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Tuesday, October 13, 2015

The 2015 Nobel Prize: Angus Deaton

Economics is a tree with many branches, but consumption patterns and the standard of living more broadly understood are certainly one of the most important. Angus Deaton won the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2015--commonly known as the Nobel Prize in economics--for "for his analysis of consumption, poverty, and welfare." Each year, the committee publishes a number of materials about the award at its websitc, including background papers and interviews. Here, I'll focus on two background publications whose names convey their ease of readability: "Information for the Public: Consumption, great and small" and "Scientific Background: Angus Deaton: Consumption, poverty and welfare."

Every year I feel a little defensive when trying to explain the intellectual contributions of the winner of the Nobel prize in economics. Non-economists want to know: "What big discovery did he make or what big question did he solve?" But professional economists are are more interested in questions like: "In what ways did he develop the theory and the empirical evidence to increase our understanding of economic behavior and the economy?" Here, let me start by quoting how the committee answered this broad question in the "Scientific Background" paper, and then let me try to disentangle the jargon a bit and offer a few thoughts of my own.

Over the last three to four decades, the study of consumption has progressed enormously. While many scholars have contributed to this progress, Angus Deaton stands out. He has made several fundamental and interconnected contributions that speak directly to the measurement, theory, and empirical analysis of consumption. His main achievements are three.
First, Deaton’s research brought the estimation of demand systems – i.e., the quantitative study of consumption choices across different commodities – to a new level of sophistication and generality. The Almost Ideal Demand System that Deaton and John Muellbauer introduced 35 years ago, and its subsequent extensions, remain in wide use today – in academia as well as in practical policy evaluation.
Second, Deaton’s research on aggregate consumption helped break ground for the microeconometric revolution in the study of consumption and saving over time. He pioneered the analysis of individual dynamic consumption behavior under idiosyncratic uncertainty and liquidity constraints. He devised methods for designing panels from repeated cross-section data, which made it possible to study individual behavior over time, in the absence of true panel data. He clarified why researchers must take aggregation issues seriously to understand total consumption and saving, and later research has indeed largely come to address macroeconomic issues through microeconomic data, as such data has increasingly become available.
Third, Deaton spearheaded the use of household survey data in developing countries, especially data on consumption, to measure living standards and poverty. In so doing, Deaton helped transform development economics from a largely theoretical field based on crude macro data, to a field dominated by empirical research based on high-quality micro data. 
As just one example of how these different ideas come together, consider the problem of learning about consumption levels of households in low-income countries. Until just a few decades ago, it was common for researchers in this area to look at national-level data on patterns of consumption and income, and then divide by population to get an average. Deaton was at the front edge of the group of researchers who pushed for the World Bank to develop the Living Standard Measurement Study, which is a set of detailed country-level surveys that collect detailed data on a nationally representative sample of people in countries around the world. This would be an example of the third point in the committee's list above.

But an obvious practical problem has to be addressed in any such survey. If you want to know about how the consumption and savings decisions of households evolve over time--for example, it may take several years for a household to adjust fully to a sharp change in prices or incomes--it seems as if you need to follow the same group of households over time. Economists call this "panel data," But it can be hard to collect panel data because tracking people over years can be hard for survey researchers to do. People move, or households split up, and especially in low-income countries, finding out where they went isn't easy.  However, Deaton showed that if you had a series of surveys over time, you would have enough data to say how households with certain groups characteristics reacted over time. He showed that you could work with this data to draw empirical conclusions from a series of surveys of many different individuals to create a "pseudo-panel" that would work just as well as actual panel data. This would be an example of the second point made by the committee above.

Another analytical problem is how you combine all the data from the different households to draw overall conclusions about how consumption and saving shift in response to changes in prices or income. When Deaton first started writing about these issues in the 1970s, a common practice was to treat the economy as if it were one giant consumer, reaction to prices and income changes. Perhaps not surprisingly, such calculations didn't work well in describing how patterns of demand across goods shifted. Deaton, working with John Muellbauer, developed a more flexible way of looking at patterns of demand for the wide range of goods and services that allowed there to be some flexibility in patterns of household demand (for example, based on the number of people in a household and how many of them were children). It turns out that by allowing this extra flexibility, it becomes possible to draw sensible conclusions about consumption patterns from the data. This is an example of the first point made by the committee above.

Once you have data and a theoretical framework in hand, you can seek out some interesting conclusions about consumption patterns in low-income countries. For example, in one of his papers, Deaton found that low income tends to lead to malnutrition, but that malnutrition doesn't seem to be an important factor in causing low incomes. In another paper, he found that household purchases of adult goods like alcohol and tobacco change in the same ways when either a boy or girl is born during normal times, but in adverse times the adult purchases are cut by less when a girl is born--providing evidence that in that setting fewer family resources are committed to raising girls. Another paper found that the costs of expenditures on children are about 30-40% of expenditures on adults--which implies that when comparing countries with higher proportions of children to countries with lower proportions of children, you need to avoid comparisons that just divide economic output by the total number of people. Deaton has been at the center of efforts to use the available data and theory to measure the global level of poverty.

Over the years, Deaton has appeared in the pages of the Journal of Economic Perspectives (where I work as Managing Editor), a number of times. Along with the materials from the Nobel prize committee, these articles would also give the interested reader a sense of Deaton's approach as well as his intellectual breadth into areas that didn't get much mention from the committee. (As always, all articles from JEP are freely available compliments of the American Economic Association.)

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