Wednesday, 15 July 2020

Why study economics? It causes higher incomes...

I've posted a number of times about why students should study economics (see the long list at the end of this post). Several of those posts highlight the earnings premium that economics students receive - students who study economics earn more than those studying in many other fields. Most of the evidence I've cited in those posts is observational - it involves a straight comparison between the earnings of economics majors and the earnings of other students. It could rightly be criticised as not demonstrated that economics causes higher earnings. Perhaps the types of students who study economics would earn more, even if they studied sometime else instead of economics - we refer to this as selection bias, because in this case it would mean that better students are selecting to study economics.

A recent working paper by Zachary Bleemer (University of California, Berkeley) and Aashish Mehta (University of California, Santa Barbara) sets out to solve the selection bias problem and provide causal estimates of the impact of studying economics on income. They make use of data from the University of California as Santa Cruz, which implemented a grade point threshold in 2008 that students needed to meet in order to be admitted into an economics major (a GPA of 2.8 based on grades in the first two economics courses). Students who are very close to, but above, the threshold should be very similar to students who are very close to, but below, the threshold. Effectively, whether or not those students very close to the threshold could choose to do the economics major or not is random. So, comparing the incomes of those two groups of students shows how much doing an economics major matters - this is referred to as a regression discontinuity design, because if the threshold has an effect, it will show up as a clear break in a regression line.

Bleemer and Mehta found that:
Among near-threshold students, we find that majoring in economics caused a $22,000 (58 percent) increase in students’ annual early-career wages without otherwise impacting their educational investment (as measured by difficulty-adjusted average grades and weekly hours spent studying) or outcomes (like degree attainment and graduate school enrollment).
In other words, students above the threshold (and able to study economics) earned 58 percent more. Here's part of Figure 1 that shows the break:

 
The blue dotted line is the threshold (the GPA that students needed to achieve in the first two economics courses, in order to be admitted to the major). The black lines track the relationship between GPA and income for those below the threshold, and those above the threshold. Notice that the black line jumps up significantly at the threshold - that demonstrates the $22,000 extra that economics majors earn compared with non-economics majors.

Interestingly, this gap appears for all student groups:
The estimated returns to majoring in economics are near-identical when estimated separately by student gender: $21,700 (s.e. $8,800) for men, $22,600 ($5,700) for women... The return is also similar in magnitude among underrepresented minority (black, Hispanic, and Native American) students: $27,600 ($13,500).
Studying economics is clearly good for all students in this sample. Bleemer and Mehta then go on to show that about half of the wage premium arises because of differences in the industries that economics majors tend to be employed in (finance, insurance, real estate, and accounting) compared with non-economics majors.

Overall, the conclusion is that the monetary returns to studying economics are high, and as I noted above, now we can say with more certainty that it is studying economics that is a cause of those higher earnings.


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