Nobel Prize 2021 In Economics EXPLAINED: Natural Experiments And The Crucial Questions They Can Answer
The 2021 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel has been awarded to David Card, Joshua Angrist and Guido W. Imbens.
New Delhi: The 2021 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel has been awarded to three economists — one half to David Card "for his empirical contributions to labour economics" and the other half jointly to Joshua D. Angrist and Guido W. Imbens "for their methodological contributions to the analysis of causal relationships".
This year's economic sciences laureates have demonstrated how natural experiments can be used to answer society's central questions, such as the effect of minimum wages and immigration in the labour market. They have shown what conclusions can be drawn about cause and effect, and have revolutionised empirical research in the economic sciences.
Natural Experiments And Causality
A natural experiment is an empirical or observational study in which the variables of interest are not artificially manipulated by researchers but instead are allowed to be influenced by nature.
There are two groups — the treatment group and the control group. The treatment group receives the intervention being studied while the control group does not receive the intervention.
Causality or causation refers to the relationship between cause and effect.
There are natural experiments in which people cannot be forced to participate, nor can be forbidden from doing so. Joshua Angrist and Guido Imbens, in 1994, analysed the causation of such experiments.
Joshua Angrist and Alan Krueger's research
In 1991, Joshua Angrist and his colleague, Alan Krueger, who is now deceased, analysed the correlation between education and income and found that the incomes of people with 12 years of education were 12 per cent higher than those with 11 years of education. Also, the income of people with 16 years of education was 65 per cent higher than those with 11 years of education. Thus, the researchers observed a clear correlation between years of education and income.
In a landmark article, Angrist and Krueger depicted the cause and effect relationship between additional years of education and future income. They compared people born in the first four months of the year to those born in the last four months, and observed that the first group had lesser years of education and lower incomes than the second group, because the first group left school earlier.
Through this natural experiment, the researchers established a cause and effect relationship which showed that more education results in higher earnings.
David Card and Krueger's Pioneering Research
David Card, in the early 1990s, used natural experiments to show the effect of minimum wage (lowest wage that an employer must pay an employee, according to a law or agreement), immigration and education on the labour market. Because of these experiments, we understand the labour market better.
Card and Krueger studied how higher minimum wages affected employment. Earlier, it was believed that increasing the minimum wage caused lower employment. In 1992, Card and Krueger considered fast-food restaurants in New Jersey (treatment group) and in eastern Pennsylvania (control group). On April 1, 1992, the hourly minimum wages in New Jersey increased from 4.25 dollars to 5.05 dollars. Despite this, there was no change in employment.
The researchers observed that the number of employees were not affected by an increase in the minimum wage. They concluded that the negative effects of increasing the minimum wage were negligible. Card showed through other experiments that higher minimum wages did not negatively impact employment.
Card's research on immigration and education
Card studied the effect of immigration and education on the labour market. In April 1980, 1,25,000 Cubans emigrated to the US, with most of them settling in Miami. There was a seven per cent increase in the Miami labour force due to the influx. Card analysed this natural experiment and observed that low levels of education had no negative impact on the labour force.
Card and Krueger also analysed how school resources affect one's future success on the labour market. They observed that school resources are important because regions with greater number of teachers invested more in education, which resulted in higher success on the labour market.
Angrist and Guido Imbens' work on LATE
In the mid-1990s, Angrist and Guido Imbens tried to establish a cause and effect relationship between education and income. They considered a natural experiment where some people are offered a computing course (treatment group) while other people are not (control group). In both groups, there were people who were interested in the course, while others were uninterested.
The researchers used a two-step method known as the instrumental variables method to analyse the relationship. They concluded that the cause and effect relationship could be established only for those participants who opted for the course just because it was offered to them, as they changed their behaviour because of the natural experiment.
Also, a cause and effect relationship between an additional year of education and income was applicable only for those people who decided to leave school when they are given a chance.
The effect on such a group, where researchers do not know who the participants are, but only the size, is called Local Average Treatment Effect (LATE).
In this way, Angrist and Imbens' methodological insights about natural experiments, and Card's use of natural experiments to understand labour economics have proved to be extremely beneficial in the field of economic sciences.
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