Free Markets

Natural Experiments Make the Case for Liberty

One of this year’s Nobel Prize winners in economics inadvertently created a pro-liberty methodology.

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Cleo McVicker made soap in Cincinnati. Then came the Great Depression. By 1933, his company reeling, McVicker pitched the Kroger grocery store chain on a new product: a cleanser designed specifically to clean wallpaper without damaging it. Kroger said yes, and McVicker produced a squishy compound of water, flour, and salt. It did the job, though it was hardly a commercial sensation.

By the 1950s, households were rapidly switching from coal furnaces to oil or gas. Sooty wallpaper was no longer a pressing concern. Desperate to salvage the family business, Cleo McVicker's son Joseph learned from a relative that schoolchildren loved playing with the squishy cleanser. He reinvented the company. Play-Doh remains a bestselling toy to this day.

Invention switcheroos are surprisingly common. Viagra first arose, so to speak, as an angina medication. Teflon was used in artillery fuses and nuclear weaponry before it made its way to the kitchen. The Internet was a conduit for military contractors and academics to share information long before it became a conduit for peddling Play-Doh, Viagra, and non-stick frying pans.

Ideas get repurposed, too. This year's Nobel Prizes in economics were awarded to David Card of Berkeley, Joshua Angrist of the Massachusetts Institute of Technology, and Guido Imbens of Stanford. The Nobel committee honored them for modeling and popularizing the use of "natural experiments" in economic analysis. Card, in particular, essentially made his reputation by co-writing a widely cited paper on the labor-market effects of the minimum wage.

The issue had, of course, been studied extensively prior to the 1994 publication of Card and Alan Krueger's paper in the American Economic Review. What made their approach distinctive was that rather than construct an elaborate national model with dozens of variables that may or may not be truly independent of each other, Card and Krueger capitalized on a natural experiment. Two contiguous states with many common characteristics, New Jersey and Pennsylvania, made different policy choices. The former raised its state-mandated minimum wage. The latter didn't. The researchers found that, contrary to conventional economic wisdom, employment at fast-food restaurants went up in New Jersey, relative to Pennsylvania, after the minimum-wage hike.

Their paper has been cited thousands of times. Its conclusion, it seems, is spurious. Using a more comprehensive set of data, two other economists, David Neumark and William Wascher, ran the same "natural experiment" and concluded that fast-food employment in New Jersey had, in fact, fallen relative to Pennsylvania after the minimum-wage hike. The debate among these scholars, and about minimum-wage effects more broadly, continues to be robust.

That doesn't mean Card and the others don't deserve praise for promoting natural experiments as a useful analytical tool. I, for one, am glad they did that. Over the ensuing decades, this tool has been used many times to make the case for limited government.

Just two years after its publication of the Card and Krueger study, for example, the American Economic Review published a paper by the University of Michigan's James Hines that exploited another natural experiment, this time regarding taxation. When companies based in other countries invested in business operations in the United States, they owed roughly the same taxes to U.S. jurisdictions as American-based companies did. But in some countries, companies received tax credits to offset their tax liabilities in America, which made these firms less price-sensitive in choosing among American states with varying tax rates on corporate income. By comparing the behavior of foreign-based companies eligible for tax credits with the behavior of all other companies, Hines was able to isolate the effects of tax policies. He concluded that corporate tax rates "significantly influence" the location of foreign direct investment.

Similarly, in a 2004 study for Public Finance Review, Florida State's Randall Holcombe and Ohio University's Donald Lacombe looked at groups of counties along state boundaries. When some states changed their tax rates and their neighbors didn't, the natural experiment played out among contiguous counties. Holcombe and Lacombe found that over a 30-year period, counties in states that raised taxes experienced slower income growth than neighboring counties that hadn't raised taxes.

More recently, Terra McKinnish of the University of Colorado returned to the minimum wage in a 2017 study for the journal Regional Science and Urban Economics. McKinnish examined the effects of a 2007–2009 increase in the federal minimum wage, from $5.15 to $7.25 an hour. Because some states set higher minimum wages than the federal one and other states don't, the federal increase had the effect of compressing differences in wage floors across states, at least for a time. Using a differences-in-differences approach, McKinnish found strong evidence that in places with substantial commuting across state borders for jobs, "low-wage workers tend to commute away from minimum wage increases rather than towards them." Progressives had long claimed otherwise, citing studies with less-compelling research designs.

I'm not so naïve as to believe contentious political debates about taxes, regulations, or other public policies can be settled by a few innovative studies in peer-reviewed journals. Political disagreements tend to originate in implicit assumptions and deeply held values, not research findings. As Oren Cass astutely observed in a 2017 essay for National Affairs, political actors who claim to practice "evidence-based policymaking" are all too often guilty of "policy-based evidence-making." They play up research conclusions that ratify their preconceived notions and play down or ignore entirely any evidence to the contrary.

But over time, the accumulated weight of empirical evidence matters. And since the early 1990s, most peer-reviewed studies of economic performance among states and localities have conclusions that support classical liberal positions. I know because my colleagues and I have counted them. So while Washington's finances continue to be a shambles, quite a few governors and legislatures have embraced fiscal restraint and adopted pro-growth tax and regulatory policies. In part this was a response to effective arguments by activists and think tanks citing the kind of research I've summarized here—research that exists at greater scale and sophistication precisely because of the kind of analysis Card and his colleagues pioneered.

That such an outcome was hardly their intention doesn't matter. Indeed, I just quoted favorably an analyst, Oren Cass, who has drifted away from free-market ideas. He's mistaken about a lot of economic issues, but that doesn't invalidate his previous insights about the perils of policymaking. And though Card and Krueger's original work was championed by progressives, their method turned out to be rather handy for the rest of us.

NEXT: Can Antibiotic Goop and an Army of Divers Save Florida's Ailing Coral Reefs?

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  1. Invention switcheroos are surprisingly common.

    It’s a vaccine! It’s a symptom mitigator!

    1. It’s a floor wax AND a dessert topping!

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  2. Viagra first arose, so to speak, as an angina medication.

    It’s still an angina medication… in a way.

    Two old people in an old folks home are preparing to have sex.

    Old Lady as she’s disrobing: Now I should warn you, I have acute angina.

    Old Man: I sure hope so ’cause your tits sure are ugly.

    1. Viagra first arose, so to speak, as an angina medication. Teflon was used in artillery fuses and nuclear weaponry before it made its way to the kitchen. The Internet was a conduit for military contractors and academics to share information long before it became a conduit for peddling Play-Doh, Viagra, and non-stick frying pans.

      Never thought I’d ever hear an endorsement of Pansexuality from a policy magazine. And from my State’s own John Locke Foundation too. So encouraging!

  3. And here we run into the biggest problem with ‘libertarian economics’. At least of the Austrian school. They object to this years Nobel winners – on the same basis that you (and I) find their work useful.

    I find the real world of empirically grounded information to be the only way we can make things happen in the real world where accountability matters. Austrians and Austrian libertarians don’t give a shit about the real world. The sole purpose of reality is to be a stage for presenting arguments.

    1. How do you measure opportunity cost?

    2. You lefties are the ones always comparing your “ideal” theoretical socialism against the real world and coming up short. “Market failure” is your favorite excuse, while “government failure” is your definition of an oxymoron.

      Don’t go preaching to the choir when your only tune is “Your stoopid and i is intellgunt.”

    3. God damn jfree. All they are saying is that chaotic theories like economics change with incentives in the population. There are very few fixed rules. And society is not in general rational.

      Way to fucking look like a fool.

      1. The paper and reason even fucking agree with the premise as both mention the studies have to be done in proximity and temporally as populations even across the 2 coasts are different and it is too difficult to control for variables.

      2. All they are saying is that chaotic theories like economics change with incentives in the population.

        No actually what they are saying is that empirical data cannot be use to prove or disprove any rationalist argument they make. So they can’t ever be held accountable. If their argument is sufficiently logical and rational, then they are correct and reality is wrong if it disagrees. This has been the core Austrian assertion ever since that school became known as ‘Austrian’ during their methodenstreit argument with German historical [empirical] school of economists.

    4. While Krugman’s analyses are noted for their predictive power and grounding in reality….

  4. The prize is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.

    It was not one of the prizes established by Nobel in his will. This prize was created in 1968.

    It is not a Nobel Prize. It is wrong and misleading to call it a “Nobel Prize”.

    Reason writers, please stop calling the Sveriges Riksbank Prize in Economic Sciences a “Nobel Prize”.

    1. Otoe County Fair Biggest Rutabaga… the Nobel Prize in Agricultural Biology.

      1. “Call Any Vegetable”–Frank Zappa.

    2. Serious question, which one did Obama win? Was the the Nobel or the Sverges Dicklebank Prize in Awesomeness?

      1. The Peace Prize, for saving the world ..or something…

      2. More like the prize for just showing up.

  5. Naively believing that historical data provides a basis for explaining future human action is spurious…

  6. Hood is hopelessly naive. “Natural experiments” may be a useful tool for the sake of scoring points in academic and political arguments, but natural experiments such as those described by Hood will never prove anything in the real world, because they are not controlled experiments. There will always be too many uncontrolled and even unknown variables to determine cause and effect relationships in economic experiments. “It makes sense” that raising the minimum wage will price some workers out of the market, but markets will adapt in unknown and unseeable ways. All other things are never equal so economic experiments – whether in thought or in the real world – will always fail to conclusively prove anything. Observational studies of economic behavior will provide useful support to anyone trying to convince others of the merits of their arguments, just so long as the others are gullible and easily duped. So politicians will love them and economists will love to produce them, for a price. As Mises observed, the economic future cannot be predicted because it will be determined by future human behavior and decisions [as well as by other external natural factors].

  7. Oh, has the field of economics reached the stage where it contemplates evidence yet? Maybe it’ll be a real science someday. Libertarians aren’t gonna like that one bit.

  8. TWO articles about the shitstain who managed to prettily hide the fact that raising the minimum wage costs jobs?

    Hey, ‘libertarians’, the thing you’re praising them for, the reason they won the award, is the exact opposite of what you’re praising.

    But I suspect you know that you leftist bastards.

    What has happened to this place? Will you go back now and purge the articles you wrote AGAINST what these people have done? Has Reason finally joined with the Ministry of Truth?

    Do you love Big Brother?

  9. Natural experiments work for comparing impacts on the environment, human health, and the economy.

    See:
    North Korea vs. South Korea
    Haiti vs. Dominican Republic
    East Germany vs. West Germany

    The socialist side has had a long history of failure, on multiple fronts.

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