preference satisfaction.

That was positive economics. Neo-classical normative economics deals with human welfare but with an additional couple of assumptions the preference model could be extended to cover this branch of the science as well. Firstly the individual is assumed to be self-interested, he only prefers x to y if he believes x is better for him than y. Secondly he is assumed to have perfect knowledge so he only believes something is better for him if it actually is better for him. On this basis welfare, or well-being can also be equated with preference satisfaction (not actual human satisfaction but individuals getting the choices they prefer given the prevailing constraints).

In building up this theory there are a number of assumptions, all of which are within the remit of the philosophy of economics to call into question. That will not be attempted here but rather it will be pointed out that the model is in fact not amoral but has at its basis the underlying ethical system of utilitarianism, a form of consequentialism[19]. Its appearance as value free comes about through the substitution of moral decisions by calculations. The basis of the ordering of preferences to maximise utility is a cost-benefit analysis which it is hoped can be established quantitatively. But there are difficulties. It was shown earlier that if the quantities underlying the analysis are operational numbers and their nature is such that there will always be a certain arbitrariness in the outcome of such calculations. There are other practical operational difficulties with establishing a policy based on maximising utility as well. First there is the problem of defining utility/welfare/well-being in such a way that it can be calculated. Secondly is the problem that although the outcomes of actions are far from certain the method requires that they be predicted beforehand. The history of the implementation of economic policy is plagued with the appearance of unintended consequences additional to those prescribed. A third problem in attempting to maximise total utility is the question of whom to include. Should future generations be accounted for and if so for how long? Should other creatures be included? If so, how does one compare the utility gained by a human to that of say one of the few remaining panda bears. Does one consider just the number of individuals or include consideration of what proportion of the total species each individual is? There is also the question of whether to go for total or average utility. If the latter, then one of the most efficient ways of maximising utility would be simply to get rid of those with low values. Finally there is the thorny issue of interpersonal comparison in which the way a particular policy will affect different people in very different ways needs to be recognised and allowed for.

There are cases where the outcome of utilitarian reasoning is simply unpalatable. Hausman and McPherson begin their Economic Analysis, Moral Philosophy and Public Policy[20] with the infamous leaked memo published in the Economist. Written by Lawrence Summers, then chief economist of the World Bank, it lays out with self-styled “impeccable logic” the case for exporting pollution from developed areas such as the west coast of the US to Third World African countries. In terms of maximising total utility the reasoning cannot be faulted but the outcome is hardly acceptable. Moral philosophers give a starker example. Suppose you were held in a hostage situation. Given the choice, would you shoot one fellow prisoner if it prevented two others from being murdered?

Those who are familiar with it will recognise that in the traditional teaching of the east the whole consequentialism is dismissed in two sentences. In the Bhagavad Geeta, set on the battlefield of Kurukshetra, the Lord Krishna tells the warrior Arjuna, in despondent mood because of a particular consequential dilemma in which he finds himself because of having to fight his relatives: “Thy concern is with action alone, never with results. Let not the fruit of action be thy motive…” [21]

And later the same message is reinforced:

Do thy duty perfectly without care for the results; (III, 19)

These directions are from a different system of ethics, deontological or duty based ethics. This consists essentially in judging an action by reference to a set of rules. Examples from the Christian tradition are the Ten Commandments or Christ’s command to “Love thy neighbour as thyself.” This method introduces both a particularity and a first person perspective into the decision making process. The focus is not now on consequences but with the nature of the action itself. The fifth commandment does not say, “minimise killings” it says, “Thou shalt not kill” and it has relevance to a particular situation in which a particular individual finds himself.

Although it is not often stated explicitly the market economy with its self-interested utility-maximising individuals is only possible in a community in which there is adherence to a deontological code, one where, for example, property is respected (not stealing) and in which there is symmetric information (honesty). These must be pre-established from the norms of the society through a hierarchy of different levels, family, nation, culture and civilisation and provide the substratum of acceptable behaviour which enables economic activity to take place. Adam Smith’s Wealth of Nations was predicated on his Theory of Moral Sentiments which describes this.

According to moral philosophy there is also a third approach to ethics and this also has relevance in economics. This is virtue ethics[22]. In the west it had its origins in Plato and Aristotle and up to the Enlightenment was the dominant approach in moral philosophy. It was eclipsed for a time after the Enlightenment but recently has started to re-emerge. Issues such as abortion, euthanasia, and developments in medicine and agriculture are demanding something more than a consequence- or even a rule-based approach to decision making. Here, finally we come at last face to face with the theme of this conference and the virtue of justice together with its companion equity, and the application of justice to correct the deficiencies of law are revealed.  Standing alongside them are the other virtues such as honesty, truthfulness, courage, compassion and wisdom.

If we have grown dissatisfied with our utilitarian based economic system and its increasingly damaging consequences both for the human species and its environment then a return to these virtues could provide an alternative ethical basis and a new direction to economics. In the context of economics justice could be interpreted in the Roman Emperor Justinian’s sense as simply “rendering to each his due”. The applications to economics are obvious – a just distribution of wealth, the worker getting the full recompense for his labour and all excluded citizens being fully compensated when one of their number acquires sole use of a particular location or natural resource.

The application and practice of virtue is not necessarily an easy thing. It is more difficult even than adhering to a system of rules of behaviour and much more difficult than just choosing what one prefers. It requires subtlety and discernment and its full cultivation may take a lifetime. Hence any major economic reform to a virtue-based system would have to be accompanied by a companion programme of human development.

Looking back at the history of mainstream economic thought from the early nineteenth century has been characterised by the avoidance of the fundamental issue of distributive justice. It has done this by attempting to transform economics from an aspect of moral philosophy to an imitation of a mathematically based positive “science.” For everyone who has prospered from this many more throughout the world have suffered.

In practice economics is collectively about how we live our lives. Most people wish to live justly and equitably. The philosophy of economics presents a method of analysing afresh the underlying assumptions of economics allowing the way to be cleared for it to return to its roots in moral philosophy and there receive due consideration from the value system upon which it should be based.

[1] Hausman, Daniel M: (ed) The Philosophy of Economics, an anthology, C U P, 1994.

[2] Hausman, Daniel M: The Philosophy of Economics, Stanford Encyclopaedia of Philosophy, 2003.

[3] Jowett, Benjamin: (translator) The Dialogues of Plato, The Republic, Book VI lines 507 to end.

[4] Smith, Adam: The Wealth of Nations first published 1776, Penguin Classics, 1999.

[5] Ricardo, David: Principles of Political Economy first published 1817, Prometheus Classics, 1996.

[6] Malthus,Thomas: Essay on the Principle of Population, 1798.

[7] George, Henry: Progress and Poverty first published 1879, new abridged edition Robert Schalkenbach Foundation, 1998

[8] Churchill, Winston: The People’s Rights, Hodder & Stoughton, 1909

[9] Mill, John Stuart: On the definition and method of political economy in ref.1, chapter 1.

[10] ref 1, Introduction.

[11] ref 1, ch 9.

[12] Galbraith, J. Kenneth: History of Economics, Penguin, 1991.

[13] Ref 1 ch 11.

[14] Quoted in ref 11

[15] Quoted in ref 16

[16] Fullbrook, E. (ed) A guide to what is wrong with economics, chapter 18, Anthem Press, 2004.

[17]  ref 1ch 4

[18] Simmons, Andrew: Tescopoly, Constable & Robinson, 2007.

[19] Wilber, Charles K: in ref 16, ch 14.

[20] Hausman, D. & McPherson, M. Economics Analysis & Public Policy CUP,2006

[21] Bhagavad Geeta II 47

[22] Hursthouse, Rosalind: Virtue Ethics Stanford Encylopaedia of Philosophy, revised 2007.