Economic Insights

2000s

Oded Galor

Oded Galor founded the field of unified growth theory, which examines the economic growth process over the entire history of the human species.

He is the father of unified growth theory which means to have a single theory that accounts for the entire growth process since the dawn of civilization. It is an attempt to understand the role of historical and pre-historical forces in differential patterns of development and the great disparity in the standard of living across the world as we see it today.

The term “Unified Growth Theory” was coined by Galor (2005) to categorize theories of economic growth that capture the entire growth process in a single framework of analysis. The only unified theory of economic growth that captures the endogenous evolution of population, technology, human capital, and income per capita over the entire course of economic development, while generating both a spontaneous transition from Malthusian stagnation to sustained growth and a great divergence has been developed by Galor (2005, 2010), based on Galor and Weil (1999,2000), Galor and Moav (2002), and Galor and Mountford (2008).

The theory examines how individuals, societies, and economies have evolved virtually since the emergence of modern humans and how this evolution contributed to the vast inequality across the globe. To do so in a unified way means that you don’t rely on a different models for different stages in the process of development. Instead, the same model and behavioral rules characterize individuals throughout human history — but individuals take different action in different stages of development, due to the fact that economic incentives are changing in the course of human history.

The [non-unified] theories we have at the moment were built to characterize economic growth in the past decades and they are inconsistent with economic development in the course of most of human history. Consequently, they are unable to shed light on one of the most important phenomena in the course of economic growth, which is the emergence of a huge and persistence gap in income per capita across the globe in the last two centuries.

The theory shows how the interaction between technological progress and population ultimately raised the importance of education in coping with the rapidly changing technological environment, brought about significant reduction in fertility rates, and enabled some economies to devote greater resources toward a steady increase in per capita income, paving the way for sustained economic growth.

One of the main insights of the theory is that initial conditions that were determined in the distant past have a persistent effect on contemporary economic outcomes. It suggests that if we really want to understand the great disparity of income per capita today, we must examine the source of variations across societies thousands of years ago.

Source: Oded Galor: Economic growth process over 100,000 years

1990s

Kenneth Rogoff

In 1996, Kenneth Rogoff completed a treatise/graduate text with Maurice Obstfeld on Foundations of International Macroeconomics. The book (832pp.) attempts to provide the first modern integrative treatment of the core issues in international macroeconomics. In addition to unifying a field that had previously been considered quite scattered and disconnected, the book contains a significant amount of new research. Perhaps the most important contribution was a model to replace the Mundell-Fleming-Dornbusch open economy model that had previously been the workhorse of virtually all policy analysis in international economics, both in and outside the government. Their “new open economy macroeconomics” model inherits many of the empirical sensibilities of the earlier framework while providing microfoundations and integrating dynamics in a coherent way for the first time. This new approach has allowed researchers to analyze intertemporal issues such as the current account and government budget deficits, and view macroeconomic policy from a welfare-theoretic perspective. There is, of course, now a large literature on new open economy macroeconomics. An application is Their 2002 Quarterly Journal of Economics paper that looks at the potential welfare gains to greater coordination in the establishment of central bank monetary rules

1980s

David Pearce (1941-2005)

David Pearce was widely considered to be the father of modern applied environmental economics, and his ideas began to have an effect in the political arena in the late 1980s.

His Blueprint for a Green Economy – written with Anil Markandya and Ed Barbier, and published in 1989 – was produced shortly before he became personal adviser to the Secretary of State for the Environment. Popularly known as “the Pearce Report”, it was widely read and widely praised, and set out the case for using market incentives in environmental policy. Measures such as the emissions trading scheme, the congestion charge in London and the landfill tax owe a direct debt to Pearce’s thinking.

Widely known as the Pearce Report, it was a concise and persuasive statement of the key contributions that economics could make to the reform of environmental policy. It advocated basing policy on the criterion of “sustainability”, valuing environmental effects, and making use of market incentives – all recurring themes in Pearce’s work.

In the words of the 1987 Brundtland Commission report, sustainable development was “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”. Pearce drew on traditional growth theory and on Hicks’s concept of income to interpret sustainability as meaning that each generation should pass on at least as much capital as it inherited. Pearce saw this stock of capital in broad terms – including physical capital (machinery and infrastructure), intellectual capital (knowledge and technology) and environmental capital (natural resources). He argued that it was idle to suggest that economic activity should never damage the environment. The notion of sustainability defined the minimum conditions for such damage to be accepted, so as to maintain the inheritance of future generations.

Paul Romer

Paul Romer is the pioneer of “endogenous growth theory”. His 1986 paper in the  Journal of Political Economy is a seminal work in the modern revitalization of growth theory. The principal engine behind endogenous growth is the elimination of the assumption of decreasing returns to “capital.” In order to justify this radical departure from a longestablished assumption of microeconomic theory, Romer and his followers have broadened the definition of capital to include human capital and/or knowledge capital.Once this broader view of capital is adopted it is no longer obvious that there are decreasing returns. This leads to radical changes in the conclusions that we derive from models that are otherwise similar to those of Solow and Ramsey.

Romer, Paul M., “Increasing Returns and Long-Run Growth,” Journal of Political
Economy 94(5), October 1986, 1002−1037. (The paper that is generally regarded
as having started it all.)

1970s

Robert Barro

Barro turned on his Keynesian roots and joined the Rational Expectations revolution with two central pieces: his celebrated “Ricardian Equivalence Hypothesis” (1974) and his famous money neutrality paper (1976). Under a particular set of assumptions (e.g. intergenerational altruism or immortality, perfect capital markets, lump sum taxation, and the condition that debt not grow faster than the economy), Barro’s (1974) “Ricardian Equivalence Hypothesis” argues that every bond-financed deficit must be met by a future tax increase, that this tax increase would be forseen by living agents and that these agents would care enough about posterity to adjust their present consumption accordingly. In short, this implies that agents do not take a bond-financed fiscal expansion as a lucky windfall but rather will save the entire proceeds in anticipation of the future tax burden – and thus not raise their demand for goods and services. Thus income received by agents from government deficit-spending is all saved – and hence has no effect on consumption (thus no multiplier) – and that these savings go into the demand for the very same bonds that were supplied to finance that government spending (so bond demand rises exactly to meet higher bond supply, and money demand is unchanged) and thus there is no effect on interest rates either.

Barro’s “Ricardian Equivalence Hypothesis” has spawned a virtual research industry of its own as a whole generation of economists have climbed over each other tortuously examining, assailing, and verifying the validity and implications of Barro’s theorem (his 1974 paper is among the most-referenced papers in economics today). Barro’s 1976 paper on the neutrality of monetary policy (i.e. that changing money supply growth would not affect output or interest or any real variables) followed up on the work of Lucas and Sargent and although less unique, it was no less controversial.

Dale W. Jorgenson

Jorgenson’s 1963 paper, “Capital Theory and Investment Behavior,” introduced all the important features of the cost of capital employed in the subsequent literature. His principal innovations were the derivation of investment demand from a model of capital as a factor of production, the incorporation of the tax treatment of income from capital into the price of capital input, and econometric modeling of gestation lags in the investment process.

In 1966 Jorgenson took a crucial step beyond the aggregate production function employed by Robert Solow (1957) in accounting for economic growth. He represented technology by means of a production possibility frontier, allowing for joint production of consumption and investment goods from capital and labor services. This provided the key channel for incorporating constant-quality prices of IT equipment and software into the accounts for U.S. economic growth created by Jorgenson and Kevin Stiroh in 2000.

1960s

Garrett Hardin

American ecologist who warned of the dangers of overpopulation and whose concept of the tragedy of the commons brought attention to “the damage that innocent actions by individuals can inflict on the environment”. He was best known for his elaboration of this theme in his 1968 paper, The Tragedy of the Commons.

1950s

1940s

1930s

Jan Tinbergen (1903-1994)

Jan Tinbergen

Jan  Tinbergen, Ragnar Frisch,  and Irving  Fischer took, in 1930, the  initiative  in the  creation of The Econometric Society.  According to  the  Society’s constitution  it  is  “an international society for the  advancement of economic theory in its relation to statistics  and mathematics”. Its main objective should “be to  promote studies that  aim at  a unification of the theoretical-quantitative  approach and the  empirical-quantitative  approach to  economic problems and that  are penetrated by constructive and rigorous thinking similar to that which  has  come to  dominate in the  natural sciences”. The Econometric Society became immediately  a success; it  obviously satisfied  a deeply-felt need. It has  served  as  a stimulating  center  of  quantitative  economic  research.

Тhis describes not only the nature of the direction into which Tinbergen and the other founders of the Society wanted to develop economics, but also because it characterizes so well Tinbergen’s own scientific work.

In addition to this organizational achievement Tinbergen made some of the most  fundamental early contributions to  econometrics. Among them I  want in  particular to stress the  discovery of the so-called cobweb theorem and the related  contributions to  dynamic theory,  and the  attempts  of statistical testing of business-cycle theories.

In  uncontrolled,  agricultural markets  it  is  usual  to  find  that  prices  and quantities fluctuate in opposite directions. This pattern of behavior is difficult to  explain in  terms  of  ordinary demand and supply theory  without  making rather artificial assumptions of repeated shifts  in the  demand and/or supply curves. In  a  celebrated  article,  “Bestimmung  und  Deutung  von  Angebots- kurven:  Ein  Beispiel,”  Zeitschrift fiir  Nationalkonomie,  1930,  Tinbergen (simultaneously with,  but independent  of, two  other economists, Hanau and Ricci) pointed  out that  this  phenomenon could be explained on the  assumption  of fixed  demand and supply  curves, provided that supply  (production) reacts to prices with  a time lag of one year. This mechanism is now known as the  “cobweb theorem”.  Quite  apart from increasing the  understanding  of price formation in agricultural markets, this  innovation  in the thoery  of  an isolated  market  had  profound repercussions on  economic theory in  general.

Economic theory at that time ran almost exclusively in static terms. Genuine dynamic economic theory  describing  a  process  over  time  was  not entirely unknown; Wicksell’s and  Robertson’s monetary theories are the  outstanding examples.  But  there  had  been  few attempts to  formalize dynamic theories; Moore is  an example.  The  cobweb theorem thus  became a starting point for modern dynamic theory  with the  use of difference equations as a characteristic  feature.  Tinbergen  himself applied this  mathematical technique to  the  business cycle problem as early as 1931 in an article on the shipbuilding cycle. By the  end  of the thirties it had become a standard method of dynamic analysis in economics.

Professor Tinbergen’s second  great  contribution  to  econometrics was  his pioneering work  on statistical testing  of  business-cycle theories. It  resulted in the  two  volumes, A Method and its Application to Investment Activity, and Business Cycles in the United States of America, 1919-1932,  both published in 1939 by the League of Nations, Geneva. He had already in 1936 ventured upon a model for the  Dutch economy, see below, and in  1937 he discussed the question  more generally in  An  Econometric Approach to Business  Cycle Problems, Paris  1937; the following  year  he  applied his  methods  in  a classical article “Statistical Evidence  on the  Acceleration Principle,” Economica 1938. But it is the above-mentioned two volumes which stand out as the undisputed monument of early empirical macroeconomic model building and theory testing.

It  is  convenient to  divide  Tinbergen’s activities and contributions to economics  into  three  groups  which  also  happen to represent  consecutive  periods of his career (see above). During each period he made pioneering contributions to  economics and exerted a profound and lasting influence within the field to which he devoted his attention  and energy.  During each period he helped to set  economics  on  a  new track.  Each  time  his  contributions  opened up  new vistas  for both  economic theory  and economic policy.  His  work paralleled to some extent that  of Ragnar Frisch. They were always in close contact and influenced  each  other  on  several  occasions. In the sequel we  shall  therefore meet Frisch’s name several times.

The first period includes the  years from the  end  of the  twenties  to  World War II.  This was the  period when Professor Tinbergen together  with  a few other economists and statisticians  created econometrics as  a science.  During the war years Tinbergen was by and large isolated from international contacts, but  he used  this time  in  preparing himself for the second period, the  decade 1945 to  1955 when he,  as the  Director of the  Central Planning Bureau, laid the  foundation  for  modern short-term  economic  policies.  The  third period, beginning in  the  middle fifties  and, hopefully, continuing many years ahead, Tinbergen has devoted almost exclusively to the methods and practice of planning for long-term development, in particular of underdeveloped countries, and international economic cooperation.

Source: The Swedish Journal of Economics, Vol. 71, No. 4 (Dec., 1969), pp. 325-336, Jan Tinbergen: An Appraisal of His Contributions to Economics, Author(s): Bent Hansen

1920s

Ragnar A.K. Frisch, 1895-1973

Photo of R. Frisch from Econometrica

The Norwegian economist Ragnar Anton Kittil Frisch was the lord of economic nomenclature. He coined many of the words and phrases we are now familiar with in economics, such as “macroeconomics”, “econometrics” and “flow-input, point-output”, “impulse and propagation”, etc.  Some of his novel words did not really catch on (e.g. “passus coefficient”, “polypoly”, the “pari-passu law”,  etc.), but that hardly deterred him.    At any rate, Frisch was in an excellent position to be master wordsmith:  he also helped create the very fields he littered with his nomenclature.

Fisch research on economic theory and statistics yielded his famous 1926 paper on consumer theory (followed up by his 1932 book) which set in motion the axiomatization of consumer demand and set forth the possibility of empirically measuring marginal utility.  It was here, incidentally, where the term “econometric” was first used.

In econometrics he worked on time series (1927) and linear regression analysis (1934). With Frederick Waugh, he introduced the celebrated Frisch–Waugh theorem (Econometrica 1933) (sometimes referred to as theFrisch–Waugh–Lovell theorem).

Frisch believed that econometrics would help establish economics as a science, but toward the end of his life he had doubts about how econometrics was being used. “I have insisted that econometrics must have relevance to concrete realities,” he wrote, “otherwise it degenerates into something which is not worthy of the name econometrics, but ought rather to be called playometrics.”

The terms microeconomics and macroeconomics have their origin in the early 1930s, when economists strove to gain an understanding of factors that created the Great Depression. Separate mechanisms to describe the actions of individuals and aggregate populations were first described by the Norwegian economist Ragnar Frisch (1895-1973) in 1933.

In a paper on business cycles, Frisch was the first to use the words “microeconomics” to refer to the study of single firms and industries, and “macroeconomics” to refer to the study of the aggregate economy.

Frisch called these mechanisms “microdynamic” and “macro-dynamic.” He wrote that micro-dynamic analysis seeks to “explain in some detail the behavior of a certain section of the huge economic mechanism” within specific parameters, while macro-dynamics gives “an account of the whole economic system taken in its entirety.”

The Dutch economist Peter de Wolff was the first to publish the term “micro-economics” in a 1941 article on the income elasticity of demand.

Frank Plumpton Ramsey, 1903-1930

The Cambridge philosopher Frank P. Ramsey died tragically at the age of 26.  A wunderkind of first order, Ramsey had already written three important contributions to economics.  The first, “Truth and Probability” (written in 1926, published 1931), was the first paper to lay out the theory of subjective probability and begin to axiomatize choice under (subjective) uncertainty, a task completed decades later by Bruno de Finetti and Leonard Savage.  This was written “in opposition” to John Maynard Keynes‘s own information-theoretic Treatise on Probability.   Ramsey’s second contribution was his theory of taxation (1927), generating the famous “Boiteux-Ramsey” pricing rule.  Ramsey’s third contribution was his exercise in determining optimal savings (1928), the famous “optimal growth” model — what has since become known as the “Ramsey model” —  one of the earliest applications of the calculus of variations to economics.

Major Works of Frank P. Ramsey

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