Quality Magazine

Off-Topic: The Pareto Principle - What You May Not Know

September 29, 2009

Born July 15, 1848, Vilfredo Pareto was an Italian economist, theorist and sociologist. Pareto is chiefly known for his influential theory of ruling elites. Also, he is generally credited as the father of a diagnostic tool used by all who apply the very rudiments of quality analysis.

In the late 1930s, Dr. Joseph M. Juran began studying Pareto’s extensive work and theory on the distribution of wealth in Europe. Pareto found that there were a few people with a lot of money and many people with little money. This unequal distribution of wealth became an integral part of economic theory. Juran recognized that this concept had universal application and could be applied to many fields-including quality analysis.

Pareto became one of the leaders of the University of Lausanne. Named for the city in which the university was founded in 1537, it was initially known as the Lausanne School, which is still located in Switzerland. Pareto also was an illustrious, if not controversial, member of the “second generation” of the neoclassical revolution. This revolution was to play a significant role in transforming the thinking of economists. Although only mildly influential during his lifetime, his approach to general equilibrium theory, documented initially in his “Manual of Political Economy” (1906), was resurrected during the 1930s. This period has been named the “Paretian Revival,” in his honor, and has guided much of the economic world since.

Pareto was born in the year of people’s revolutions at its epicenter-Paris, 1848-to an Italian aristocratic family. His father was a Ligurian marquis (a nobleman ranking above an earl and below a duke) and educated as a civil engineer. Pareto’s family had fled to Paris in 1835 in self-imposed exile, following the example of other Italian nationalists. Pareto was the third child (and first son) of his father’s marriage to a French national.

The Pareto family returned to Piedmont, Italy, in 1855. Following in his father’s footsteps, Pareto studied the classics and later engineering at the Polytechnic Institute of Turin. It was there that he acquired his proficiency in mathematics and his basic ideas about mechanical equilibrium that were to characterize his later contributions to economics. After graduating in 1869 at the top of his class, Pareto took his first job as a director of the Rome Railway Company. He performed well in this position and, in 1874, was named managing director of an iron and steel concern, the Società Ferriere d’Italia in Florence, Italy.

Political activity, much of it fueled by his frustrations with government regulations, marked Pareto’s stay in Florence. A democratic republican and free trader by instinct, Pareto deplored aristocratic and government corporatism. He sided with the radical democratic movements and the liberals, who, he believed, would replace privilege with meritocracy, restore real democracy, pursue free trade and true competition, and promote social welfare. So moved, Pareto ran unsuccessfully for office on an opposition platform in the district of Pistoia in 1882.

In 1889, after the death of his parents, Pareto changed his lifestyle. He inherited the marquis title, but he never felt comfortable using it because of his political and societal beliefs. Instead, he quit his job, married a penniless Russian woman from Venice, Alessandrina (Dina) Bakunin (from whom he was estranged in 1901), and moved to a villa in Fiesole.

From his retreat, he began writing numerous controversial articles against the government and accepted economic doctrine, and gave public lectures at a workingman’s institute. For attacking previously accepted principles of wealth and economics, authorities targeted Pareto as a troublemaker. His lectures often were closed down and his applications for teaching positions rejected.

His activities brought him to the attention of Maffeo Pantaleoni, then Italy’s leading neoclassical economist. A friendship sparked between the two men, and Pantaleoni introduced Pareto to economic theory. Pareto, a quick learner with exceptionally good mathematical aptitude, took to it immediately and published several theoretical articles in the Giornale degli economisti.

Pareto became so well known that Léon Walras, a well established economist in his own right, selected him, in 1893, as his replacement as chair of political economy at the University of Lausanne in Switzerland. From his academic position, Pareto’s nerve and confidence increased. His views on the Italian government continued in his monthly column to the Giornale degli economisti and in foreign journals.

Pareto produced a three-volume edition of his lecture notes, “Cours d'économie politique” (1896, 1897). This was more than merely a restatement of the current economic doctrines. Interspersed with his presentations of pure economic theory were numerous asides on methodology and applied economics and extensive sociological observations. This work evoked a great deal of commentary from other economists of the time.

In “Cours,” his main economic contributions were his exposition of “"Pareto’s Law” of income distribution. He argued that in all countries and times, the distribution of income and wealth follows a regular logarithmic pattern that can be captured by the following formula:
    log N = log A + m log x
N is the number of income earners who receive incomes higher than x, and A and m are constants. During the years, Pareto’s Law has proved remarkably resilient in empirical studies.

Pareto also was troubled with the concept of utility. In its common usage, utility meant the wellbeing of the individual or society, but Pareto realized that when people make economic decisions, they are guided by what they think is desirable for them, whether or not that corresponds to their wellbeing.

In 1896, Pareto inherited a small fortune from an uncle. This additional wealth caused him to think of retiring to pursue research. At this point he began developing his theories for which he is most famous, elitism and irrationalism in politics.

In his own political career Pareto had been an ardent activist on behalf of democracy and free trade, which is consistent with his father’s beliefs. His lifelong views, however, were changing. The reasons for changes in his political outlook have been debated extensively. Most likely they were engendered by the results of his study.

In 1906, Pareto published his “Manual of Political Economy,” his magnum opus on pure economics, which moved him out of the shadow of Walras, his mentor at the University of Lausanne. Unlike the “Cours,” “Manual” concentrates on presenting pure economics in an explicitly mathematical form (especially after it was heavily revised for the 1909 French edition).

The Walrasian equations are still there, but the focus is on formulating equilibrium in terms of solutions to individual problems of objectives and constraints. To illustrate this, the indifference curve of Edgeworth (1881) was employed extensively-both in his theory of the consumer and, another great novelty of the time, in his theory of the producer. It is in “Manual” that we find the first representation of what has since become known as the “Edgeworth-Bowley” box.

Like Irving Fisher (1892), Pareto stumbled on the idea that cardinal utility could be dispensed with. Preferences were the primitive datum, and utility a mere representation of preference ordering. With this, Pareto inaugurated modern microeconomics. He introduced the notion of Pareto-optimality, the idea that a society is enjoying maximum ophelimity when no one can be made better off without making someone else worse off.

Pareto retired from his chair at Lausanne in 1907. He moved to Villa Angora in Céligny, near Lake Geneva. Pareto used his time at Céligny to write his “Trattato di sociologia generale” (“The Treatise on Sociology”), which was finished in 1912 and published in 1916. (The work was published in English translation as “The Mind and Society” in 1935.) This was his great sociological masterpiece. He explains how human action can be neatly reduced to residue and derivation. People act on the basis of non-logical sentiments (residues) and invent justifications for them afterwards (derivations). The derivation is thus just the content and form of the ideology itself. But the residues are the real underlying problem, the particular cause of the squabbles that lead to the circulation of élites. The underlying residue, he thought, was the only proper object of sociological enquiry.

Pareto colored his sociological theory with numerous classical and contemporary illustrations of his theory. He published two more books (1920, 1921) expanding on the theme. His quasi-mystical arguments about the non-logical motivations attracted many followers.

Pareto’s work on economics and social reform had an extended impact. He managed to construct a progressive school around himself at Lausanne and influence countless economists and others as disciples of his theories. However, Pareto’s big break came posthumously in the 1930s and 1940s, a period which has been called the Paretian Revival. Harold Hotelling, Oskar Lange and the New Economics movement resurrected Pareto’s works on social welfare.

When discovering Pareto’s work in the late 1930s, Juran realized that Pareto’s theory very much correlated to his own application of quality analysis. Juran, himself, had detected as a young engineer, that quality defects were unequal in frequency. When observing a long list of defects he discovered that defects were arranged in an order of frequency; a relative few of the defects accounted for the bulk of defectiveness. Later, he, and others, discovered that a similar distribution existed with other data sets like absenteeism and causes of accidents, for example.

After WWII, Juran began a career dedicated to the field of management, research, writing, teaching and consulting. By the late 1940s, he had recognized the principle of the vital few and the trivial many as a true universal application more general than specific. With this truth, Juran discovered that Pareto had not uncovered a unique distribution but that many others had detected this phenomenon.

It was in Juran’s first edition of his book “Quality Control Handbook” that several instances of mal-distributions of quality losses were discussed. In his text, Juran related the quality loss curves to Pareto’s distribution of wealth. The caption under these curves reads, “Pareto’s principle of unequal distribution applied to distribution of wealth and to distribution of quality losses.” Although the accompanying text makes clear that Pareto’s contributions specialized in the study of wealth, the caption implies that he had generalized the principle of unequal distribution into a universal theory. Juran has commented, “This implication is erroneous. The Pareto Principle as a universal was not original with Pareto.”

Juran, however, continued to associate the mal-distribution of quality defects or loss with Pareto. Because of his writings and lectures, Pareto’s name has become well recognized. Juran continued to espouse the theory and created the “80/20 Rule” and coined the phases vital few and trivial many.

But where did the universal of the mal-distribution of quality defects and loss originate? Juran was likely to have discovered it; therefore, this theory could very well have been called the Juran Principle.

An interesting and controversial personality, Vilfredo Pareto has authored numerous works and many others have been written about him. Pareto was troubled by the events of his time, using influence to change perceptions and alter established trends. He developed theories, wrote and lectured extensively to promote fairness and the betterment of society, and his work had a definite impact during as well as after his lifetime. Juran made the Pareto name universal through his association of the mal-distribution theory in the field of quality.