How is the global economy interconnected?

Wassily Leontief witnessed history. He was a young boy when his country mourned the death of Leo Tolstoy. He saw Lenin talking to a crowd in front of the Winter Palace. As a young academic, he decided to leave Russia to escape censorship, and eventually moved to the United States to further develop what would become his most important contribution to economics: the input-output-analysis. Before the age of computers, Leontief started mapping the flow of goods and services between different economic sectors, which proved to be crucial to learning more about how economies interconnect through global supply chains. The importance of his models has increased over time and today they’re still vital to our understanding of the economy.

Wassily W. Leontief

Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 1973

At a glance

Born: 1906, St. Petersburg, Russia

Died: 1999, New York, New York, USA

Field: Macroeconomics

Prize-winning work: Development of the input-output analysis, a method to systematically analyze inter-industry transactions in an economy

Taking chances: Was offered work as an advisor to the Ministry of Railroad Services in Nanking after having a beer with some Chinese gentlemen in a Berlin pub

Travel lover: Chose the slowest way possible to travel to China in the 1920s: he took a Japanese boat from Marseilles

Passing on the success: Four of his doctoral students have also been Nobel Prize winners: Paul Samuelson, Robert Solow, Vernon Smith and Thomas Schelling

In the middle of a revolution

Leontief was only ten years old when the Russian Revolution started with the replacement of the Czarist regime by a provisional government. He lived in Leningrad (present-day St. Petersburg) and, even as an old man, he still remembered how he would play with his friends in the streets, and sometimes bullets would go by. He shared vivid memories of incredible hunger, and how his parents would barely eat anything so their son could have more. There wasn’t even wood to heat the house. "Life at that time was extremely hard", Leontief later said.

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Politically, it wasn’t an easy time for the family. Leontief’s father, a professor of economics who had studied in Germany, disagreed completely with what was happening in Russia, as did Leontief himself. "There was a great tension," he remembered. If there was one thing he’d learned from his father, it was to speak freely. "I was definitely on the protesting side. I protested with fellow students against censorship. We printed leaflets, and deep at night we went pasting them on the walls in the city."

An important lesson learned

At the age of 15, Leontief was arrested for the first time due to disputes he’d had with his friends, all of them strong defenders of the Bolsheviks. Leontief sided with the other faction of the socialist movement, the Mensheviks. Though times were rough, he remembered how life just went on. "As a young person, I could take it," he explained. "People just continue." But he learned an important lesson back then, "in how hard life can be. It was a very good lesson."

A passionate reader, Leontief took the first important steps towards a successful academic career in the midst of turbulent times. He was given special permission to be admitted to university at a very early age, starting his studies in philosophy, sociology, and eventually economics. He earned his master’s degree in 1924 - when he was only 19 years old.

The first steps towards an academic career

But Leontief soon realized he wouldn’t be able to develop a scientific career in his home country. Censors forbade the publication of his academic articles because he’d campaigned for freedom of speech and institutional autonomy. "And I wanted to leave," he remembered.

In 1925, Leontief got to Germany. Stalin was in power, and it was only a few years before his regime of terror would reach its peak. Leontief knew a little German from his father, but he had to study hard and spent hours in the public library every day to keep up. Though he was extremely poor, he enjoyed every day. "I bought a bottle of milk each morning. And when the milk became sour, it was also a meal. But it was marvelous!"

Before the Nazis took over, Leontief left for the United States. He’d already started his systematic economic research while still at the Institute for the World Economy in Kiel, but had engaged mostly in statistical work on supply and demand curves. At Harvard University, he realized that this wasn’t the approach to understand how an economy works. "To study little pieces, to use very fancy statistical measures, you never understand the economy. One must get the facts, and I developed a theory of how to analyze it."

Leontief started the work that, decades later, would earn him the Nobel Prize in Economic Sciences, and would turn him into a world-renowned academic. "The economic system of a country is like a big computing machine," Leontief said when he introduced his input-output-analysis. "And very often computers break down. Find out what’s wrong with the computer with a good analysis."

How do different industries affect each other?

In general, Leontief’s approach sought to answer the question of how economic sectors’ activities affect each other. "With input-output analysis, we try to describe what happens in an economy. We show how products are distributed," Leontief explained. He was able to depict, for the first time in economic history, how all the different industries are interconnected, how they sell and buy from each other.

"Imagine you have an economy which consists of two sectors, agriculture, and manufacturing. And then you also have final consumption, households. If you have to deliver more to households, you have to increase output. And you can compute how much more additional products you need. It’s a complete system!" If, for example, there was an increase in the production of cars, Leontief could use an input-output table to estimate how much additional steel, labor, machinery and other inputs were required.

A cooking recipe for global economies

Leontief used a cooking recipe analogy to demonstrate how the analysis works. "To make 100 units of agricultural products," he pointed out, "you need 10 units of this, and 10 units of that, and this is what you look at in the kitchen when you want to make a pound of bread." Leontief knew, of course, that although the cookbook was an easily understandable image, his theories would give wrong answers when used to make literal predictions. "There’re also time lags, something which is produced today, the input must be produced a year or two years before. It’s a problem of synchronization. That’s why much of the modern theory of the business cycle doesn’t involve the input-output table exactly. It’s an extremely complicated system."

Nevertheless, his approach to economic interconnections became increasingly important over time. To this day, it is a method every student of economics has to learn by heart, and a useful tool for institutions such as the World Bank or the United Nations.

How to help developing countries?

Much of Leontief’s work was devoted to the question of how to make his research useable for developing countries. In the 1970s, for example, the UN asked for his expertise. "They came to me and asked to help with a report on how one could help less developed countries. They thought that I would just write a nice report that they can put on the shelf, and I said no."

The study he was eventually able to conduct was titled "The future of the world economy", and it proposed alternative paths for future developments. For example, Leontief showed how industrialized countries could reduce the production of arms and use some of the resources saved for helping developing countries. The basis for his analysis: the computation of an input-output-table.

Looking at the big picture in all its details

Though Leontief became known as a theoretical economist, he felt strongly that theory was simply an instrument to approach reality, and that many of his fellow economists didn’t pay enough attention to the collection of data. "Unfortunately," he pointed out, "instead of collecting data, we make assumptions! Instead of looking at figures, we say let’s assume! Then of course, you get something that has no relation to reality."

Leontief accused some academics of "making gymnastics instead of advancing knowledge". He was never shy to express himself, even when he served as president of the American Economic Association in the early 1970s. As such, he delivered a speech titled "Theoretical assumptions and non-observed facts". He cared deeply for making quantitative data more accessible, for looking at the big picture in all its details, and that was exactly what he tried to do with his input-output-tables.

A map of the economy - and no computer

Financial Times columnist Tim Harford explains how Leontief even can be called an "intellectual ancestor" to the PageRank-Algorithm developed by Google-co-founder Lawrence Page. After all, Page tried to map the way webpages are all interconnected with similar mathematical techniques to those Leontief had used decades before to map out the interconnections between industries. The major difference: when Leontief calculated the first input-output tables for the American economy in the 1940s, he used a hand-held calculator.

Eventually, the first computers came, and they simplified the whole process. At Harvard, Leontief would use one of the earliest computers to describe the US economy alongside 500 different economic sectors. Today, technological progress allows for a whole new dimension of analysis, of course. Did Leontief ever have the chance to use Google? Harford smiles. "I can’t say."

 

"Pursue what you think is right!"

While he was a mathematical genius, Leontief also enjoyed the arts, music, traveling, and reading. He was a political person all his life, caring for the less fortunate, and hoping that the relationship between Russia and the United States would improve. "Hostility between Russia and America splits the entire world. It’s ridiculous."

When we interviewed Wassily Leontief at the age of 82 in 1988, we asked him for an advice he would like to share after having lived such a long and fruitful life in many different worlds. "Don’t be afraid," he answered. "Don’t compromise too much, and pursue what you think it’s right." Without a doubt, he clearly followed his own advice.

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What does Leontief's work mean for us?

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"Everything is connected to everything else, and Leontief was able to track those connections using his input-output table. That allowed him to question some received wisdom in economics."

Tim Harford
Financial Times columnist and author of
The Undercover Economist

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"Leontief’s Nobel Laureate was awarded for creating input-output models, work he started in the 1930s. The importance of these models has increased over time and today they are vital to understanding the global economy."

Paul Donovan
Global Chief Economist
UBS Wealth Management

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