vol IV chap 15 sect 2
Previous: 15.1. Selection of Prizes in Economic Sciences in Memory of Alfred Nobel.
15.2. Role of statistical analysis in the formulation of models.¶
In this Section we refer to the 1969 Prize in Economic Science as a recognition of the initial steps in econometry. We include excerpts from the Award ceremony speech presented by Professor Erik Lundberg of the Royal Academy of Sciences, and afterwards we present summaries and quotes related to the Prize Lectures given by Ragnar Frisch and by Jan Tinbergen.
Award ceremony speech.
MLA style: Award ceremony speech. NobelPrize.org. Nobel Prize Outreach AB 2023. Thu. 19 Oct 2023. https://www.nobelprize.org/prizes/economic-sciences/1969/ceremony-speech/
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“In the past forty years, economic science has developed increasingly in the direction of a mathematical specification and statistical quantification of economic contexts. Scientific analysis along these lines is used to explain such complicated economic processes as economic growth, cyclical fluctuations, and reallocations of economic resources for different purposes.”
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“To the layman, it may seem somewhat reckless to seek, without support from experiment, for laws of development within these extremely complicated processes of economic change, and to apply for this purpose the techniques of mathematical and statistical analysis. However, the attempts of economists to construct mathematical models relating to strategic economic relations, and then to specify these quantitatively with the help of statistical analysis of time series, have, in fact, proved successful. It is precisely this line of economic research, mathematical economics, and econometrics, that has characterized the development of this discipline in recent decades.”
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“Professor Frisch and Professor Tinbergen have been working along essentially the same lines. Their aim has been to lend economic theory mathematical stringency, and to render it in a form that permits empirical quantification and a statistical testing of hypotheses. One essential object has been to get away from the vague, more “literary” type of economics. The arbitrary “naming” of causes of cyclical fluctuations, for instance, and the concentration upon certain simple chains of causal connection, has given way, in the work of both Frisch and Tinbergen, to mathematical systems that state the mutual relationships between economic variables.”
“Let me take, as an example, Professor Frisch’s pioneer work in the early thirties involving a dynamic formulation of the theory of cycles. He demonstrated how a dynamic system with difference and differential equations for investments and consumption expenditure, with certain monetary restrictions, produced a damped wave movement with wavelengths of 4 and 8 years. By exposing the system to random disruptions, he could demonstrate also how these wave movements became permanent and uneven in a rather realistic manner. Frisch was before his time in the building of mathematical models, and he has many successors. The same is true of his contribution to methods for the statistical testing of hypotheses.”
“Professor Tinbergen was concerned primarily to confront dynamic economic theory with statistical application. His great pioneer work in this field is an econometric study of cyclical fluctuations in the United States. An important aim in this impressive investigation was to test the explanatory value of the existing flora of business cycle theories by trying to specify, quantitatively, the importance of different factors. Tinbergen built up an econometric system involving some 50 equations and determined reaction coefficients and “leads and lags” with the help of statistical analysis. Several of his conclusions excited great attention and are still the subject of debate. Professor Tinbergen’s pioneer work in econometrics has been of major importance for subsequent methodological development.”
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“During the past ten years, both Professor Frisch and Professor Tinbergen have devoted themselves primarily to long-term economic policy and planning, with a view particularly to the problems of the developing countries. Both have served as advisers in different contexts. In the rapid development of methods for long-term planning, our two laureates have made major contributions. Professor Tinbergen, for instance, with regard to systems of priorities in investments, and the use of “shadow prices”. Professor Frisch has developed decision models for economic planning, devising mathematical programming methods with a view to exploiting modern computer techniques.”
PRIZE LECTURE: From Utopian Theory to Practical Applications: The Case of Econometrics by Ragnar Frisch.
MLA style: Ragnar Frisch – Prize Lecture. NobelPrize.org. Nobel Prize Outreach AB 2024. Sat. 3 Aug 2024. https://www.nobelprize.org/prizes/economic-sciences/1969/frisch/lecture/
INTRODUCTION.
“In this essay on econometrics in its conception and its use in economic planning for the betterment of man’s fate, I will try to cover a very broad field.” ….
1. THE LURES OF UNSOLVABLE PROBLEMS.
“Deep in the human nature there is an almost irresistible tendency to concentrate physical and mental energy on attempts at solving problems that seem to be unsolvable.”
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Description of the following problems: The mountain climber, The Alchemists, The alluring symmetry problem in particle physics, The population explosion in the world of elementary particles, Matter and antimatter, Travelling at a speed superior to that of light, The dream of Stanley Jevons (The English mathematician and economist Stanley Jevons (1835-1882) dreamed of the day when we would be able to quantify at least some of the laws and regularities of economics, and Struggle, sweat and tears.
2. A PHILOSOPHY OF CHAOS. THE EVOLUTION TOWARDS A MAMMOTH SINGULAR TRANSFORMATION.
Definition of Philosophy in The Concise Oxford Dictionary: “love of wisdom or knowledge, especially that which deals with ultimate reality, or with the most general causes and principles of things”.
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“Indeed, science too has a constant craving for regularities. Science considers it a triumph whenever it has been able by some partial transformation here or there, to discover new and stronger regularities.”
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“This search for regularities may well be thought of as the essence of what we traditionally mean by the word “understanding”. This “understanding”is one aspect of man’s activity. Another - and equally important - is a vision of the purpose of the understanding.”
3. A BRIEF SURVEY OF THE DEVELOPMENT OF ECONOMICS IN THE LAST CENTURY.
“In the middle of the 19th century John Stuart Mill (1806-1873) in his famous work “Principles of Economics”said that so far as general principles are concerned the theory of value and price was now completely elaborated.”
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“The economic process is an equilibrium affair where both technological and subjective forces are at play. The subjective element was nearly left out by the classicists.”
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…. “Partly under the influence of the criticism of the historical school and the institutionalists the theoreticians themselves took up a systematic work of building up the theory in such a way that the theory could be brought in immediate contact with the observational material. One might say that from now on economics moved into that stage where the natural sciences had been for a long time, namely the stage where theory derives its concepts from the observational technique, and in turn theory influences the observational technique.”
“For the first time in history it now seemed that the work on the theoretical front in economics - now to a large extent mathematically formulated - and the work on the outer descriptive front should converge and support each other, giving us a theory that was elaborate enough to retain the concrete observational material, and at the same time a mass of observations that were planned and executed with a view to be filled into the theoretical structure.”
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“As long as economic theory still works on a purely qualitative basis without attempting to measure the numerical importance of the various factors, practically any “conclusion”can be drawn and defended.”
4. SOME HISTORICAL NOTES ON THE FOUNDING OF THE ECONOMETRIC SOCIETY.
Reference to letters dating from the years when the plans for the creation of an econometric society took shape…. The creation of the journal “Econometrica” as well as an international cercle of mathematical economist were also considered.
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The beginning of the abstract of a meeting organized at Harvard University on 29 February 1928 reads as follows:
“I. The terms econometric and econometrics are interpreted as including both pure economics and the statistical verification of the laws of pure economics, in essential distinction to the purely empirical manipulation of statistical data on economic phenomena.
II. The possibility of establishing a systematic annotated bibliography of econometric literature was discussed.”
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The Econometric Society was formed in Cleveland, Ohio on 29 December 1930.
5. TYPES OF ECONOMETRIC MODELS AS SEEN FROM AN ADVANCED VIEWPOINT TODAY.
“In connection with the Second World Congress of The Econometric Society to be held in Cambridge, England 7-14 September 1970, Frisch gives a survey of types of econometric models at the national level and an example of how one selected problem may be handled.
Some general remarks on types of econometric models at the national level.
“The list of variables and the equations and/or bounds that are introduced, constitute the core of the model. It may be linear or non-linear.”
The preference function.
… “A preference function is a function whose maximization defines the goal of the decisions that might be studied through the model.”
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“The interview approach to the preference function is only a first stage in an iterative process which in each step proceeds by an optimal solution of the model.”
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…. “Thus the preference function as it appears in our models is an expression for the preferences of the decision making authority, whatever this authority may be. The preference function in the model must not be confounded with a general “Welfare function” in the sense of welfare theory.”
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“It is not the task for us as econometricians and social engineers to go into a detailed discussion of the political system. Somewhere in the hierarchy of sciences a line of demarcation has to be drawn. And here is where we find the line of demarcation for the econometric planner.”
6. THE TRANSITION TOWARDS ECONOMIC PLANNING AT THE NATIONAL LEVEL.
“Any econometrician who wants to see practical application of his science, will be highly concerned with applications to economic planning at the national level.”
Economic planning the basis for efficiency and a living democracy.
…. “The problem I am driving at is more ambitious than just to increase the long-term average growth rate of gross national product. My purpose is to make economic planning at a high aspiration level one of the pillars of a living democracy.”
A high aspiration level.
….. “And we are hopeful that we will one day come at least very much closer to the precision of the physicists, than we are today. It is comforting to know that already politicians in many countries do find our work useful.”
The cooperation between the politicians and the experts.
“Already today there is, of course, a good deal of cooperation between politicians and experts. But on one point there is need for a new break-through, namely in making it a practice to cooperate on the formalization of the preference function. This will be of basic importance for clarifying what the political authorities really are aiming at.
For simplicity let me first describe how to attack the problem for a given political party.”
“A preparatory phase of the expert’s work would simply consist in his making a systematic use of his general knowledge of the political atmosphere in the country, and in particular the political atmosphere in the party in question.”
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“In a subsequent phase the expert - on the basis of his tentative formalization- will work out a system of interview questions through which he will get closer to the formalization of the preferences in question.”
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“In the third phase the expert will go back to his electronic computer in which he had already entered the data regarding the core of the economy. To this he will now add the formalization of the preferences in the quantitative form as he now sees it. From this will come out a solution, in the form of an optimal development path for the economy. ….. The expert will understand more or less precisely what sort of changes are needed in the formulation of the preference function in order to produce a solution that comes closer to what the politicians now say they want. This leads to a discussion back and forth.”
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“We should proceed to a discussion of what sort of political compromise that might be reached in the formulation of a unified system of preferences. And then having reached this compromise formulation, there would appear a compromise optimal solution. Here too an iteration between politicians and experts would take place.”
7. INVESTMENT STARTING vs. INVESTMENT SINKING.
“I shall give an example illustrating an advanced approach to a point in the planning technique. It concerns the measurement of investments in an advanced planning model. If the planning model has a time horizon of more than, say, a year or two, and if investment decisions are an important part of the analyses, the distinction between investment starting and investment sinking (investment carry-on-activity) is essential.”
7.1. A verbal definition: investment starting and investment sinking.
7.2. The project description is a collection of all the descriptive details regarding a project, that can be given by the specialists.
7.3. The sinking year and the starting year.
7.4. Sinking flows.
7.5. Sinking Coefficients in the Non-Substitution Case for Sinking Inputs.
7.6. Sinking Coefficients and Equivalent Coefficients in the Case of Substitution Possibilities for Sinking Inputs.
7.7. The complementarity restrictions that may be associated with an equivalence ring.
PRIZE LECTURE: The Use of Models: Experience and Prospects by Jan Tinbergen.
MLA style: Jan Tinbergen – Prize Lecture. NobelPrize.org. Nobel Prize Outreach AB 2024. Sat. 3 Aug 2024. https://www.nobelprize.org/prizes/economic-sciences/1969/tinbergen/lecture/
1. Essence of models.
“In this lecture I propose to discuss the experience we have had with the method of model building as a contribution to economic science and the prospects for its further application. First of all I want to remind you of the essential features of models. In my opinion they are: (i) drawing up a list of the variables to be considered; (ii) drawing up a list of the equations or relations the variables have to obey and (iii) testing the validity of the equations, which implies the estimation of their coefficients, if any. As a consequence of especially (iii) we may have to revise (i) and (ii) so as to arrive at a satisfactory degree of realism of the theory embodied in the model. Then, the model may be used for various purposes, that is, for the solution of various problems. The advantages of models are, on one hand, that they force us to present a “complete” theory by which I mean a theory taking into account all relevant phenomena and relations and, on the other hand, the confrontation with observation, that is, reality. Of course, these remarks are far from new.”
“While building models econometricians were often forced to supplement “literary” theories, since these often did not specify all relationships they were implicitly using.”
“Models have been built for a number of different purposes; first of all, for purposes of explaining actual developments and next, for finding ways of influencing actual development in some desired direction. Another aspect is whether short-term or long-term movements were the objective of either explanation or policies. There are large numbers of further alternatives of focusing. We will discuss some of them in this lecture.”
2. Some experiences.
“First, I am going to discuss a number of experiences econometricians had with the activity of model building. Some of us were masters in hunting after high correlations, that is, good fits with observed values. …. I am afraid that the first subject I tackled in my work for the League of Nations, namely to explain the fluctuations in investment activity never has become a great success. In the Netherlands Central Planning Bureau we found it safer, after some years, to ask industrialists for their investment programs rather than rely on an econometric explanation. Also government expenditures were among the variables difficult to explain. In both cases we may account for the lack of success by the fact that a small number of decision makers determine the picture and that hence random deviations will be important.”
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“In several parts of our science, and I presume in other sciences as well, we must beware of following vogues too easily. Model building has become a vogue, just as, after that, linear programming or matrix algebra have become. …. But a critical examination of the structure of the problem before we try to solve it remains useful. And let me add immediately that linear programming does constitute a very useful technique in many cases indeed.”
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“In an attempt to evaluate what model building has contributed to the theory and practice of economic science I feel that at least we can say that models have had a didactic value. Often in our textbooks we bring simplified, not to say over-simplified, pictures of reality which nonetheless contribute to making understood some essential features of that reality.”
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“What I called “didactic value” also stands for communication value. The ability of a planning expert to communicate with politicians and with citizens constitutes an important element in any type of democratic or semi-democratic planning and such communication can be enhanced by relatively simple models.” ….
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“I do think, however, that the utility of models goes beyond their didactic value. They are a real and essential element in the preparation of well-coordinated policies. But they cannot do this job all by themselves. Models constitute a framework or a skeleton and the flesh and blood will have to be added by a lot of common sense and knowledge of details.” ….
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“A need generally felt by model builders and their critics is the need for refinement, that is, for the introduction of many more variables. In a way this experience again was a lesson also to economists in general, since often their arguments run in terms not showing this degree of detail.” …
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“The other additional example of the need for more refined models and information can be taken from the experiences of the United Nations Research Institute for Social Development (UNRISD). The essential feature of this Institute’s work is to include a number of so-called social variables. …. Precise knowledge about interrelationships can be obtained only by the technique of quantitative models; but the lack of homogeneity of crude information is the reason for the lack of success in the social area and hence refinement of the base material is the real need here.”
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“All these refinements will make for ever more complicated models and therefore threat to make models unmanageable. This once again underlines the need for several stages of decision-making and hence of planning. As already said, the need for communication with the people and groups involved also points into the direction of this step-wise use of models. So also does the organizational aspect of decision making; a correspondence between the organizational setup of an optimum socio-economic order and the levels or stages of planning and the use of models for it is desirable. One of the future features of such a setup will also be the more precise location of the flows of information and, more particularly, the type of information needed.”
3. Prospects of model building
“Let us now turn to the future of model building. The primitive state of the art has become clear from our preceding remarks. We have already indicated some of the directions in which models will have to be developed. Our present subject, the prospects of model building, of course overlaps with the subject discussed so far. As a consequence, some repetition cannot be avoided; but we will approach the subject from a somewhat different angle. Our central question will now be what extension should be given to the scope of model building. Some of the developments to be discussed have already been started.”
“A first subject to be dealt with refers to the necessity to introduce the element of space into socio-economic models.” ….
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“While these various examples show the picture of lively activity in the field of the economics of space, it is clear that some fundamental features characteristic of the subject can hardly be included already into the methods used. On one hand, empirical data are lacking on such features as external effects and on the other hand mathematical techniques are lacking – or at least not known to my collaborators, let alone to myself – needed to generalize sufficiently the models developed as examples.”
“A second subject to deal with, in discussing the widening of the scope of economic models, is the inclusion of so-called social and political variables. …. With the increased awareness of the role of education in economic and social development and with the budget for education being among the largest budgets of the various ministries, the need for further work in this type of models can easily be understood.”
“Another social subject is income distribution. …. Models of this kind may soon be used to study in a more precise way also the possibilities to change income distribution and, for example, to find out what degree of inequality is inevitable.”
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“A third example of the simultaneous introduction of many social and political variables into models, especially for developing countries, is the impressive attempt made by Irma Adelman and her collaborators using factor analysis and discriminant functions in order to discover, which of some thirty odd factors, measured in a heroic way, seem to play a preponderant part in the process of development.”
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“The third subject to be discussed under the heading of widening the scope of models is the one off specifying optimum socio-economic orders. Optimization is not a new subject, of course. Mathematical programming models are now widely used, both on the level of the production unit and on higher levels. Scientific development took place along various tracks.”
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“There are two other tracks, however, which I want to sketch out. One is the discussion of the social welfare function, or the objective function. …. The second other track I want to sketch out is to reformulate the problem of the socio-economic optimum.” …..
“It is also our hope that the interpretation of the socio-economic optimum as a set of institutions may help to get under way a discussion of a more scientific character than was usual so far about the relative merits of various existing socio-economic orders, especially those of Eastern and Western Europe, including such interesting cases as Sweden, Switzerland and Yugoslavia. A considerable amount of better information about various types of external effects will be one of the necessary ingredients if we want to give concrete content to such merit rating of various systems. It is my hope that in such a way we may again, as Marx claimed, find scientific arguments in the competition between various systems, but up-to-date scientific arguments rather than obsolete ones. This more fundamental research in economics deserves relatively more attention and resources than the more superficial versions of economic research directed at forecasting or analyzing very short-term fluctuations in market prices, on which quite some money is being spent to-day.”
Next: 15.3. Interpretation of natural experiments in Economic sciences.