Special Report: The Sveriges Riksbank, Nobel Prize in Economics

On October 12th 2015, economist Angus Deaton was awarded the 2015 Nobel Prize in Economics for his work on consumption, poverty and welfare. A Scottish-born economist who earned his PhD in economics at the University of Cambridge before moving to the United States, where he currently holds the position of Professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs and the Economics Department at Princeton University. This year, the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel honored his work. His contributions have helped governments to improve policy through tools such as household surveys and tax changes.

Deaton is an economist who looks closely at what poor households consume to gain a better understanding of their living standards and possible paths for economic development. His work has been praised for having helped to “transform the fields of microeconomics, macroeconomics, and development economics.” According to the Royal Swedish Academy of Science’s website, his work has helped to provide answers for three big issues in economics.
Firstly, how do consumers distribute their spending among different goods? Answering this question is not only necessary for explaining and forecasting actual consumption patterns, but also crucial in evaluating how policy reforms, such as changes in consumption taxes affect the welfare of different groups of people. In his early work, Deaton developed the Almost Ideal Demand System (AID) a flexible, yet simple, way of estimating how the demand for each good depends on the prices of all goods and on individual incomes. His approach and its later modifications are now standard tools, both in academia and in practical policy evaluation.

Secondly, how much of society’s income is spent and how much is saved? To explain capital formation and the magnitudes of business cycles, it is necessary to understand the relationship between income and consumption over time. In a few papers around 1990, Deaton showed that the prevailing consumption theory could not explain the actual relationships if the starting point was aggregate income and consumption. Instead, one should sum up how individuals adapt their own consumption to their individual income, which fluctuates in a very different way to aggregate income. This research clearly demonstrated why the analysis of individual data is key to untangling the patterns we see in aggregate data, an approach that has since become widely adopted in modern macroeconomics.

Thirdly, how do we best measure and analyze welfare and poverty? In his more recent research, Deaton highlights how reliable measures of individual household consumption levels can be used to differentiate mechanisms behind economic development. His research uncovered important pitfalls when comparing the extent of poverty across time and place. It also exemplified how the clever use of household data may shed light on such issues as the relationships between income and calorie intake, and the extent of gender discrimination within households. Deaton’s focus on household surveys transformed development economics from a theoretical field based on aggregate data to an empirical field based on detailed individual data.
Deaton’s name has appeared for years on lists of likely laureates. His allocation of the award has been received well by many of his colleagues and peers. Many note that he deserved recognition for refining a rigorous approach to studying economic development based on careful consideration of detailed data.

In addition to his specific contributions to our understanding of the world, Deaton offers three lessons to aspiring economists upon his acceptance of the award. First, that although theory should be consistent with data, inconsistencies are not always a death knell for theory. Puzzles and inconsistencies help to promote innovation. Second, that the population average is rarely good enough. It is only by understanding nuanced differences between people that we can understand the whole. Finally, that measurement matters. In the words of Professor Deaton, “progress cannot be coherently discussed without definitions and supporting evidence”.

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