Difference-in-Differences

Module 3.1: Basics

Alex Cardazzi

Old Dominion University

What is DiD?

Difference-in-differences (DiD or diff-in-diff) is a quasi-experiential research design that isolates casual treatment effects when treatment and control groups can be observed before and after some treatment. DiD is likely the most widely used causal inference design in economics and other social science disciplines. This is due to its accessibility and (relative) parsimony.

Rather than belabor some clunky, abstract definition, let’s jump right into an example.

Minimum Wage

One of the most famous topics in economics is the minimum wage. In Micro 101, we talk about how a price floor set above an equilibrium price will cause an oversupply relative to demand. In the case of labor markets, the price floor is the minimum wage and the oversupply is called unemployment. In 1994, David Card & Alan Krueger published an infamous paper in the American Economic Review that studied the minimum wage as if it were an experiment. Read Section 9.2.3 in The Mixtape for a great discussion of Card and Krueger (1994).

Minimum Wage

In early 1992, Card and Krueger decided to survey fast food establishments in New Jersey and Pennsylvania before and after a minimum wage change impacted New Jersey in April of 1992. They surveyed these stores in February and then again in November. They collected a lot of data, but most importantly they asked about each store’s wage rate and level of employment. The February survey was meant to serve as a baseline and the November survey an update after the minimum wage.

Minimum Wage

The first time Card and Krueger surveyed these fast food establishments, the distribution of wages seemed to be fairly similar. This makes sense – these are bordering states likely catering to, and employing, a rather homogenous population. The minimum wage in both states was also the same ($4.25) at the time. In April 1992, New Jersey increased its minimum wage to $5.05, which amounts to an increase of almost 20%. This forced every store in NJ whose wages were previously below $5.05 to immediately jump up to this new threshold. Stores in neighboring PA could remain at whatever wage they wanted so long as it was above the original minimum wage of $4.25.

Minimum Wage

Here is a visualization of the wage distributions in NJ and PA before and after the minimum wage change:

Plot

I’m guessing that with this figure alone, Card and Krueger have convinced you that the minimum wage policy had some “bite” to it, or more simply, it mattered for a lot of stores. This is important: if the minimum wage did not really impact any stores, then the rest of the study would be moot.¹

Minimum Wage

So – stores were forced to increase their wages – but what happened to employment? In words, Card and Krueger’s theory is that if the minimum wage change hadn’t happened, New Jersey’s employment would have followed a trajectory similar to Pennsylvania. They used the change in PA’s employment to predict, or infer, the (unobservable) counterfactual NJ’s employment. Then, they could compare the “real” NJ to its counterfactual. This is causal inference in a nutshell – creating a counterfactual treatment group for comparison.

Minimum Wage

Let’s visualize Card and Krueger’s analysis before approaching it econometrically. We’ll start by taking a look at the Feb. 1992 average employment in both PA and NJ.

Plot

For whatever reason, PA seems to have higher levels of employment. This could be due to a multitude of reasons that aren’t all that important. Card and Krueger are either going to assume that none of these factors change from Feb. to Nov., or control for them explicitly in their regression.

Minimum Wage

Next, let’s examine how PA’s employment evolved in the absence of treatment. We are able to observe this since PA did not have a minimum wage change.

Plot

Employment fell in PA from Feb. to Nov. Once again, this could be for a variety of reasons, but Card and Krueger are either going to assume that these reasons can either be controlled for in a regression or they impacted both PA and NJ simultaneously.

Minimum Wage

Card and Krueger use this change in PA to fill in the blanks for a counterfactual New Jersey, which they cannot observe.

Plot

This is another assumption that Card and Krueger are going to make, which is called the parallel trends assumption. Card and Kreuger assume that, in the absence of treatment, NJ would have followed the exact path as PA.

Minimum Wage

What actually happened, though?

Plot

Interestingly, the real NJ saw an increase in employment! Now, I want to be very clear about the increase I’m talking about. Of course, NJ in Nov. had higher employment than NJ in Feb. This is not the increase I’m referring to. The increase I’m mentioning is the increase relative to the counterfactual NJ, which is determined by the change in PA. In other words, the difference in employment in NJ is more positive than the difference in employment in PA. This is where the name “difference-in-differences” comes from. So, even though NJ increased from 20.7 to 21.1 ($\Delta = 0.4$), it was supposed to decrease by 1.9 ($\Delta$ in PA). Therefore, NJ made up the drop and more for a total effect of 2.3.

Minimum Wage

The treatment effect would therefore still be positive even if New Jersey’s employment hadn’t increased from the previous level. See below for an example.

Plot

This is still a positive, albeit smaller, treatment effect. Again, the point is that the difference between the change in NJ and change in PA is positive. In other words, NJ’s employment did not fall as much as PA’s employment even though NJ was the one with the minimum wage change.

Minimum Wage

It’s important to note that we cannot just look at what happened in New Jersey. Since this is observational data, there may have been things that happened at the same time as our policy change that could have influenced the employment measures. This is why we are using the changes in PA – we are assuming that these changes reflect general fluctuations in employment that are generalizable to New Jersey.

Similarly, we cannot just look at differences between NJ and PA after the minimum wage hike. As we saw, PA had higher employment than NJ in both periods. We don’t want to accidentally attribute the effect of the minimum wage to pre-existing differences. This is why we need multiple periods to remove time-invariant effects of being in PA or NJ.

Assumptions

Before moving on to the econometrics, what assumptions are Card and Krueger making, either implicitly or explicitly?

First and foremost, they assume that NJ and PA would have moved in parallel if there were no minimum wage change. This assumption is crucial, because we use PA’s trajectory to inform us about NJ’s counterfactual. This is the parallel trends assumption.
Second, Card and Krueger are assuming that NJ was unable to anticipate the upcoming minimum wage change. Or, perhaps a little more flexibly, NJ was able to anticipate the change but not act on it until the policy took effect. Is this a reasonable assumption? According to this document from NJ, the minimum wage increases were scheduled in 1990. So, since Card and Krueger interviewing these stores only a month or so before the law went into effect, the stores may have already adjusted their employment levels in anticipation of the change.
Third, they are making a SUTVA (Stable Unit Treatment Values Assumption) assumption¹. The main point of SUTVA is that the outcomes of Unit $j$ are not impacted by the treatment status of Unit $i$. This assumption is also a bit tricky. If the wage of a nearby store has increased, it only makes sense for a) workers to prefer working at the higher paying store and b) the untreated stores increase their own wages to stay competitive.
Finally, they are assuming that the treatment is not endogenous, or being caused by prior outcomes. What does this mean? In plain English, if law makers in NJ increased the minimum wage because of the trajectory of employment, this would violate the parallel trends assumption because the counterfactual group would have diverged anyway.

Estimation

To estimate a modification of the regression in Card and Krueger, we are going to use a simplified version of their data. These data can be downloaded here. Read the data into a data frame called ff.

Estimation

Difference-in-differences equations typically control for differences in treatment/control groups, differences in pre/post time periods, and the combination of both. The equation we will estimate will look like the following:

\[\text{FTE}_{ist} = \alpha + \gamma \text{Treat}_s + \lambda \text{Post}_t + \delta(\text{Treat}_s \times \text{Post}_t) + \epsilon_{ist}\]

PA Pre: $\alpha$

PA Post: $\alpha$ + $\lambda$

NJ Pre: $\alpha + \gamma$

NJ Post: $\alpha + \lambda + \lambda + \delta$

This implies:

$\gamma$ is a measure of how the treatment group differs from the control group before treatment.
$\lambda$ is a measure of how the control group changes following treatment.
$\delta$ is the difference in the change in the treatment group relative to the control group.

Estimation

In R, this equation can be translated into treat + post + treat:post or simply treat*post. In ff, the variable for $\text{Treat}$ is nj and the variable for $\text{Post}$ is post. The outcome variable is fte for full-time employment. Estimate the model and display its estimates with summary().

Your coefficients should look like the following:

Output

α: 23.7         γ: -3.03        λ: -1.88        δ: 2.28

MLB

Let’s switch gears and think about another application of difference-in-differences. Unfortunately (or maybe fortunately), I consider myself to be $\approx$ 50% sports economist. Sports are convenient to think about because the rules are clear and well known, employee (player) performance is nearly perfectly observable, labor demand is fixed, etc. So, let me tell you a little bit about baseball.

Major League Baseball is organized in two leagues: the American League (AL) and the National League (NL). This distinction is nearly entirely for organizational purposes. For example, the New York Yankees are in the AL and the New York Mets are in the NL. The Chicago White Sox are in the AL and the Chicago Cubs are in the NL. Not all cities have two teams, but the point is that it has nothing to do with geography, or anything else, really. The only material difference between the two leagues is a single rule difference.

MLB

Historically, pitchers are the worst hitters on their teams by a lot. In 1973, the American League decided that enough was enough, and they created the Designated Hitter (DH) position. This player stands in for the pitcher when it is the pitcher’s time to bat. The stereotypical DH is a big, burly player who hits a lot of home runs. DHs are often one of the best hitters on their teams. So, the AL replaced their worst hitter with possibily their best hitter. Of course, this instantly increased offense in the AL. For whatever reason, the NL voted against the DH position and forced those poor pitchers to keep hitting.

MLB

Fast forward to 2021, and the MLB has started toying with some ideas about how to improve the experience of watching baseball games. Generally speaking, viewership numbers and fan engagement metrics have been heading south for some time. One idea they had to reverse this trend was to increase offensive production. Their hypothesis (and hope) was that additional scoring would cause an increase in interest in games.

In 2021, the MLB finally decided to allow the DH position in NL games.¹ Before we go any further, let’s think about what we have: there are two groups of teams, AL and NL. One of them had a DH for the entire time and the other one adopted the position at the start of the 2021 season. It sounds like we have treatment and control groups!

MLB

Usually, control groups in DiD settings are never treated. In this setting, the control group (AL teams) are always treated. The important part is that the treatment status of the control group does not change.

Let’s approach this problem like Card and Krueger. Game-level information for games during the 2013-2019 and 2021-2022 MLB seasons can be downloaded here. These data have already been cleaned to remove games with no attendance (i.e. the 2020 season and a few other outlier games), and we are left with 22,011 observations. Some important variables are as follows:

tm (tm_o): This is a variable identifying the home (away) team in the game.
nl: This is a variable identifying if the home team is in the National League.
yr: This variables denotes the season.
post: This variable denotes the 2022 season.
score_home (score_away): This variable tells the runs scored for the home (away) team.
ATT: This variable contains the attendance at the game.

MLB

Read the data into R and calculate the average home-team runs scored by league before and after the DH rule was implemented. Use the aggregate() function to do this.

Your output should match the following:

Output

  Period League Home_Score
1   Post     AL   4.179487
2    Pre     AL   4.566034
3   Post     NL   4.453871
4    Pre     NL   4.413892

MLB

Using lm() and summary(), estimate the following 2x2 DiD model:

\[\text{Runs} = \beta_0 + \beta_1\times\text{NL} + \beta_2\times\text{Post} + \beta_3\times(\text{NL}\times\text{Post}) + \epsilon\]

Your coefficients should match the following:

Output

β.0: 4.57       β.1: -0.15      β.2: -0.39      β.3: 0.43

In this model, $\widehat{\beta}_3$ is our parameter of interest, or treatment effect. This suggests that home-team offense increased in the National League by 0.43 runs relative to expectation. We are relying on our parallel trends assumption to say that teams in the National League would have otherwise followed a trend similar to that of teams in the American League if they had not been treated with Designated Hitters. More concretely, in the American League, we estimate an average change in runs of -0.39. We are assuming that, in the absence of the DH rule change, offense in the National League would have also decreased by 0.39 runs.

MLB

Now that we have established an increase in offense, which was the point of the DH rule change, what happened to attendance? Estimate the following 2x2 DiD models:

\[\text{Attendance} = \alpha_0 + \alpha_1\text{NL} + \alpha_2\text{Post} + \alpha_3(\text{NL}\times\text{Post}) + \epsilon\] \[log(\text{Attendance}) = \beta_0 + \beta_1\text{NL} + \beta_2\text{Post} + \beta_3(\text{NL}\times\text{Post}) + \epsilon\]

Interpreting $\widehat{\alpha}_3$, the DH rule increased attendance by about 1,200 fans. $\widehat{\beta}_3$ suggests the DH rule increased attendance by about 5.3%.

MLB

Perhaps there are some oddities in the data that are not representative of the average MLB team. For example, the Houston Astros (hou) were found guilty of cheating. This may have impacted their attendance numbers due to fan distastes of cheating (or tastes for boo-ing). Also, in the 2021 MLB season, the Toronto Blue Jays (tor) were not allowed to play in their home stadium due to COVID restrictions in Canada that did not exist in the US.

Re-estimate the regressions, but exclude games played by the Houston Astros (home or away) and the 2021 Blue Jays from the sample.

Two-Way Fixed Effects

We can grant our model some flexibility by using fixed effects. For example, the New York Yankees and Los Angeles Dodgers likely attract larger crowds than, say, the Milwaukee Brewers, since the first two teams play in the largest cities in the United States. To control for this, we can use team fixed effects. This will remove all time invariant factors associated with each individual team. Second, it might just be that certain seasons had higher levels of attendance (or offense) overall. For example, the MLB has been accused of using “juiced” baseballs in the past. To address this, we can use year fixed effects. This will control for all factors that are common to all teams within a season.

Two-Way Fixed Effects

In a simple 2x2 DiD, the standard framework (treat + post + treat:post) and TWFE will generate the same treatment effect. However, in the case where there are multiple time periods and multiple units, this is not the case. Using feols() from the fixest package, estimate one model using the standard framework and another using TWFE.

Staggered Treatment Timing

It’s not often that some policy changes for only half of some population and not for others like in the case of the DH. Rather, policies are typically rolled out at different times across geography. For example, same-sex marriage laws were adopted in different states at different times. The frequency at which fuel taxes and minimum wages update varies by state. Facebook, Uber, Walmart, and your other favorite stores are also rolled out over time and space.

Before $\approx$ 2018, TWFE and/or event studies were seen as totally acceptable methods for analyzing these types of staggered shocks. However, the econometrics literature is in the midst of a difference-in-differences revolution, and these sorts of settings need to be handled very carefully. This is outside the scope of this sub-module, but I wanted to bring it to your attention.

Event Study

In both the 2x2 and TWFE models, we are implicitly assuming that once the treatment is applied, its effect is constant over time. However, this might not be the case in reality. For example, maybe the effect starts off strong but then tapers off. To model this, researchers use event studies.

To estimate an event study, the researcher will create a variable that measures time to treatment. Then, this variable gets interacted with treat (instead of post).

Estimating event studies also allows us to observe how the treatment group was trending relative to the control group before treatment. Significant trends leading up to treatment suggests a violation of the parallel trend assumption.

Event Study

To demonstrate this, we can continue using the MLB data.

We can create a “time to treatment” variable by substracting 2022 from the yr variable. This is going to put 2021 and -1, 2019 as -3, etc.
Make this variable a “factor” variable using as.factor(). This turns the values into indicator variables rather than simply numeric.
Estimate the model of the form time_to_dh:nl | tm + yr

Code

mlb$time_to_dh <- as.factor(mlb$yr - 2022)
mlb$score_total <- mlb$score_home + mlb$score_away
feols(score_total ~ time_to_dh:nl
      | tm + yr,
      mlb, se = "iid")

Output

OLS estimation, Dep. Var.: score_total
Observations: 22,011 
Fixed-effects: tm: 30,  yr: 9
Standard-errors: IID 
                 Estimate Std. Error  t value  Pr(>|t|)    
time_to_dh-9:nl -0.995903   0.252187 -3.94907 0.0000787 ***
time_to_dh-8:nl -0.656511   0.251618 -2.60916 0.0090826 ** 
time_to_dh-7:nl -0.665590   0.251440 -2.64711 0.0081240 ** 
time_to_dh-6:nl -0.452071   0.250835 -1.80227 0.0715170 .  
time_to_dh-5:nl -0.504603   0.251363 -2.00747 0.0447120 *  
time_to_dh-4:nl -0.762460   0.250611 -3.04241 0.0023497 ** 
time_to_dh-3:nl -0.748276   0.252159 -2.96747 0.0030058 ** 
time_to_dh-1:nl -0.518359   0.252055 -2.05653 0.0397435 *  
... 1 variable was removed because of collinearity (time_to_dh0:nl)
---
Signif. codes:  0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1
RMSE: 4.38426     Adj. R2: 0.035415
                Within R2: 8.735e-4

Event Study

The estimated coefficients represent the effect of being in the NL on total scoring relative to being in the NL in the 2022 season. In short, scoring had been statistically significantly lower in each season relative to the 2022 season. Flipping the logic on its head, this suggests that the 2022 season had higher scoring than previous seasons. This gets us the answer we want, but not in a particularly aesthetic way. Moreover, to remain consistent with our previous results, the coefficient should represent the effect of the DH relative to previous seasons, not relative to the DH season.

Event Study

To fix this, we can use the i() function from fixest. With this function, you can tell R which factor level(s) you’d like to be the reference. The norm for event study models is to make the time period immediately before treatment, which is generally -1, the reference.

Code

mlb$time_to_dh <- mlb$yr - 2022
feols(score_total ~ i(factor_var = time_to_dh,
                      var = nl,
                      ref = -1)
      | tm + yr,
      mlb, se = "iid") -> es
iplot(es)

Plot

Event Study

Now, we can see the effect of the DH before and after it was put into place. The effect of the policy before it happens should be zero. If it were not zero, then this may be evidence of anticipatory effects. If we had more years of data, we’d be able to examine the effect of the DH over time. Unfortunately, since the rule change is so recent, those data are not available yet.

Revisiting Assumptions

Before finishing up, let’s revisit some of the assumptions of DiD.

Parallel Trends: There is very little reason why we would not expect offensive output and attendance levels for a random half of MLB teams to proxy for the other half.
Anticipation: the rule change occurred before the 2022 MLB season but following the free agency period where teams make the most changes to their rosters. This rules out anticipation as a significant concern.
SUTVA: In this setting, each team’s offensive output is independent of other teams offensive output. While it could be argued that attendance is a function of the offense of both teams, NL teams always used DHs when playing at AL stadiums. So, the increase in offense should be limited to only NL stadiums. This rules out violations of SUTVA.
Endogenous Treatment: This is likely the most difficult thing to argue. The MLB made this rule change in order to increase fan interest. However, the MLB did not make this change in the 2022 season because NL offense had been dipping in the previous years. In other words, this change was forward looking and not reactionary.

2023 MLB Rule Changes

In the 2023 season, Major League Baseball implemented even more rule changes. For example, they began using a pitch clock to make sure the game is moving at a fast enough pace. Unfortunately, these rule changes cannot be studied using DiD because the change occurred to every teams at the same time. Therefore, there’s no control group to inform the counterfactual. The effect of the pitch-clock would simply be absorbed by the season fixed effects.

Quirks

As always, it’s important to be able to visualize your data. While event studies are helpful for this, the raw data can also be helpful. For example, in Card and Krueger, we were able to see how NJ and PA changed from pre-treatment to post treatment. Sometimes, it can be the case that changes in the control group could be driving your estimated effect. This is fine if you have strong reasons to believe in the parallel trends assumption, but otherwise you should look at your analysis sideways.

Quirks

For example, suppose you have the following data:

Quirks

Estimate the treatment effect:

OLS will estimate a positive treatment effect for this setting because DiD assumes that the red line should have also dropped in the treatment period, but didn’t. Therefore, the treatment should have had a positive effect! Sometimes, this can be valid, but you ought to have a good reason because this can look suspicious.