Econometrics and Nonobserved Facts

Theoretical Assumptions and Nonobserved Facts

Wassily Leonteif

Economics today rides the crest of intellectual respectability and popular acclaim. The serious attention with which our pronouncements are received by the general public, hard-bitten politicians, and even skeptical businessmen is second only to that which was given to physicists and space experts a few years ago when the round trip to the moon seemed to be our only true national goal. The flow of learned articles, monographs, and textbooks is swelling like a tidal wave; Econometrica, the leading journal in the field of mathematical economics, has just stepped up its publication schedule from four to six issues per annum. (Leontief 1971, 1)

And yet an uneasy feeling about the present state of our discipline has been growing in some of us who have watched its unprecedented development over the last three decades. This concern seems to be shared even by those who are themselves contributing successfully to the present boom. They play the game with professional skill but have serious doubts about its rules. (Leontief 1971, 1)

Much of current academic teaching and research has been criticized for its lack of relevance, that is, of immediate practical impact. In a nearly instant response to this criticism, research projects, seminars and undergraduate courses have been set up on poverty, on city and small town slums, on pure water and fresh air. In an almost Pavlovian reflex, whenever a new complaint is raised, President Nixon appoints a commission and the university announces a new course. Far be it from me to argue that the fire should not shifted when the target moves. The trouble is caused, however, not by an inadequate selection of targets, but rather by our inability to hit squarely any one of them. The uneasiness of which I spoke before is caused not by the irrelevance of the particular problems to which present day economists address their efforts, but rather by the palpable inadequacy of the scientific means with which they try to solve them. (Leontief 1971, 1)

If this simply were a sign of an overly high aspiration level of a fast developing discipline, such a discrepancy between ends and means should cause no worry. But I submit that the consistently indifferent performance in practical applications is in fact a symptom of a fundamental imbalance in the present state of our discipline. The weak and all too slowly growing empirical foundation clearly cannot support the proliferating superstructure of pure, or should I say, speculative economic theory. (Leontief 1971, 1)

Much is being made of the widespread, nearly mandatory use of modern economic theorists of mathematics. To the extent which the economic phenomena possess observable quantitative dimensions, this is indisputably a major forward step. Unfortunately, any one capable of learning elementary, or preferably advanced calculus and algebra, and acquiring acquaintance with the specialized terminology of economics can set himself up as a theorist. Uncritical enthusiasm for mathematical formulation tends often to conceal the ephemeral substantive content of the argument behind the formidable front of algebraic signs. (Leontief 1971, 1-2, emphasis added.)

(….) By the time it comes to the interpretation of the substantive conclusions, the assumptions on which the model has been based are easily forgotten. But it is precisely the empirical validity of these assumptions on which the usefulness of the entire exercise depends. (Leontief 1971, 2)

What really is needed, in most cases, is a very difficult and seldom very neat assessment and verification of these assumptions in terms of observed facts. Here mathematics cannot help and because of this, the interest and enthusiasm of the model builder suddenly begins to flag: “If you do not like my set of assumptions, give me another and I will gladly make another model; have your pick.” (Leontief 1971, 2)

(….) To sum up with the words of a recent president of the Econometric Society, “… the achievements of economic theory in the last two decades are both impressive and in many ways beautiful. But it cannot be denied that there is something scandalous in the spectacle of so many people refining the analysis of economic states which they give no reason to suppose will ever, or have ever, come about…. It is an unsatisfactory and slightly dishonest state of affairs.” (Leontief 1971, 2)

But shouldn’t this harsh judgment be suspended in the face of the impressive volume of econometric work? The answer is decidedly no. This work can be in general characterized as an attempt to compensate for the glaring weakness of the data base available to us by the widest possible use of more and more sophisticated statistical techniques. Alongside the mounting pile of elaborate theoretical models we see a fast-growing stock of equally intricate tools. These are intended to stretch to the limit the meager supply of facts. (Leontief 1971, 2-3)

(….) However, like the economic models they are supposed implement, the validity of these statistical tools depends itself on the acceptance of certain convenient assumptions pertaining to stochastic properties of the phenomena which the particular models are intended to explain; assumptions that can be seldom verified. (Leontief 1971, 3)

In no other field of empirical inquiry has so massive and sophisticated a statistical machinery been used with such indifferent results. (Leontief 1971, 3)

(….) Continued preoccupation with imaginary, hypothetical, rather than with observable reality has gradually led to a distortion of the informal valuation scale used in our academic community to assess and to rank the scientific performance of its members. Empirical analysis, according to this scale, gets a lower rating than formal mathematical reasoning. (Leontief 1971, 3)

A natural Darwinian feedback operating through selection of academic personnel contributes greatly to the perpetuation of this state of affairs…. Thus, it is not surprising that the younger economists, particularly those engaged in teaching and in academic research, seem by now quite content with … building more and more complicated mathematical models and devising more and more sophisticated methods of statistical inference without engaging in empirical research. Complaints about the lack of indispensable primary data are heard from time to time, but they don’t sound very urgent. (Leontief 1971, 3)

(….) To deepen the foundation of our analytical system it will be necessary to reach unhesitatingly beyond the limits of the domain of economic phenomena as it has been staked out up to now…. To penetrate below the skin-thin surface of conventional [econometric mathematical models], it will be necessary to develop a systematic study of the structural characteristics and functioning of [economic targets, e.g., households, etc.], an area in which description and analysis of social, anthropological and demographic factors must obviously occupy the center of the stage. (Leontief 1971, 4, emphasis added.)

Establishment of systematic cooperative relationships across the traditional frontiers now separating economics from these adjoining fields is hampered by the sense of self-sufficiency resulting from what I have already characterized as undue reliance on indirect statistical inference as the principal method of empirical research. (Leontief 1971, 4, emphasis added.)

Formally, nothing is, of course, wrong with such an apparently circular procedure. Moreover, the model builder in erecting his hypothetical structures is free to take into account all possible kinds of factual knowledge and the econometrician in principle, at least, can introduce in the estimating procedures any amount of what is usually referred to as “exogenous” information before he feeds his programmed tape into the computer. Such options are exercised rarely and when they are, usually in a casual way. (Leontief 1971, 4-5, emphasis added.)

(….) The same well-known sets of figures are used again and again in all possible combinations to pit different theoretical models against each other in formal statistical combat…. The orderly and systematic nature of the entire procedure generates feelings of comfortable self-sufficiency. (Leontief 1971, 5)

This complacent feeling … discourages … attempts that would involve crossing the conventional lines separating ours from the adjoining fields. (Leontief 1971, 5)

An exceptional example of a healthy balance between theoretical and empirical analysis and the readiness of professional economists to cooperate with experts in the neighboring disciplines is offered by Agricultural Economics as it developed in this country over the last fifty years…. Preoccupation with the standard of living of the rural population has led agriculture economists into collaboration with home economists and sociologists, that is, with social scientists of the “softer” kind. While centering their interest on only one part of the economic system, agricultural economists demonstrated the effectiveness of systematic combination of theoretical approach with detailed factual analysis. They were also the first among economists to make use of the advanced methods of mathematical statistics. However, in their hands, statistical inference became a complement to, not substitute for, empirical research. (Leontief 1971, 5, emphasis added.)

The shift from casual empiricism that dominates much of today’s econometric work to systematic large-scale factual analysis will not be easy. (Leontief 1971, 5, emphasis added.)

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