His work illustrates how data-set-rich India benefits from microeconomics meeting econometrics
In awarding the Royal Bank of Sweden Nobel Memorial Prize in Economics (to give it the full title) for 2015 to Angus Deaton, the Committee has affirmed two important truths about the state of the subject. First is that while macroeconomics as a collective enterprise failed to either predict the 2008 crash or the long time the recovery from the crisis would take, all economics, especially microeconomics, is not in any sort of crisis. Of course, it could do with improvement such as absorbing the discoveries of behavioural economists but that is an ongoing part of any science. Microeconomics, which is by and large what Angus Deaton has been doing since I first met him 45 years ago, is hale and hearty.
The second truth is to bring out the central importance of empirical, especially econometric work. This is not as obvious as it sounds. There are many macro-models and statistical forecasts. But a lot of macroeconomic modelling is passive empirical work. The researcher downloads statistical series collected by the national statistical body and proceeds to estimate parameters of equations without having to look at the data in any concrete way. (In my student, and even later days, we plotted each series and examined it. Now, there is no such practice.) Macro-modelling is time-series-oriented and recent technical developments such as co-integration have led to equilibrium dynamics being the dominant model with deviations being treated just as random shocks. It was this which misled macroeconomists from spotting the crisis ahead or appreciating that deviation from the equilibrium path could be not just a one-off, random shock, but a sustained downturn.
Obviously, a priori logical construction of competitive equilibrium has a high reputation in economics. Ricardo worsted Malthus in argument about the possibility of a depression (glut as they called it) by saying that facts had nothing to do with the argument. Theory proved that a supply creates its own demand. Ever since, theory has been the Queen of Economics. Theorists have virtually monopolised the Nobel Prize.
There has been another tradition which has been there for a long time. This is the tradition of empirical economics, especially econometrics. This began in the area of demand studies, later on called consumer behaviour, which has been Deaton’s forte. It started with practical concern about farmers’ incomes, especially in the US, during the interwar period. Data were collected to find out how demand matched supply and led to fluctuations or even depression in prices. It took till the late-1930s for the economic theory of consumer behaviour to take shape with the work of John Hicks (Nobel Prize winner) and Henry Schultz (who, sadly, died young).
It was Richard Stone, the winner of the 1984 economics Nobel and Deaton’s teacher and mentor, who put the empirical study of consumer behaviour on its sound footing. Cambridge was more famous for its theorists—Joan Robinson, Richard Kahn, Nicholas Kaldor , Pierro Sraffa—none of whom got the Nobel. It was Stone who combined theory and data with econometrics. Stone was a pioneer of national income accounting and methods of data collection. Stone estimated consumer demand for commodities, not separately but as a system—the Linear Expenditure System—in a path-breaking study of UK data for 1920-1938. Deaton carried the torch from then on. He advanced the theory of consumer behaviour in his joint work with the Oxford economist John Muellbauer and updated the estimates beyond where Stone had left.
Consumer behaviour can be studied as time-series with aggregate data or at the level of households. This is where microeconomics and econometrics meet and have generated the most fruitful findings about economic behaviour in relation to consumption, savings, labour market and demographic behaviour, health economics , environmental problems. The data-sets are enormous with thousands of households or individuals being surveyed. The techniques are quantitative as well as qualitative. It is in studying household behaviour with data that the economist comes closest to making field studies like an anthropologist does—albeit never leaving his desk and the desk-top! Deaton has studied problems of consumer behaviour, of consumers’ demand for health services and, further on, in the Indian context (thanks to the large NSS data-sets) of poverty. He has also been to villages in India studying family conditions.
In India as elsewhere, theory has higher prestige than empirical economics. Our famous economists —Amartya Sen, Jagdish Bhagwati, Sukhamoy Chakravarty—made their mark as theorists. But there has been an empirical tradition in India over the years— for instance, at the Gokhale Institute where, for many decades, DR Gadgil led studies of the local economy. The Indian Statistical Institute and the NCAER have pioneered many methods useful for economists. Even so, one gets the impression that the potential of the immense data-sets available in India has not been realised. India needs its own Angus Deaton.
The author is an eminent economist and Labour peer