ESTIMATING THE KEY RELATIONSHIPS OF NEOCLASSICAL PRICE THEORY AT CHICAGO

IN THE 1920S AND 1930S

Henry Schultz and Paul Douglas

Henry Schultz (1893-1938)(Chicago Faculty 1926-1938)

“Just as a sailor needs a compass, so the quantitative worker, if he is to have a deep understanding of his own work, needs an economic theory. It may not be a perfect theory, but a theory he must have . . . Without stretching the metaphor, it may be affirmed that the pure (mathematical) theory of economics stands in relation to literary theories as the Sperry gyroscopic compass does to the ordinary variety of mariner’s compasses.” (1926)

Schultz on the Theory of Demand, as developed by Pareto and those who followed him

“The equations summarizing the interrelations [of demand for related goods] constitute a category of laws that is rare in the social sciences: they specify quantitatively definite relations which must exist between the variables – if the theory is true. They enable us to test extent of the agreement between theory and fact. Probably the most important of these relations is that given by the Slutsky condition, which is essentially a test of rationality or consistency in the marketplace . . . The Slutsky condition is valid, whether or not utility is measurable. . . ” (1935)

Schultz on the failure of his tests of demand theory

“A very easy way out of the difficulty is to assume that farmers are not rational economic beings – which may be true. . . I prefer to believe . . . that the contradiction in question is an instance of the treacherous difficulties of inference from time series, or that some factor has been overlooked, or that the data are not reliable for the purpose in view.” (1933)

Paul Douglas (1892-1976)(Chicago Faculty 1920-1948)

“It has long seemed to me that the inductive, statistical, and quasi mathematical method must be used if we are ever to make economics a fruitful and progressive science. The neoclassical school has constructed a valuable theoretical scaffolding . . . This is a beginning, but only a beginning. For in order to make the analysis precise . . . it is plainly necessary to determine the slopes of the demand and supply curves . . . There is need for a similar approach to the problems of distribution. We need to know whether the assumed curves of diminishing marginal productivity are merely imaginative myths or whether they are real, and if the latter, what their slopes are. We need to know more about the supply functions of the factors and whether the actual processes of distribution furnish any degree of corroboration to the inductive tendencies discovered” (1933)

Douglas on his Critics (I)

It is one of the amusing and at times irritating ironies of the present state of economic science that many modern statisticians . . . seem resolved to maintain the innocence of their beloved figures by keeping them unsullied from intelligent analysis . . .They seem resolved to do battle to the end against anyone who seeks to use them as a means of obtaining significant and interpretive results.” (1934)

(T)he high priests of “pure” theory never tire of pointing out that they are dealing with only static conditions . . .when statistical series dealing with time sequences or even relative distributions in space are brought forward the armchair theorists brush these aside on the ground that they may include either shifting of curves or different curves. Should we [therefore] abandon all efforts at the inductive determination of theory and remain in the ivory tower of “pure” theory? If this is what is done, we may as well abandon all hope of further developing the science of economics. . . . (1934)

Douglas on his Critics (II)

[Use of industry level data] is somewhat disconcerting to those who are accustomed in their a priori reasoning to start with the theory of production for an individual firm . . . Such theorists probably believe that we are starting at the wrong end . . . I should be glad to make studies of individual firms if the necessary data were available. But I am reluctant to believe that we should stop all our investigations until . . . facts are forthcoming from a multitude of firms. I personally see no reason why we cannot approach this problem from either end and study the macrocosm as well as the microcosm. . . Why should we not study the economy as a whole as well as speculate about the individual firm, particularly since knowledge of the former throws a great deal of light on the problems of the latter? (1947)

Criticisms of the production function of the type advanced by the users of confluence analysis such as Dr. Mendershausen are in our judgment essentially sterile. Recent discussion along this line shows that this group will reject any analysis which does not show every conceivable point on a production surface. But enormous quantities of labor are seldom wedded to minute quantities of capital, any more than giants and pygmies are often mated in real life. (1942)

The “Empirical Tradition” of H. Schultz and P. Douglas: Four Propositions

Economics, if it is to be a progressive science, must have an important empirical component.

Empirical research in economics should be informed and guided by theory, and the neoclassical theory of value and distribution, expressed in mathematical form, is a very useful theory for this purpose

The essential concepts and relationships of neoclassical theory, though static in nature and in a sense “unreal”, can be identified and measured in the data generated by the real dynamic economy through the use of advanced statistical methods. Thus, the development of such methods is an important task for empirical economists.

The statistical procedures used to measure these theoretical entities can also be used to test fundamental assumptions and implications of the theory, thus providing a means by which economics can satisfy an important criterion of modern science.