2015 Nobel Prize in Economics Goes to Angus Deaton

This year’s Nobel Prize in Economic Science is awarded to Angus Deaton, a British-American economist of Princeton University. The Nobel Prize committee emphasized three related achievements: an approach to estimating demand for different goods, the studies of the relationship between income and consumption, and the work on measuring living standards and poverty.

Demand estimation

Any government has to make economic policy choice on daily basis. Should the government raise taxes or is it better to cut the expenditures in the government budget? Is it worth protecting a domestic industry and should it be done by raising tariffs, imposing quotas, or offering subsidies? What is the best way to provide safety nets for elderly: by increasing their pensions, subsidizing utility costs, or by providing in kind transfers of food?

A mistake in a choice of policy can have grave consequences from suffering of poor to destroying business to a political turmoil. By contrast, oaptimal choice of economic policies can lead to country’s prosperity and development.

The choice between good and bad policies is difficult. There are no simple answers and different policies are suited for different circumstances. Any policy should be judged on its probable consequences. Analysis of such consequence requires good understanding of the reaction to the policy by consumers, producers, and other participants of the market to the product.

Angus Deaton’s work in 1980’s has enhanced our ability to estimate demand functions for the consumers. Prior work has been unable to provide estimation of demand functions that would sufficiently agree with data. Consequently, economists suggested that the concepts underlying the model of demand should be challenged. Angus Deaton demonstrated that the existing models employed a number of more narrow assumptions and showed a way to relax these assumptions to accommodate the data. His work allowed to substantively improve our ability to estimate demand from the empirical data.

Income and consumption

Imagine that an economy grows by 5%. Economic growth will lead to more income and individuals will respond by increasing their purchases of goods and services as well as financial and other savings. An increase in consumption will lead to higher prices and possibly even more production and more economic growth. But what is the precise relationship between increase in income and individual consumption? Understanding this relationship is important for a proper governmental policy in response to the economic growth (or decline).

In the 1990s, Angus Deaton worked on the link between income and consumption. The existing models predicted that the consumption should overreact to changes in income. In other words, consumption should be more volatile than income. This prediction was not borne out in data, which showed the opposite pattern. The existing models treated the economy as a single (representative) consumer. Angus Deaton showed that models of economy with multiple types of consumers that have different income, wealth, borrowing constraints, and income distribution are capable of explaining the data. Today, the models of multiple heterogenous consumers have become the standard.

Living standards and poverty

In the last two decades, Angus Deaton has worked on the issues of development economics.

As an example, the Nobel committee mentions the following ingenious idea of Angus Deaton. Imagine you have to measure whether the families treat sons better than daughters. In particular, you would like to know if sons are better fed. This is an important question because of the phenomenon of “missing girls”: in many countries families tend to treat male offsprings better than female offsprings.

There is no direct and reliable way to find out whether males receive more resources, food, money, and care than females. Even if it were possible to put a researcher to live in a family and do it for a hundred of families, we wouldn’t be sure if we can trust the results. The families could simply change their behavior because of a researcher monitoring them. Angus Deaton suggested to measure consumption of strictly adult goods such as alcohol and tobacco for families with comparable income. Imagine that we finds that families that have daughters show more purchases of adult goods than families with sons. Then, we can infer that it is likely that daughters receive less food than sons even if overall amount of money spent on groceries is the same.

The contributions of Angus Deaton are much more broad than this example.They range from better ways to collect data to ideas how to measure economic variables of interest to new approaches of how to get at the economic questions of interest that cannot be directly measured.

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