**JDN 2457345 **

I’ve been thinking of expanding the topics of this blog into some basic statistics and econometrics. It has been said that there are “Lies, damn lies, and statistics”; but in fact it’s almost the opposite—there are truths, whole truths, and statistics. Almost everything in the world that we *know—*not merely guess, or suppose, or intuit, or believe, but actually *know*, with a quantifiable level of certainty—is done by means of statistics. All sciences are based on them, from physics (when they say the Higgs discovery is a “5-sigma event”, that’s a *statistic*) to psychology, ecology to economics. Far from being something we cannot trust, they are in a sense the *only *thing we can trust.

The reason it sometimes feels like we cannot trust statistics is that most people do not understand statistics very well; this creates opportunities for both accidental confusion and willful distortion. My hope is therefore to provide you with some of the basic statistical knowledge you need to combat the worst distortions and correct the worst confusions.

I wasn’t quite sure where to start on this quest, but I suppose I have to start somewhere. I figured I may as well start with an adage about statistics that I hear commonly abused: “Correlation does not imply causation.”

Taken at its original meaning, this is definitely true. Unfortunately, it can be easily abused or misunderstood.

In its original meaning, the formal sense of the word “imply” meaning **logical implication**, to “imply” something is an extremely strong statement. It means that you *logically entail *that result, that if the antecedent is true, the consequent *must *be true, on pain of logical contradiction. Logical implication is for most practical purposes synonymous with mathematical proof. (Unfortunately, it’s not *quite *synonymous, because of things like **Gödel’s incompleteness theorems** and **Löb’s theorem**.)

And indeed, correlation does not *logically entail *causation; it’s quite possible to have correlations without any causal connection whatsoever, simply by chance. One of my former professors liked to brag that from 1990 to 2010 whether or not she ate breakfast had a statistically significant positive correlation with that day’s closing price for the Dow Jones Industrial Average.

How is this possible? Did my professor actually somehow influence the stock market by eating breakfast? Of course not; if she could do that, she’d be a billionaire by now. And obviously the Dow’s price at 17:00 couldn’t influence whether she ate breakfast at 09:00. Could there be some common cause driving both of them, like the weather? I guess it’s possible; maybe in good weather she gets up earlier and people are in better moods so they buy more stocks. But the most likely reason for this correlation is much simpler than that: *She tried a whole bunch of different combinations until she found two things that correlated. *At the usual significance level of 0.05, on average you need to try about 20 combinations of totally unrelated things before two of them will show up as correlated. (My guess is she used a number of different stock indexes and varied the starting and ending year. That’s a way to generate a surprisingly large number of degrees of freedom without it seeming like you’re doing anything particularly nefarious.)

But how do we *know *they aren’t actually causally related? Well, I suppose we don’t. Especially if the universe is ultimately deterministic and nonlocal (as I’ve become increasingly convinced by the results of recent quantum experiments), any two data sets *could *be causally related *somehow.* But the point is they don’t *have *to be; you can pick any randomly-generated datasets, pair them up in 20 different ways, and odds are, one of those ways will show a statistically significant correlation.

All of that is true, and important to understand. Finding a correlation between eating grapefruit and getting breast cancer, or between liking bitter foods and being a psychopath, does not necessarily mean that there is any real causal link between the two. If we can replicate these results in a bunch of other studies, that would suggest that the link is real; but typically, such findings cannot be replicated. There is something deeply wrong with the way science journalists operate; they like to publish the new and exciting findings, which 9 times out of 10 turn out to be completely wrong. They never want to talk about the really important and fascinating things that we know are true because we’ve been confirming them over hundreds of different experiments, because that’s “old news”. The journalistic desire to be *new *and *first *fundamentally contradicts the scientific requirement of being replicated and confirmed.

So, yes, it’s quite possible to have a correlation that tells you absolutely nothing about causation.

But this is *exceptional. *In most cases, correlation actually tells you quite a bit about causation.

And this is why I don’t like the adage; “imply” has a very different meaning in common speech, meaning merely to *suggest *or *evoke. *Almost everything you say *implies *all sorts of things in this broader sense, some more strongly than others, even though it may logically entail none of them.

Correlation does in fact *suggest *causation. Like any suggestion, it can be overridden. If we know that 20 different combinations were tried until one finally yielded a correlation, we have reason to distrust that correlation. If we find a correlation between A and B but there is no logical way they can be connected, we infer that it is simply an odd coincidence.

But when we encounter any given correlation, there are three other scenarios which are far more likely than mere coincidence: A causes B, B causes A, or some other factor C causes A and B. These are also not mutually exclusive; they can all be true to some extent, and in many cases are.

A great deal of work in science, and particularly in economics, is based upon using correlation to infer causation, and *has to be—*because there is simply no alternative means of approaching the problem.

Yes, sometimes you can do randomized controlled experiments, and some really important new findings in behavioral economics and development economics have been made this way. Indeed, much of the work that I hope to do over the course of my career is based on randomized controlled experiments, because they truly are the foundation of scientific knowledge. But sometimes, that’s just not an option.

Let’s consider an example: In my master’s thesis I found a strong correlation between the level of corruption in a country (as estimated by the World Bank) and the proportion of that country’s income which goes to the top 0.01% of the population. Countries that have higher levels of corruption also tend to have a larger proportion of income that accrues to the top 0.01%. That correlation is a fact; it’s there. There’s no denying it. But where does it come from? That’s the real question.

Could it be pure coincidence? Well, maybe; but when it keeps showing up in several different models with different variables included, that becomes unlikely. A single p < 0.05 will happen about 1 in 20 times by chance; but five in a row should happen less than 1 in 1 million times (assuming they’re independent, which, to be fair, they usually aren’t).

Could it be some artifact of the measurement methods? It’s possible. In particular, I was concerned about the possibility of **Halo Effect**, in which people tend to assume that something which is better (or worse) in one way is automatically better (or worse) in other ways as well. People might think of their country as more corrupt simply *because *it has higher inequality, even if there is no real connection. But it would have taken a very large halo bias to explain this effect.

So, does corruption cause income inequality? It’s not hard to see how that might happen: More corrupt individuals could bribe leaders or exploit loopholes to make themselves extremely rich, and thereby increase inequality.

Does inequality cause corruption? This also makes some sense, since it’s a lot easier to bribe leaders and manipulate regulations when you have a lot of money to work with in the first place.

Does something else cause both corruption and inequality? Also quite plausible. Maybe some general cultural factors are involved, or certain economic policies lead to both corruption and inequality. I did try to control for such things, but I obviously couldn’t include all possible variables.

So, which way does the causation run? Unfortunately, I don’t know. I tried some clever statistical techniques to try to figure this out; in particular, I looked at which tends to come first—the corruption or the inequality—and whether they could be used to predict each other, a method called **Granger causality**. Those results were inconclusive, however. I could neither verify nor exclude a causal connection in either direction. But is there a causal connection? I think so. It’s too robust to just be coincidence. I simply don’t know whether A causes B, B causes A, or C causes A and B.

Imagine trying to do this same study as a randomized controlled experiment. Are we supposed to create two societies and flip a coin to decide which one we make more corrupt? Or which one we give more income inequality? Perhaps you could do some sort of experiment with a *proxy *for corruption (cheating on a test or something like that), and then have unequal payoffs *in the experiment—*but that is very far removed from how corruption actually works in the real world, and worse, it’s prohibitively expensive to make *really life-altering *income inequality within an experimental context. Sure, we can give one participant $1 and the other $1,000; but we can’t give one participant $10,000 and the other $10 million, and it’s the latter that we’re really talking about when we deal with real-world income inequality. I’m not opposed to doing such an experiment, but it can only tell us so much. At some point you need to actually test the validity of your theory in the real world, and for that we need to use statistical correlations.

Or think about macroeconomics; how exactly are you supposed to test a theory of the business cycle experimentally? I guess theoretically you could subject an entire country to a new monetary policy selected at random, but the consequences of being put into the wrong experimental group would be disastrous. Moreover, nobody is going to accept a random monetary policy democratically, so you’d have to introduce it against the will of the population, by some sort of tyranny or at least technocracy. Even if this is theoretically possible, it’s mind-bogglingly unethical.

Now, you might be thinking: But we *do *change real-world policies, right? Couldn’t we use those changes as a sort of “experiment”? Yes, absolutely; that’s called a **quasi-experiment** or a **natural experiment***. *They are tremendously useful. But since they are not truly randomized, they aren’t *quite *experiments. Ultimately, everything you get out of a quasi-experiment is based on statistical correlations.

Thus, abuse of the adage “Correlation does not imply causation” can lead to ignoring whole subfields of science, because there is no realistic way of running experiments in those subfields. Sometimes, statistics are all we have to work with.

This is why I like to say it a little differently:

Correlation does not *prove *causation. But correlation definitely can *suggest *causation.