Philip Hans Franses is a Full Professor of Applied Econometrics. He specialises in the use of mathematical models, their predictive value and how they can help us draw up policies. In the past twelve years, he served as the Dean of the Erasmus School of Economics, which is currently celebrating the fact that its affiliate Jan Tinbergen was awarded the unofficial Nobel Prize in Economic Sciences fifty years ago, when the school was still called the Netherlands School of Economics.
Jan Tinbergen, one of the Netherlands’ most famous economists, was affiliated with Erasmus University for a long time. He is considered the originator of the field of econometrics and helped establish CPB [the Netherlands Bureau for Economic Policy Analysis], among other organisations. How would you describe his legacy?
“He left the Netherlands so many things. There’s good reason why we are celebrating this Tinbergen Anniversary in conjunction with agencies such as Statistics Netherlands, the Netherlands Bureau for Economic Policy Analysis, DNB, the Social and Economic Council and several ministries. He was awarded an unofficial Nobel Prize – the first time one of those was awarded – by Sweden’s central bank for the way in which he and the Norwegian economist Ragnar Frisch distilled economics into models. That was a genuinely revolutionary idea at the time. Models had been devised before that time, by Keynes, Marshall, Pigou and Walras, but those were a lot less complex. Tinbergen introduced a model allowing us to capture reality in all its complexity.”
What kind of impact did his model have?
“It gave economists and policymakers a shared language. They were suddenly able to make pronouncements on the effect of, say, inflation, price levels or wages.”
In recent years, these types of models have come in for a great deal of criticism. To what extent do they reflect reality?
“There isn’t a single economist in the world who will tell you that he completely understands the world. For instance, the Netherlands Bureau for Economic Policy Analysis explicitly admits that there is a difference between the model of the Dutch economy, which contains some 2,500 comparisons, and the economy itself. But we do know that the model helps us map out economic processes somewhat, thus allowing us to fix things together. Economists and econometrists bend over an economic model the same way auto mechanics bend over an engine block to examine it.”
Economists have been asked why they weren’t able to predict the global crisis back in the day.
“There were people at the time who noted that house prices were rising fast and that people were borrowing money they would never be able to repay. We’re seeing the same thing happening today. People do this a lot, by the way. It’s called the pork cycle.1 But no one could have foreseen that things would get out of hand that badly. And to some extent, these things cannot be foreseen. Just like earthquakes or tsunamis cannot entirely be predicted, either.
“There are people in my line of work who are currently seeking to determine to what extent our models overlooked certain essential variables. For instance, in keeping with the spirit of Tinbergen, they are looking at whether the capital market shouldn’t be playing a larger role in that process.”
Do you believe it behoves economists to show a little more humility? Don’t you think there are a lot of things that simply can’t be predicted?
“I’d say it’s your duty as a researcher to come up with an idea that matches reality to the maximum extent possible. And I should probably explain here as well that some of the predictions actually serve to develop policies that will undo the prediction or steer things in the right direction. For instance, we know that polar bears are threatened with extinction. We are now taking action to prevent that from happening. So what we don’t want to hear in twenty years is this: ‘That prediction was wrong.’ Rather we’d like to hear: ‘We managed to turn things around in such a way that that prediction didn’t come true.’ Economic predictions work the same way.”
To what extent did Tinbergen have an easier time of it than today’s economists?
“The Dutch economy has become more complex and more interwoven with the world economy, and everything is happening faster. In the last few decades, we’ve had several financial crises, but between World War II and the first oil crisis in 1973 – the period during which Tinbergen conducted much of his work – the Netherlands was a very quiet place. There were no major financial upsets; life went on without anything eventful happening. Economists were able to take their time turning small cogs so as to steer inflation or unemployment into a slightly different direction. Generally speaking, Tinbergen’s predictions came true very nicely.”
Now a negative interest rate has been added to this complex economic reality. Many economists believe we are now entering uncharted and possibly dangerous territory. Does this make working with models – and therefore understanding and correcting the course of the economy – even more difficult?
“Economists aren’t particularly fazed by the negative interest rate. It’s a direct consequence of things such as the unbridled creation of money by the European Central Bank. No, events that genuinely cause a mess are what Nassim Nicholas Taleb calls ‘black swans’ – the attack on the World Trade Center, a tsunami with countless fatalities. Unlikely and unpredictable events that determine the course of history.
“If the volcano in Yellowstone National Park erupts tomorrow, half of the United States will be wiped off the planet. If Donald Trump somehow manages to reunite North and South Korea, he will go down in history as one of the best presidents ever, even though at present everyone considers him an idiot.
“Expect the unexpected – it sounds like the motto of a Star Trek episode, but it’s the only thing we can do. We can make sure we are resilient. And models may play a vital part in this. For instance, imagine a situation, five years from now, in which a steak no longer costs two euros per one hundred grams, but rather twenty euros. It’s entirely possible. A model can give us some understanding of the impact this will have on the consumption of meat, the consumption of water, the changes in the value chain. We can’t do those things without models. Without models, all we can do is freak out. And it’s hard to do anything useful when you’re governed by your emotions.”
A few years ago, you conducted a study on the degree to which skirt hemlines and recessions are interrelated.
“That was more of a joke. In the 1920s, a guy called George Taylor invented the Hemline Index, the idea that share prices rise when skirt hemlines go up, and vice versa. Of course, that’s nonsense, and we demonstrated that – by means of a serious amount of data, it should be noted. The study was actually published. At a time when academic research must find its way to a general audience, this has definitely been my most impactful study. We were namechecked everywhere, from Giel Beelen’s radio show to the NOS News.”
Criticism of the ‘mainstream economy’ is quite popular at present. For instance, Kate Raworth’s book Doughnut Economics, in which she posits that economic models do not provide enough answers to today’s questions, particularly in terms of social and ecological violence, was quite a bestseller. How do you feel about this criticism?
“I can’t help noticing in these discussions that people seem to think we still operate on the premise of homo economicus, which is to say, a belief that people act in a completely rational manner. We stopped doing that fifty years ago. It’s an essential tenet of behavioural economics that humans are irrational beings. Another thing critics keep getting wrong is that economists were responsible for the global economic crisis. It’s like blaming a doctor for a patient’s death, or a fireman for a raging fire. We study crises. We don’t orchestrate them. People do so of their own accord.”
If Jan Tinbergen were to walk into today’s Faculty of Economics, do you think he’d recognise the place at all?
“I think he’d be surprised to see the enormous growth our field of study has experienced. Here in Rotterdam, in particular, economists deal with a huge variety of subjects, ranging from gender studies to the impact of natural disasters, and from price levels to the optimal allocation of medicines in remote areas in Africa. I think he’d see that economists continue to be socially engaged people who wish to make society a better place – just like he himself did. Oh, and another huge difference with his era is the pace of the work being done. We can now calculate a complex model in a mere fraction of a second, whereas half a century ago, we were given four years to conduct PhD research on such a model.”
- The pork cycle is an economic phenomenon in which surpluses and shortages alternate because suppliers respond to price levels. By the time suppliers’ responses start affecting supplies, prices have already changed again. ↩︎