This encapsulates the “on the one hand... but on the other...” approach you need to develop for a high grade.
The credibility revolution
The Nobel prize for economics went this year to David Card, Joshua Angrist and Guido Imbens, says Alex Tabarrok. “If you seek their monuments, look around you.” They developed methods to analyse “natural experiments” – that is, observing the results when circumstances change in one part of the world but not another. Much empirical work in economics follows their lead.
JUST OPEN YOUR EYES
Take the long-running row about minimum wages. The obvious way to estimate the effect of a minimum wage is to look at the difference in employment before and after the law goes into effect. But other things are changing over time, making it hard to know whether the observed changes were really due to the wage floor or not. When New Jersey passed a minimum-wage law in 1992 but neighbouring state Pennsylvania didn’t, a natural experiment was set up, and its results studied by Card and fellow economist Alan Krueger in 1994. Given that it is reasonable to assume that factors affecting employment in both states would be roughly similar apart from the changed law, the effect of the law on employment levels could be seen. Their surprising finding was that minimum wages in fast-food restaurants did not reduce employment and may even have boosted it. Their approach seems obvious today, but it was a brilliant innovation in 1992, at least in economics.
Angrist and Krueger dealt similarly with another classic problem in economics – how to estimate the effect of schooling on earnings. People with more schooling earn more, but is this because of the schooling or because people who get more schooling have more ability? To find out, the economists exploited a quirk of US education, meaning that children born in the fourth quarter of the year are more likely to have had a little more education than those born in the first quarter. The effect is as if someone had randomly assigned some children to get more education than others – ie, another natural experiment. Analysis of the data showed that those getting less education did indeed earn less – the implication of the numbers is that an extra year of education raises earnings by 10%. (Imbens, the last of the Nobel-winning trio, was more involved in the development of the theoretical framework underlying work such as this.)
The real lesson from this “worthy trio” is not so much in their results as the method: “Open your eyes, be creative, uncover the natural experiments that abound – this was the lesson of the credibility revolution”.
What the Nobel winners get wrong
The work of the Nobel-prize winners (see above) purports to have solved the problem of how to distinguish cause and effect from mere correlation in data, says Frank Shostak. This is nonsense. Even in the natural sciences, all that can be done is to isolate various facts and hypothesise about the true law that governs their behaviour. If the theory and the facts agree, the theory is tentatively accepted. But economics, as Ludwig von Mises explained, is nothing like this. In economics, we do not need to hypothesise, for we can “ascertain the essence and the meaning of people’s conduct”. We know from introspection that human action is purposeful and that the meaning of our actions can be determined. This knowledge is “certain and not tentative”.
So, to take the example of minimum wages, we know that fast-food workers take the job in order to earn money to achieve their goals. The business owner is set on making profits, and will not employ workers if he is forced to pay more for the work than it is worth. It stands to reason, then, that wage floors will undermine the labour market to the detriment of both workers and businesses. No amount of data gathered from complex phenomena and then examined will tell us anything to challenge these insights.
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