2021 Nobel Prize in Economic Sciences – Explained, pointwise

Introduction

Economists David Card, Joshua Angrist and Guido Imbens won the 2021 Nobel Prize in Economics.

David Card was awarded for his empirical (verifiable by observation or experience) contribution to labor economics. For example, how different minimum wages affect jobs and businesses.

Joshua Angrist and Guido Imbens were awarded for pioneering new methods to analyze causal relationships. For example: the relationship b/w immigration and its economic impacts.

The Nobel Prize Committee says the trio’s research efforts have been “of great benefit to society” as they “substantially improved our ability to answer key causal questions”.

The trio utilized ‘natural experiments’ that have led to the so-called “credibility revolution” in empirical economics.

Methods like Randomised controlled trials (RCTs) have been predominantly used in empirical economics to draw causal relationships. However, it is dreadfully challenging to conduct trials in many cases. They are expensive, time-consuming, and ethically tricky.

What are Natural Experiments?

​​The research framework utilised by these economists can be broadly categorised as “natural experiments”. Natural experiments are somewhat different from the other experimental technique adopted in economics known as randomised control trials (RCT) which was popularised by Nobel Laureate Abhijit Banerjee.

Natural experiments are real-life situations that economists study and analyse to determine cause-and-effect relationships.

They differ from clinical trials in one important way — in a clinical trial, the researcher has complete control over who is offered a treatment and eventually receives it (the treatment group) and who is not offered the treatment and therefore does not receive it (the control group).

In a natural experiment, the researcher also has access to data from treatment and control groups but, unlike a clinical trial, the individuals may themselves have chosen whether they want to participate in the intervention being offered.

Why are Natural Experiments important?

Usually, a government has a limited set of resources and various problems competing for them. Therefore, any policy decision must be backed by credible evidence, not just theory. But it is difficult for economists to conduct empirical research via RCTs due to ethical concerns being involved.

In such cases, natural experiments provide economists, psychologists, and other social scientists with an opportunity to collect data when experimentation with human lives is impossible.

David Card’s work on Wages & Jobs

David Card and Alan Krueger (he died in 2019 and Nobel Prize is not awareded posthumously) studied the relationship between the minimum wage and employment in the early 1990s.

They compared the labour market of US states of New Jersey, where the minimum wage had been increased and Pennsylvania, where it had not.

They studied employment in the fast-food industry in the two states before and after the wage changes in New Jersey

The research showed that the minimum wage increase had no downward effect on the number of employees.

That finding went against the prevailing theory at the time, which assumed that an increase in the minimum wage would destroy jobs as it would make it more expensive for companies to do business.

Angrist and Imbens work on education and pay

Angrist and Imbens won the other half of the award for their methodological contributions to the analysis of causal relationships.

​​For example, extending compulsory education by a year for one group of students (but not another) may or may not affect everyone in the groups in the same way. This is because some students would have kept studying anyway, and for them, the value of education is often not representative of the entire group. So, is it even possible to draw any conclusions about the effect of an extra year in school?

In the mid-1990s, the duo solved this methodological problem, demonstrating how precise conclusions about cause and effect can be drawn from natural experiments.

Significance of the work done by 2021 Economics Nobel laureates

Importance of natural experiments: 2021 Nobel Prize in economics establishes the eminent place that natural experiments have come to acquire in policy spheres. They provide evidence, based on real-world conditions, thereby helping formulate policies that are bottom-up and robust.

Impact of immigrants on jobs: A source of great anxiety in the contemporary world is the apprehension that entry of immigrants will adversely affect the employment and wages of non-immigrant residents. Prof. Card’s analysis of another natural experiment — the Mariel boat lift that brought 1,25,000 Cubans to the U.S. in 1980, half of whom settled in Miami — showed this anxiety to be invalid. As a result of the boat lift, the Miami workforce increased by 7%, but this had no adverse impact on the wages or employment of the non-Cuban native workforce. Thus, the rhetoric of immigrants eating away jobs of the natives is not based on logic.

Answer to many big-picture questions: Both Prof. Imbens and Prof. Angrist has made innovative methodological contributions to causal inference that have enabled explorations of big-picture questions. For example, in the U.S., private university graduates earn 14% higher wages than public university graduates. Does that mean private universities cause wages to go up? Prof. Angrist’s
research finds that attending private universities does not confer a wage premium.

Transforming how econometrics is taught: The Nobel Laureates have also contributed to transforming pedagogy. Learning econometric techniques through the body of their work has made econometrics less abstract, more relatable, and interesting. For instance: Prof. Angrist, through his immensely popular textbooks (co-authored with Steve Pischke) and short videos in the Marginal Revolution University series on ‘Mastering Econometrics’ (as Master Joshway), is an excellent communicator. He starts with a real-world problem and takes us through techniques of analysis. This approach is totally different from the econometrics textbooks that begin with dry, math-heavy abstract proofs, losing students along the way by the time the chapters end with examples.

Conclusion

This year’s Nobel prize is a worthy successor to last year’s that also recognised the importance of empirical work, using randomised control trials.

This year’s winners went further in using natural experiments, and developed a toolkit to discern causality relationships between economic variables and policies.