Economics Nobel for Natural Experiments

Q What is the context  ?

A The 2021 Nobel Prize in Economic Sciences was awarded to three US-based economists.

• Nobel Committee awarded half the Prize to David Card for his “empirical contributions to labour economics”
• Other half to Guido Imbens and Joshua Angrist “for their methodological contributions to the analysis of causal relationships”

Q What makes this year’s award special?

A 

• This is the first time the economic prize has been divided in this fashion with one half going to one awardee and other half divided across two awardees.
• In the past, prize money was divided equally between the awardees even if the prize was for different topics as is the case this time around.
• It may appear that the Nobel Prize has been given for two different contributions, but there is a common theme: “natural experiments.”

Q What are Natural Experiments?

A 

• Economists are often interested in causal questions such as the impact of education on incomes, impact of COVID-19 on poverty and so on.
• They are also interested is understanding the direction of causality.
• Economists have used two kinds of experiments to study these causality and direction of causality questions: random experiments and natural experiments.

(I) Random experiments

• Under randomized experiments, the researchers allocate say medicines to a treatment group and compare the effect of the medicine with the control group which is not given the medicine.
• In 2019, the Nobel Committee gave awards to three scholars for their contribution to the field of randomized experiments.
• However, one cannot randomize experiments to study issues such as why certain people and regions are more unequal or have fewer educational opportunities and so on.

(II) Natural experiments

• In natural experiments, economists study a policy change or a historical event and try to determine the cause and effect relationship to explain these developments.
• The trio used such natural experiments to make some landmark contributions to economic development.
• Natural experiments are more difficult for two reasons. The first is to identify what will serve as a natural experiment.
• Second, in a random experiment, the researcher knows and controls the treatment and control groups which allows them to study the cause and effect of medicine.
• But in natural experiments, such clear differentiation is not possible because people choose their groups on their own and even move between the two groups.
• Despite the limitations, the researchers could use the natural setting to answer some big policy questions.

Q What are Natural experiments conducted by David Card ?

A 

• One question of interest for policymakers is to understand the impact of higher minimum wages on employment.
• Earlier studies showed that increasing minimum wages leads to lower unemployment.
• Economists were also not sure of the direction of causation between minimum wages and employment.
• Say a slowdown in the economy leads to higher unemployment amid lower income groups.
• This could lead to lower income groups demanding higher minimum wages. In such a case, it is higher unemployment which leads higher minimum wages.

Q What is Contribution of Angrist and Imbens ?

A 

• Angrist and Imbens showed how natural experiments can be used to identify cause and effect precisely.
• We have discussed above how natural experiments make it difficult to separate control and treatment groups. This makes it difficult to establish causal relations.
• In the 1990s, the duo developed a methodology – Local Average Treatment Effect (or LATE) – which uses a two-step process to help grapple with these problems of natural experiments.
• Say, one is interested in finding the impact of an additional year of schooling on the incomes of people.
• By using the LATE approach, they showed that effect on income of an additional year of education is around 9%.
• While it may not be possible to determine individuals in the group, one can estimate the size of the impact.

Q What is the importance of the award today?

A 

• Earlier it was difficult to identify natural experiments and even if one identified them, it was difficult to generate data from these experiments.
• With increased digitalization and dissemination of archival records, it has not just become easier to identify natural experiments but also get data.
• Economists have been using natural experiments to help us understand the impact of past policies.
• As the 2020 pandemic struck, economists used the natural experiments approach extensively to analyse how previous pandemics impacted different regions and tried to draw policy lessons.

Q How is it related to Indian Context ?

A 

• The methodology date back to the early and mid-90s and they have already had a tremendous influence on the research undertaken in several developing countries such as India.
• For instance, in India, too, it is commonly held that higher minimum wages will be counterproductive for workers.
• It is noteworthy that last year, in the wake of the Covid-induced lockdowns, several states, including UP, had summarily suspended several labour laws.
• This included the ones regulating minimum wages, arguing that such a move will boost employment.
• The main learning is that minimum wages can be increased in India without worrying about reducing employment.