Joshua Co

11213442
Ecomet2 Midterm Paper
James J. Heckman greatly contributed to the field of Microeconometrics as we now
know. In his 2000 nobel prize in economic sciences for his paper entitled Microdata,
Heterogeneity and the Evaluation of Public Policy, he discusses just that, how the development
of microeconomics addresses 1) the importance of complete data that is lacking, 2) the
diversion away from the average individual in recognition of more heterogeneity and diversity in
the data, and 3) the way we look at and evaluate public policy.
Heckman defines econometrics as a branch of economics that unites economic theory
with statistical methods to interpret economic data and to design and evaluate social policies.
Microeconomics is an empirically oriented field that has evolved in the last 40 years to aid
economists in finding the link between economic theories and data, and thus evaluating public
policy. This lead to more intuitive results, and provided for counter factual analysis. Heckman
takes off from the research and models from the Cowles commission. Early Microeconometrics
pioneers used aggregate data to create models for a scientific and empirically based approach
in testing public policy. The results however, were weak and ineffective. This moved economists
towards the use of time-series statistics, which provided a weak link to economic theory. It was
Orcutt, who combined micro and macro data to produce more credible analysis, which paved
way for much of Microeconometrics.
Heckman gave 4 themes that contributed to the development of Microeconometrics. The
first is the post-world war II surge of rich new data on individuals and firms that gave economists
a host of information to work with. At the same time, economists were limited by the current
models of the Cowles commission in interpreting this data. The second was the failures of the
models of the Cowles commission. The models were weak and did not precisely solve individual
decision problems. Microeconometrics tightened the link between formulated models of
individual behavior and estimated models on individual data, and at the same time, constructed
counter-factuals when faced with missing data to be used in evaluation of public policy. The third
was the emergence of heterogeneity and diversity in economic life. Microeconometrics extends
the Cowles methods by: 1) using the individual as the unit of observation, and recognizing the
diversity of life more fully, and 2) building richer econometric models where heterogeneity plays

a fundamental role. By moving away from the representative average individual, Heckman
found that people are diverse and that diversity and heterogeneity have important implications
on how we think about economic life and how we evaluate policies. This overall provides a
higher degree of correlation. As said by Heckman, at its heart, Microeconometrics is about
individuals, family units, and firms and their interactions with the economic environment. The
fourth was the need for scientific evaluation of public policy. Through the use of treatment
effects as well as structural parameters, economists are able to answer policy questions in a
principled way. Microeconomics was further honed through the growth of the modern welfare
state, and the ensuing demand for the identification and solution to social problems, as well as
the public demand for proper evaluation of these solutions.
In his paper, Heckman addresses 2 problems. The first is treatment effects problem, that
is, what is the effect of a program in place of participants and non-participants compared to no
program at all or some alternative program? This of course is the classical problem of whether
or not a program works. The second problem is a structural problem, that is, what is the likely
effect of a new program or an old program applied to a new environment? This involves
studying the parameters of individual or firm behavior and finding well defined economic
parameters. In his speech, he mentions 3 cases with tax policy. The first is, that same tax that is
implemented in the past is implemented in the future under the same regime. This means that
the future is like the past, and things will carry on to the future. All we want to know here is what
will happen in the future? The second is, the same tax is imposed for the past to the future, but
there is a new environment. Here we ask, what will the new environment? What effect will it
have? How will people react to it? The third question is, that there has never been a tax
implementation so there is no data for it. We have no idea how people will respond, and we
need an economic theory to relate old data to new data. Problem 2 and 3 in the tax example are
examples of the structural problem. One would need to determine the unobserved variable and
make a projection about the future. Here we go out of out of sample to analyze the parameters
and look at what the effects of the policies are. As Heckman said, the in sample problem
(problem 1) is not actually a problem of knowledge or economics. The problem of economics
arises when we try to obtain a wide arrange of counter-factuals, and this is a fundamental
problem in public policy. That is, would individuals be better off had there been no tax at all?
When looking at the measure of fit or how well you measure outcomes, Heckman noted
that the econometric models only explain a small portion of the variability. These models show a

diversity that was essentially ignored. We then ask the question, given the lack of dimensions of
the data, how can we relate them to each other in order to do counter-factual analysis?
According to Heckman, we must go out of the sample to make counter-factual simulations. The
question becomes how to accommodate for the different features of the micro econometric data.
These are: 1) Accounting for discreetness of outcome variables; 2) Rationalizing choices at
what are called extensive and intensive margins, for example decision to work and not to work
and how many hours to work; and 3) How to account systematically for missing data.
Microeconometric models help develop and exploit the micro data. It emphasized the
role of economic theory and causal frameworks for interpreting evidence and constructing
counter-factuals especially for missing data. It is now more of a question of interpretation where
heterogeneity plays an important role, which became more evident on panel data. The work of
Heckman was more centered on specific decision problems. Particularly he worked on labor
policy. He produced an economically motivated, low dimensional, simultaneous equations
model with both discrete and continuous endogenous variables that could take into account the
different dimensions in labor. He also addressed issues of selection bias and missing data.
Using simultaneous equations, he was able to show empirical findings on heterogeneity in the
slopes and intercepts, thus showing its importance.
REFLECTION
It is clear from Mr. Heckmans work that he (among others) has contributed greatly to its
development and application today. As a labor economist whose work looks at public policy
implementation and evaluation, he of all people should know the ins and outs of
Microeconometrics. Given the importance of public policy in the economy at an individual basis,
it is fitting that Microeconometrics gets the recognition it deserves, much so for Heckman. As
noted by him, it is important to understand the diversity and heterogeneity that plauges microdata. Without taking these into account, we face the risk of facing errors in our policy
evaluations. This is the main thing we learn about Microeconometrics and the reason why it
becomes so technical and difficult. Heterogeneity happens when the unobserved factors that is
not capture in our data and that our regressors do not take into account. With the massive
amounts of data in our palms and with interconnectedness of data, particularly micro-data,
heterogeneity can become real threat to the integrity of our results.

When thinking about public policy, I think of programs like conditional cash transfers, K
to 12, unemployment rates, and the like. When we are talking about things like education,
poverty, and unemployment, it is important that our programs and their successive evaluations
are spot on. We cannot leave any room for error. That is why it is important to recognize
heterogeneity, it is crucial to decide if a program would actually work is did it only work because
of these unobserved heterogeneity, or a specific endowment in an observation. This is
particularly important for 3rd world countries like the Philippines. I would think that our public
policy bears more weight than wealthier countries as ours is not even improving social welfare
as it is about ensuring the survival of the marginalized. Therefore, it is not sufficient that 3rd
world countries exactly imitate policies implemented by 1st world countries (or for any country for
that matter), without taking into account the diversity in each country. Things like culture,
mentality, and habits must be taken into account when implementing a policy. The level of
nationalism, conservatism, discipline, can all ruin a perfectly good policy. What is the point of
having better road infrastructure and public transportation when the people are all disorganized
and exhibit a crab-mentality. Thus by looking at the unobservable factors, the government must
not only solve the symptoms, but the causes.
I personally have developed an appreciation for Microeconometrics. It is clear to me now
how crucial the recognition of heterogeneity is, and why we look for the perfect model in our
regression. Public policy is, in my opinion, always something only economists will be good at.
More than our knowledge in advanced econometrics is our keen understanding of how things
work, and our ability to put 1 and 1 together. That is not to say that public practice is the only
path for us economists. Ultimately I find an economics degree allows us to be prepared for
anything, by giving us this sophisticated view of the world. I would like to end with a quote by
Frank Knight that Heckman said in his speech. The existence of a problem of knowledge
depends on the future being different from the past, while the possibility of the solution of the
problem depends on the future being like the past. Preparation is therefore key.