Nobel Prize in Economics - Revolutionizing Natural Experiments

The Royal Swedish Academy of Sciences this year decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel to David Card, Joshua D. Angrist, and Guido W. Imbens. While David Card provided new insights about the labour market through natural experiments, Angrist and Imbens made methodological contributions to the analysis of causal relationships via using natural experiments. This approach has spread to other fields and has helped in revolutionising empirical research in the last 30 years.

Natural experiments are the experiments done by researchers using situations in which chance events or policy changes result in groups of people being treated differently, in a way that resembles clinical trials. As simple as they sound, it is still difficult to interpret these experiments. Joshua Angrist and Guido Imbens solved the methodological problems in natural experiments, demonstrating how precise conclusions about cause and effect can be drawn. David Card did an analysis on the labour market effects of minimum wage, immigration and education using natural experimentation. The studies done by him in the early 1900s challenged the conventional understanding, leading to new analyses and additional insights on these. Results from David Card’s studies have shown that increasing minimum wage does not necessarily lead to lesser jobs, income of people who were born in a country can benefit from new immigration, people who immigrate at an early time are at risk of being negatively affected and resources in schools are far more important in determining future labour market success of the students. Abhijeet Banerjee, Ester Duflo and Michel Kremer received Nobel Prize in the year 2019 for their contribution to the experimental approach to alleviate global poverty. The approach that they used for the field research was Randomised Control Trials, which is usually used in medical science and other fields to understand the results of after-effects of an intervention or change. They used RCTs to test how people responded when they receive a regular sum of money in order to sustain their life without worries, and they found out that different type of interventions such as monetary finding helps people to stay happy, work on their skills, and earn even more in the future as they get free from finding ways to fulfil their daily needs.

Natural experiments differ from Randomised Controlled Trials (RCTs) or the clinical trials in one crucial way i.e. in RCTs, the researcher has complete control over the control group and the treatment group, while in natural experiments, the researcher only has access to the data from the treatment and the control group in which the individuals choose by themselves if they wish to participate in the experiment or not, as the experiment is a normal occurrence due to some policy changes. Since people can neither be forced to participate in the intervention being studied nor can they be forbidden from doing so, it gets difficult to interpret the results of such natural experiments. One question that arises in everyone’s mind is, what value does one extra year of education add to his/her income? An initial research was done in order to understand this relationship by taking a dataset on how people’s earnings relate to their education. In every possible context, it was found that an extra year of education leads to seven percent higher income from those not having an additional year of education. So can this result be concluded in the same way? No. Because here people who choose to study longer differ in various characteristics, they may be talented at studying and working, therefore they are likely to earn more. They would have had a higher income even if they didn’t study an extra year. The other possible case is that the people who expect to earn more after studying an extra year will choose to study longer. Hence, problem occurs when we just try to interpret the results and don’t find other linkages to those results.

In relation to this, Angrist along with Alan Krueger wrote an article showing that the effect of an additional year of schooling on income was nine per cent. They looked at the data of years spent in school by students when they are born in the first quarter of the year and the fourth quarter of the year, the results showed that the students who were born in the fourth quarter of the year spend more time in schooling compared to the students who were born in the first quarter. These results arise because, in the US, all children who are born in a particular calendar year start school on the same date, children who are born early in the year can leave school sooner than children born later in the year. The result was different here compared to the initial studies.

David Card with Kruegar also used Natural Experiments to investigate how increased minimum wages affect employment. The minimum hourly wage in New Jersey was raised from 4.25 dollars to 5.05 dollars in the early 1990s. To do an experiment they needed a control group, so they observed that there was no increase in neighbouring Pennsylvania. Differences were there between the two states but the labour markets near the border would evolve similarly, hence they studied the effects on employment in the two neighbouring areas – New Jersey and Eastern Pennsylvania – which have a similar labour market, but where the minimum wage was increased on one side of the border and not the other. To do the study effectively, Card and Kruegar chose employment in fast food restaurants, which is an industry that pays low and minimum wages. The results of their study showed conflicting insights to the previous research, as they found that an increase in the minimum wage had no effect on the number of employees.

Studies by David Card also attempted to explain the absence of negative effects of employment. Companies can transfer the increased cost on consumers without reducing much demand and companies which dominate their labour market can keep the wages low. These studies by David Card have improved the understanding of labour markets. The work of these laureates have demonstrated the possibility to answer questions about cause and effect using natural experiments. Angrist and Imbens’ methodological insights and David Card’s application of this approach has led a way forward for the researchers. Their work has revolutionized the way of empirical research in social science to answer questions of great relevance.