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MostlyPointlessSpatialEconometrics?

1
SteveGibbons(SERCandLSE)2
HenryOverman(SERCandLSE)3

Abstract:Wearguethatidentificationproblemsbedevilappliedspatialeconomicresearch.Spatial
econometricsusuallysolvestheseproblemsbyderivingestimatorsassumingthatfunctionalforms
areknownandbyusingmodelcomparisontechniquestoletthedatachoosebetweencompeting
specifications.Wearguethatinmanysituationsofinterestthisachieves,atbest,onlyveryweak
identification.Worse,inmanycases,suchanapproachwillbeuninformativeaboutthecausal
economicprocessesatwork,renderingmuchappliedspatialeconometricresearchpointless,
unlessthemainaimisdescriptionofthedata.Weadvocateanalternativeapproachbasedonthe
experimentalistparadigmwhichputsissuesofidentificationandcausalityatcentrestage.

ThetitleisareferencetoAngristandPischkes(2009)MostlyHarmlessEconometricswhichoutlinesthe
experimentalistparadigmandarguesthatfanciereconometrictechniquesareunnecessaryandpotentially
dangerous.
2

SteveGibbons,SpatialEconomicsResearchCentreandDepartmentofGeographyandEnvironment,London
SchoolofEconomics,HoughtonStreet,London,WC2A2AE,UK.Email:s.gibbons@lse.ac.uk.
3

HenryG.Overman,SpatialEconomicsResearchCentreandDepartmentofGeographyandEnvironment,
LondonSchoolofEconomics,HoughtonStreet,London,WC2A2AE,UK.Email:h.g.overman@lse.ac.uk.

1.INTRODUCTION
Thelasttwodecadeshaveseeneconomistsbecomeincreasinglyinterestedingeographicalissues
(Martin,1999,BehrensandRobertNicoud,2009).Thishasbeenvariouslyattributedtotheoretical
developments,agrowinginterestincitiesorsimplythegreateravailabilityofgeoreferenceddata.
Theresulthasbeengreaterinteractionbetweeneconomicgeographers,regionalscientistsand
economistsinterestedinspatialaspectsoftheeconomy.Morerecently,asimilarprocesshasseen
mainstreameconometrictheoristsbecomingincreasinglyinterestedinspatialprocesses,
traditionallythepreserveofagroupofspatialeconometricians.4Onemightthinkthatthenextstep
wouldbeconvergencebetweenthetoolsdevelopedbyspatialeconometriciansandthemethods
usedbyappliedeconomiststoassesstheempiricalvalidityofmodelsofspatialeconomics.We
arguethatthisisunlikelybecause,whiletheremayhavebeenconvergencebetweenmainstream
andspatialeconometrictheory,mostappliedeconomicresearchistakingadifferentpath.
Inmany(micro)economicfieldsparticularlydevelopment,education,environment,labor,health,
andpublicfinanceempiricalworkisincreasinglyconcernedwithquestionsaboutcausality(Angrist
&Pischke,2010).Ifweincreaseanindividualsyearsofeducation,whathappenstotheirwages?If
wedecreaseclasssizes,whathappenstostudentgrades?Thesequestionsarefundamentallyofthe
typeifwechangex,whatdoweexpecttohappentoy.Justaswitheconomicsmoregenerally,
suchquestionsarefundamentaltoourunderstandingofspatialeconomics.Whenmoreskilled
peopleliveinanarea,whathappenstoindividualwages?Ifajurisdictionincreasestaxes,what
happenstotaxesinneighbouringjurisdictions?
Inanexperimentalsetting,agents(individuals,firms,governments)wouldberandomlyassigned
differentxandtheoutcomesyobserved.Measuringwhetherdifferentxareassociatedwith
differentoutcomeswouldthengivethecausaleffectofxony.Thefundamentalchallengeto
answeringthesequestionsfor(most)economicdataisthatxisnotrandomlyassigned.Instead,we
jointlyobservexandysowelackthecounterfactual,thatis,whatwouldhavehappenedifxhadnot
beenchanged.Fortunately,appliedeconomicshascomealongwayinitseffortstofindcredibleand
creativewaystoanswersuchquestionsbyconstructingcounterfactualsfromobservationaldata.
Agoodstartingpointforthinkingaboutwhetheraquestionaboutcausalitycanbeansweredand
howtoanswerit,istoconsideranidealexperiment.Theexperimentmaynotbefeasible,butwith
thedesigninminditiseasiertothinkofwaystofindsourcesofvariationinthedatathatmimicor
approximatetheidealexperiment.Theexperimentalistparadigm(AngristandKrueger1999,
AngristandPischke,2009,2010)doesthisbyusingsimplelinearestimationmethods,takingcareto
pinpointandisolatesourcesofvariationinxthatcanplausiblybeconsideredexogenous.Theaimof
thesemethodsistomimic,asfaraspossible,theconditionsofanexperimentinwhichagentsare
randomlyassigneddifferentxandoutcomesyobserved.Thecentralideaistofindotherwise
comparableagents(e.g.twins,siblings,neighbours,regions)whoforsomereasonhavebeen
exposedtodifferentx.Thisapproachisstill'econometric'itdrawsontheorytoguidethe
questionsaskedandthinkingaboutthecausalprocessesatwork.However,thefundamental

SeeAnselin(2010).Manyofthespecialisedeconometricianswhodevelopedthefieldarerecognisedby
FellowshipoftheSpatialEconometricAssociation.Seehttp://spatialeconometr.altervista.org/

attractionisthattheassumptionsrequiredforidentificationofcausaleffectsareusuallyclearly
specifiedandunderstandablewithoutreferencetospecific(anduntested)economictheories.Put
anotherway,theaimistoobtainplausibleestimatesofcausaleffectswithoutrelyingonadhoc
functionalformsandexclusionrestrictionsimposedarbitrarily,orderivedfromuntestedtheories
aboutwhichthereisnoconsensus.5Thisapproachisparticularlyattractiveinareas,likemuchof
spatialeconomics,whereavailablestructuralmodelsdonotcloselycapturethecomplexitiesofthe
processesforwhichwehavedata.6Unfortunately,althoughtheseissuesmaybewellunderstoodby
moreexperiencedpractitioners,theyarenotwidelydiscussedinmanyofthestandardspatial
econometricsreferences.7Forthisreasonthereisadangerthatpeopleenteringtheworldof
appliedeconomicresearchusingspatialeconometricswillignoretheseinsightsintoframing
questionsandachievingcredibleresearchdesigns.
Whyisitthecasethatthespatialeconometricsliteratureoftenignorestheseissues?Wesuspect
thisispartlybecausetheunderlyingtheorydevelopedfromtimeseriesfoundations,sothat
questionsaboutcausalityhavenotbeencentrestage.Thestandardapproachtospatial
econometricshasbeentowritedownaspatialmodel(e.g.thespatialautoregressivemodel),to
assumeitaccuratelydescribesthedatageneratingprocessesandthentoestimatetheparameters
bynonlinearmethodssuchas(quasi)maximumlikelihood(ML).Becauseestimationisnotalways
simple,muchefforthasgoneintodevelopingtechniquesthatallowestimationofarangeofmodels
forlargedatasets.Questionsofidentification(i.e.doesanestimatedcorrelationimplythatxcauses
y?)havebeenaddressedbyaskingwhichspatialprocessesbestfitthedata.Whilethissounds
straightforward,inpractice,aswediscussbelow,itishardtodistinguishbetweenalternative
specificationsthathaveverydifferentimplicationsforwhichcausalrelationshipsareatwork.
Inthisarticleweexplainwhythestandardspatialeconometrictoolboxisunlikelytoofferasolution
totheproblemoftheidentificationofcausaleffectsinmanyspatialeconomicsettings.Ofcourse,
muchstandard(i.e.nonspatial)empiricaleconomicanalysisfallssomewayshortoftheloftyideals
ofidentifyingcausaleffectsfromrandomvariationinthevariableofinterest(x).Findingsourcesof
trulyexogenousorrandomvariationinxisdifficult,butgoodappliedworkaimedatcausalanalysis
mustsurelymakesomecredibleattempttodoso.Thisisnottosaythatnoncausalassociationsare
neverwithoutmerit,becausedescriptionandcorrelationcanprovideessentialinsights.However,
identificationofcausaleffectsremainsthegoldstandardtowhichmanyeconomistsclaimtoaspire.
Wewillarguethatthisshouldalsobethecaseinappliedspatialeconomicresearch.

Therelianceonsimplelinearmethodsmayseemastrongfunctionalformassumption.However,the
assumptionofalinearstructuralrelationshiptheConditionalExpectationFunction(CEF)isnotreally
necessaryforacausalinterpretationofregressionAngristandPischke2009(p.69).IftheCEFiscausalthen,
linearregressionisinformativeaboutcausalitybecauseitprovidesthebestlinearapproximationtotheCEF.
6

Sutton(2002)makesasimilarargumentaboutstructuralmodellingwhenmodelsarefarfromreality.Thisis
nottosaythattheoreticalstructurehasnoplaceinempiricalspatialeconomics.Particularlywhengeneral
equilibriumconsiderationsareimportant,theremaybeagreaterrolefortheory(preferablybasedonmicro
economicbehaviouralfoundations).SeeCombes,DurantonandGobillon(2011)fordiscussion.Laterinthe
paperwebrieflydiscusstheuseofspatialeconometricsintheestimationofstructuraleconometricmodels.
7

Forexample,thereislittlediscussionoftheseissuesinArbia(2006)andLeSageandPace(2009).

Therestofthispaperisstructuredasfollows.Section2providesabasicoverviewofstandardspatial
econometricmodels,whilesection3discussesproblemsofidentification.Section4returnstothe
relationshipbetweenthespatialeconometricsandtheexperimentalistparadigm.Section5
concludes.

2.SPATIALECONOMETRICMODELSANDTHEIRMOTIVATION
Thissectionprovidesanintroductiontospatialeconometricmodels,ofthetypepopularisedby
Anselin(1988).Itisnotcomprehensivebutprovidesenoughbackgroundsothatsomeoneunfamiliar
withspatialeconometricsshouldbeabletofollowtheargumentsmadelater.Wegenerallyusethe
modelterminologyofLeSageandPace(2009)andreferthereadertherefordetails.
Todevelopideas,startwithabasiclinearregression:

yi xi' ui

(1)

whereiindexesunitsofobservation, yi istheoutcomeofinterest, xi isavectorofexplanatory


variables, ui isanerrortermandisavectorofparameters.8Themostbasicregression
specificationassumesthatoutcomesfordifferentunitsareindependent.Thisisastrongassumption
andtheremaybemanyreasonswhyoutcomesarenotindependent,particularlywhenobservations
areforgeographicallyreferencedevents,agentsorplaces.Inaspatialsetting,thismodelisoftennot
veryinteresting.Therearemanycontextsinwhichestimatingandinterpretingtheparametersthat
characterisethisdependenceisofacademicandpolicyinterest.
Estimatingthecompletebetweenobservationvariancecovariancestructureisinfeasible.However,
ifthedataarespatialsocanbemappedtolocations,relativepositions(anddirection)mayrestrict
theconnectionsbetweenobservations.Forexample,outcomesmaydependonoutcomesin
nearbylocationsbutnotthosefurtheraway.Asimplewaytocapturetheserestrictionsistodefine
avector w i wherethejthelementisbigger,themorecloselyconnectedjiswithi(e.g. 1/ distanceij ).
Withnobservations,multiplying w i' bythenx1vectorofoutcomes y givesavalue w i' y thatspatial
econometriciansrefertoasaspatiallag.Foreachobservation, w i' y isalinearcombinationofall y j
withwhichtheithobservationisconnected.If,asisusuallythecase, w i isnormalisedsothatthe
elementssumto1,then w i' y isaweightedaverageofthe'neighbours'ofi.
Whatnowifwewanttoknowwhethertheoutcome yi isrelatedtooutcomesatlocationstowhich
iisconnected?Ord(1975)proposesasimplesolution,toassumethattheeffectofthespatiallagof

yi islinearandconstantacrossobservations.Thisgivesthespatialautoregressivemodel(SAR):

yi w i' y xi' ui

(SAR)

Foreaseofexpositionwesubsumetheconstantin xi .
'

LeSageandPace(2009)suggestatimedependencemotivationfortheSARmodel.Assumefixed
acrosstimeexogenousvariables xi determineoutcome yi .Nowassumethatwhendetermining
theirownoutcome,agentstakeintoaccountboththeirowncharacteristicsandrecentoutcomes
forothernearbyagents.Wemightthinkof yi asthepriceofahouse, xi asthefixed
characteristics(numberofrooms)andassumethatwhenagreeingasaleprice,peopleconsiderboth
thecharacteristicsofthehouseandthecurrentsellingpriceofnearbyhouses.Inthiscase
capturesthecausaleffectofhousecharacteristicsandrepresentsthecausaleffectofneighbouring
prices(conditionalonobservedhousingcharacteristics).
Wecoulddroptheassumptionthat yi isaffectedbythespatiallagof yi andinsteadassumethat

yi isaffectedbyspatiallagsoftheexplanatoryvariables.IfXdenotesthematrixofexplanatory
variablesandavectorofparameters,thisgivesthespatial(lagof)Xmodel(SLX):

yi xi' w i' X ui

(SLX)

LeSageandPace(2009)provideanexternalitymotivationforthismodel.Continuingwiththe
housingexample,thisassumesthecharacteristicsofnearbyhouses,e.g.theirsize,directly
determineprices(ratherthanworkingthroughobservedsalesprices).Ofcourse,anexternality
motivationcouldjustifytheSARmodeliftheexternalityworksthroughthespatiallagof yi
Next,droptheassumptionthatoutcomesareaffectedbyspatiallagsoftheexplanatoryvariables
andinsteadassumespatialautocorrelationintheerrorprocess(using,e.g,theSARprocessto
imposestructure).9If u denotesthevectorofresiduals,thisgivesthespatialerrormodel(SE):

yi xi' ui ; ui w i' u vi

(SE)

Finally,combiningtheSARandSLXmodelsgivesustheSpatialDurbinModel(SD):

yi w i' y xi' w i' X ui

(SD)

whichassumesdependencebetween yi andthespatiallagsofboththeoutcomeandexplanatory
variables,butdropstheassumptionofspatialautocorrelationintheerrorprocess.Alternatively,the
SDmodelcanbemotivatedbysimplyrearrangingtheSEmodelinaspatialCochraneOrcutt
transformation:

ui yi xi'

(2)

yi xi' w i' y w i' X vi

(3)

yi w i' y xi' w i' X vi

(4)

Thisideaprovidesanothermotivationforincludingspatiallags,asasolutiontotheomitted
variablesproblem.Seetheappendixforfurtherdiscussion.

Moregeneralspecificationsareavailable,buttheSEmodeldefinedinthetextissufficientforourpurposes.

Thesefiveprocessesarenotexhaustiveofallpossiblemodels,andweconsideraparticularly
importantgeneralisationfurtherbelow,butforthemomenttheyaresufficientforourpurposes.In
thetext,weusetheacronyms(SAR,etc)torefertothespecificationsabove.
EstimationusingOLSgivesinconsistentparameterestimatesifthemodelsincludeaspatiallagof yi
andisnonzero(e.g.theSARandSDmodels).Thisinconsistencyarisesbecauseofamechanical
linkbetween ui and w i' y formostspecificationsof w i .Standarderrorsarealsoinconsistently
estimatedforthesemodels,aswellasformodelsincludingaspatiallagin ui (e.g.theSEmodel).
OLSprovidesconsistentparameterestimatesifthespatialcorrelationoccursonlythroughtheerror
term(SEmodel)orexogenouscharacteristics(SLXmodel).Inbothcasesstandarderrorsare
inconsistent,andOLSestimationoftheSEmodelisinefficient.Incontrast,Lee(2004)showsthat
(quasi)MLestimationprovidesconsistentestimatorsforallthesemodelsconditionalonthe
assumptionthatthespatialeconometricmodelestimatedisthetruedatageneratingprocess.
Alongsidetheoreticaldevelopments,advancesincomputationalpowerandmethodshavemadeML
estimationfeasibleforlargedatasets.10Asaresult,itispreferredinthespatialeconometrics
literature.TheSARandSLXmodelsarenestedwithintheSDmodelandasshowntheSEmodelcan
berearrangedtogivetheSDmodel.ThefactthattheSDmodelnestsmanyoftheothermodels
providesanargumentforestimatingtheSDmodelandthentestingthisagainstthenestedmodels
throughtheuseoflikelihoodtests.Modelcomparisontechniquescanbeusedtocomparemodels
basedondifferentweightmatricesandexplanatoryvariables.Thisistheapproachadvocatedby
LeSageandPace(2009).
Tobegintounderstandtheproblemswiththisapproachitisusefultoseehowthesemodelsare
relatedtoeachother.Considerthereducedform(expressing yi intermsofexogenousfactors)of
theSARmodel.Ifthemodeliscorrect,theonlyexogenousfactorsaffecting yi are xi and ui ,sothe
onlyfactorsaffecting w i' y are w i' X and w i' u .Thespatiallag w i' y alsodependsonthesecond
orderspatiallagof w i' Wy ,thatis,onoutcomesfortheneighboursofmyneighbours.Byrepeated
substitutionthereducedformis:

yi xi' w i' X 2 w i' WX 3 w i' W 2 X [] vi

(5)

where vi w i' v ui ,Wisthematrixofstackedweightvectors( w i' )and W 2 WW .


Noticethat,inthereducedform,theonlythingthatdistinguishesthisfromtheSLXmodelisthe
absenceoftermsin n w i' W n 1X forn>1.Asweexplaininthenextsection,inpracticethesetwo
modelswilloftenbehardtotellapart.
ItisalsoinformativetoderivethereducedformforthegeneralSDmodel.Substitutingfor yi we
get:

10

Theseimprovementsallowmodelsinvolvingsamplescontainingmorethan60,000USCensustract
observationstobeestimatedinonlyafewsecondsondesktop[]computersLeSageandPace(2009,p.45)

yi w i' ( Wy X WX u) xi' w i' X ui


2 w i' Wy w i' X w i' WX xi' w i' X vi

(6)

2 w i' Wy xi' w i' X( ) w i' WX vi


[]
n w i' W n 1y xi' w i' X( ) w i' WX( ) 2 w i' W 2 X( ) [] vi
where vi denotesthespatiallagtermsin ui .Understandardregularityconditionsonand w i ,

lim n n w i' W n 1y 0 sothattermcanbeignored.Inthereducedform,theonlythingthat


distinguishesthisfromtheSLXmodelisthecrosscoefficientrestrictionsonthetermsin

w i' W n 1X forn>1.
Inshort,spatialinteractionin yi ,spatialexternalitiesin xi ,orspatiallyomittedvariablesleadto
differentspatialeconometricspecifications.Thesemodelshavedifferentimplicationsforthe
economicprocessesatwork.However,thereducedformforallthesemodelsis:

yi xi' w i' X1 w i' WX 2 w i' W 2 X3 [] vi

(7)

andtheonlydifferencesarisefromhowmanyspatiallagsof xi areincluded,constraintsontheway
theunderlyingparametersdeterminethecompositeparameters ,andwhethertheerrortermis
spatiallycorrelated.Distinguishingwhichofthesemodelsgeneratesthedatathattheresearcherhas
athandisgoingtobedifficultasthespecificationofWisoftenarbitrary,andbecausethespatial
lagsof xi arejustneighbouraveragesthatarealmostalwaysveryhighlymutuallycorrelated.Put
anotherway,thesedifferentspecificationsaregenerallyimpossibletodistinguishwithoutassuming
priorknowledgeaboutthetruedatageneratingprocessthatweoftendonotpossessinpractice.In
shortcontrastingmotivationsleadtomodelsthatcannotusuallybeeasilydistinguished.Itwouldbe
usefuliftheseproblemsweremoregenerallyrecognisedbyallresearchersworkingwithspatial
data,butwethinktheygenerateparticularproblemsforthespatialeconometricsapproachas
outlinedinthissection.Wenowconsiderthesedifficultiesindetail.

3.THEREFLECTIONPROBLEMANDCRITIQUEOFSPATIAL
ECONOMETRICMODELS
Readersfamiliarwiththeneighbourhoodeffectsliterature,willseeimmediateparallelsbetween
thespatialeconometricsmodels(SAR,etc)andlinearinmeansneighbourhoodeffectsmodels.11
TheparallelsbetweenthesefieldshavealreadybeenhighlightedbyLee(2004,2007)andothers.
ThegenericneighbourhoodeffectsmodeldescribedbyManski(1993,2000)andusedbycountless
appliedeconomicspapersonneighbourhoodeffects,takestheform:

yi 1 E[ yi | a ] xi' E[xi | a] vi ,

vi 2 E[vi | a ] ui

(8)

11

Thepointswemakehereapplyequallytothepeereffectsliterature.

where yi istheoutcomeofinterest, xi avectorofexogenousvariables,and ui and vi areerror


termsrepresentingunobservables.Variable a indexeslocations,usuallynonoverlapping
neighbourhoodsintheneighbourhoodeffectsliterature.Thisspecificationallowsforthreesources
ofneighbourinfluence.Parameter 1 capturestheendogenouseffectofneighboursexpected
outcomeonownoutcomes.Parameter capturesthecontextualorexogenouseffectofmean
groupcharacteristicsonindividualoutcomes.Parameter 2 capturesthecorrelatedeffectsof
unobserved(atleasttotheeconometrician)meancharacteristicsofagentsinlocation a orfactors
affectingagentsinlocation a .
Thereareinherentidentificationproblemsinestimating(8),evenassumingthat vi and xi are
independent.Firstly, 1 and 2 cannotbeseparatelyidentifiedwithoutdataon vi .Thisisclearif
wesubstitute E[vi | a ] and(usingthelawofiteratedexpectations)rewrite(8)as:

yi 1 2 1 2 E[ yi | a ] xi' E[xi | a]( 2 2 ) ui

(9)

toseethattheparameteron E[ yi | a ] isacompositeofthecausal'endogenous'andincidental
'correlated'effects.Whatthencanbeidentifiedfromtheobservablecharacteristics?Taking
expectationsof(8)andrearranginggivesareducedformversionof(8):

yi xi' E[xi | a]( 1 ) / (1 1 ) 1 / (1 1 ) E[vi | a] vi

(10)

Equation(10)showsthatthecausaleffectsofneighbourhoodmeanoutcomes( 1 )andof
neighbourhoodmeancharacteristics( ),cannotbeseparatelyidentifiedfromthereducedform
parameters,evenwhenthereisnospatialautocorrellationintheunobservables( 2 0 ).Only
andthecompositeparametervector ( 1 ) / (1 1 ) areidentified.ThisisManski's'reflection
problem':onlytheoveralleffectofneighbourscharacteristicsisidentified,notwhethertheywork
throughexogenousorendogenousneighbourhoodeffects.Theseissuesareintuitive:Howcanyou
distinguishbetweensomethingunobservedandspatiallycorrelateddrivingspatialcorrelationiny
fromthesituationwhereyisspatiallycorrelatedbecauseofdirectinteractionbetweenoutcomes?
Further,howcanyoutellwhetheranindividualisaffectedbythebehaviouroftheirgroup,orbythe
characteristicsoftheirgroupwhengroupbehaviourdependsonthecharacteristicsofthegroup?In
manycircumstancesyoucannot,withoutimposingfurtherrestrictions,eitherassumingawayoneor
moreofthesourcesofneighbourhoodeffects,orbyimposingnonlineartheoreticalrelationships
between E[ yi | a ] and E[xi | a ] (e.g.asinBrockandDurlauf2001,whentheoutcomeisdiscrete,
andtheresearcherimposesalogitorprobitfunctionalform).Insomesituations,however,
experimentaldata(oftherealornaturalvariety)canremovetheneedforsucharbitraryrestrictions.
Wediscussfurtherandprovidesomeconcreteexamplesinsection4.
Inpractice,theneighbourhoodeffectsliteratureusesempiricalcounterpartsto(8)and(10):

yi 1w i' y xi' w i' X vi

yi xi' w i' X( 1 ) / (1 1 ) 1 / (1 1 )w i' v vi

(8a)

(10a)
8

where w i asthespatialweightvectorthatcreates'neighbourhoodaverages'asestimatesof

E[ | a ] 12.Forneighbourhoods,wheregroupsarecontiguousandnonoverlapping,thejthelementof

w i takesvalue 1/ na ifiandjareinthesameneighbourhood a ,ofsize na .Inthesespecifications,


ui and i arepotentiallyspatiallyautocorrelatederrorterms(when 2 0 ).Notethat(8a)is
identicaltotheSDmodeland(10a)isanSLXmodel(withaspatiallyautocorrelatederrorterm).
Appliedeconomistsusuallyworryalotaboutidentificationissueswhentheytake(8)and(10)tothe
datausingspecificationslike(8a)and(10a).Whythen,aretheseissuesconsideredfarlessin
applicationsoftheSAR,SDandSEmodels?Thisquestionhasbeenthesubjectofsurprisinglylittle
discussion(Lee,2004,2007andPinkseandSlade,2010arenotableexceptions).
Oneimportantdifferenceisthat,inspatialeconometrics,equationslike(8a)aretreatedasthe
populationdatageneratingprocess,ratherthananempiricalanalogueto(8).Parameter 1 istaken
tobetheeffectoftheobservedsamplemeanneighbourhoodoutcome,ratherthantheeffectofan
unobservedpopulationmeanestimatedfromthedata.Asaconsequence,repeatedsubstitutionofy
in(10a)leadstoareducedformasinequation(6):

yi xi' w i' X(1 ) 1w i' WX(1 ) 12 w i' W 2 X(1 ) [] i

(11)

Nowallthestructural,causalparameters 1 , and are,intheoryidentified,becausethereare


onlythreeparameters,butaninfinitelylargenumberofspatiallagsof xi .Theparameterscan,in
principlebeestimatedbynonlinearmethods(includingmaximumlikelihood),orbylinear
instrumentalvariables(IV,or2SLS)estimationof(8a),usingthelinearfirststagepredictionsfrom
^

wi yi w i' W w i' WX 1 w i' W 2 X 2 w i' W 3 X 3 []

(12)

wheretheeconometriciancanchooseanarbitrarynumberofspatiallagsof xi asinstruments.13
Sowhydospatialeconometriciansarguethat(8a)isidentified,byvirtueof(11),whenother
economistswouldarguethat(8a)isn'tidentified,byvirtueof(10a)?Thecrucialdifferenceisthat
spatialeconometricsassumesthat W isknownandrepresentsrealworldlinkages.Neighbourhood
effectsresearchersarguethatthetrue W isalmostneverknown,andis,atbest,ameansof
estimating E[ | a ] .Inotherwords,theassumptionofknowledgeabout W iscritical.14

12

ThisinterpretationoftheuseofthespatialweightingvectorhasbeennotedbyPinkseandSlade(2010)
McMillen(2010b)andothers.
13

Inprinciple,when and arezero,theparametercanalsobeidentifiedfromtheerrorstructure

i 1w i' v 21w i' Wv 13w i' W 2 v [] vi usingmaximumlikelihood,althoughthisidentificationis


clearlypurelyparametricinthesensethatitreliesontheempiricalmodelbeinganexactrepresentationof
thedatageneratingprocess.
14

Interestingly,theideaofputtingmorestructureonneighbourhoodeffects(e.g.byassumingahierarchical
network)hasrecentlybeensuggestedasawayofsolvingtheidentificationproblem.SeeLeeatal(2010).

If W takesthetypicalblockdiagonalstructureusedinneighbourhoodeffectsstudies(or W is
otherwiseidempotent)then(11)collapsesto(10a)andtheparametersarenolongerseparately
identified.Butevenif W isnotidempotent,thereareseriousproblemsinrelyingon(11)and(12)
foridentificationoftheparametersin(8a).Firstlyiftheexactstructureof W isnotknownthen
identificationbreaksdownbecause w i' W , w i' W 2 etc.maybettercapturetheconnectionsbetween
observationianditsneighboursthandoes w i (e.g. xi hasaneffectupto5km,but w i incorrectly
restrictseffectstowithin2km).Ifthehigherorderlags w i' WX , w i' W 2 X affectydirectly,they
cannotprovideadditionalinformationtoidentify 1 .Itiseasiesttothinkaboutthisinthecontextof
thelinear(2SLS)IVestimatorimplicitin(11)and(12)(e.g.KelejianandPrucha1998):Ifthe
exclusionrestrictionson w i' WX , w i' W 2 X etc.in(8a)areinvalid,thenthesespatiallagsarenot
suitableasinstruments,norassourcesofidentificationmoregenerally.
Secondly,evenif W isassumedknown(andisnotidempotent)thereareseriousestimation
problemsbecausethespatiallags w i' X w i' WX , w i' W 2 X etc.arelikelytobehighlycorrelated.In
theIVcontext,thereisaweakinstruments/identificationproblem,becausethereislittle
independentvariation(andhencelittleadditionalinformation)inthehigherorderspatiallagsof xi ,
conditionalon w i' X .SinceBound,JaegerandBaker(1995)andStaigerandStock(1997),applied
researchersworryaboutthestrengthoftheinstrumentsinIVregressions,becauseweak
instrumentscanleadsecondstagecoefficientestimatestobeseverelybiasedandimprecisely
estimated.Thisissuehascertainlybeenrecognisedinthespatialeconometricsliteraturebutthe
profoundconsequencesdonotappeartohavehadmuchinfluenceonappliedresearch.
Intheory,thedegreeofcollinearitybetweenspatiallagsdependsonsamplesize,samplingframe
andhowWchangesasobservationsareadded.15Inpractice,inlargesamples(andusingstandard

w i ), w i' X , w i' WX ,etcarelikelytobehighlycorrelatedforthesimplereasonthattheyarea


weightedaverage(andconsistentestimatesofthemean)of xi insomeneighbourhoodofi.Asa
resultinmanyapplicationstheparameterson w i' X , w i' WX ,etcarelikelytobeimprecisely
measuredand/orseverelybiased.Earlierversionsofthispaperprovideanexamplewhich
demonstratestheseproblemsareimportantinpractice.16
Tosummarise,intheoryif W isnotidempotent,identificationispossible,buttheparametersinthe
SDmodelarelikelyonlyweaklyidentifiedinpractice.Eventhisweakidentificationdependsonthe
strongassumptionthat W iscorrectlyspecifiedsothathigherorderspatiallagsof xi provide

15

Intheoreticalanalysisitisusualtodistinguishbetweenincreasingdomainasymptotics(addingobservations
expandsthespaceoverwhichweestimate)andinfillasymptotics(increasingsamplesizemeanssampling
moreobservationsinagivenarea).Thelattermakesmoresenseinmanymicroeconometricsettings,whichis
problematicbecause,generalresultsarenotavailableforMLEunderinfillasymptotics(seeLee(2004)).Our
intuitionisthatconsistencyunderinfillasymptoticswillbedifficulttoderivepreciselybecause,formany
commonWmatrices,infillasymptoticsincreasesthecorrelationbetweenxanditsspatiallags.
16

SeeGibbonsandOverman(2010).

10

additionalinformation(e.g.satisfytheexclusionrestrictionsrequiredtomakethemvalid
instruments).Itisnotclearhowthisassumptioncouldeverbeevaluated.17
Itshouldbecleartherefore,thattherearefundamentalproblemsinusingassumptionsonthe
spatialstructuretogenerateinstruments.Theproblemsareevenmoreprofoundifweallowfor
spatialautocorrelationintheerrorterms,anddroptheassumptionoftheexogeneityof xi togivea
moregeneralspatialmodel:

yi w i' y xi' w i' X ui

(13)

ui w i' u vi

(14)

xik z i' 1 2ui eik

(15)

where xik isanelementof xi and z i isavectoroffactorsdetermining xik ,whichmayinclude


elementsof xi .Thisgeneralspatialmodelpresentsallthechallengesdescribedabove,plusthe
additionalproblemofone(ormore)explicitlyendogenousexplanatoryvariables.TypicalspatialML
methodssimplyassumeaway(15)andtreat xi asexogenous.True,theparametersofthismodel
couldall,inprinciple,beestimatedbyMLorspatialIV,imposingalltherestrictionsimpliedbythe
specificationof W andthewaythemodeliswrittendown.FingletonandGallo(2010)discuss
variousapproachesalongtheselines.Nevertheless,thismechanicalapproachtoestimationwillnot
appealtoappliedeconomicsresearcherswhoviewminimalassumptionsonfunctionalformsand
explicitsourcesofexogenousvariationasnecessaryconditionstoinfercausality.
Wesaymoreabouttheseissuesinthenextsection,wherewearguethatabetterapproachto
estimatingparametersthatrepresentspatialinteractions(suchastheSAR,SDorSLXmodels)orto
dealwithomittedvariablesinspatialcontexts,istopreciselydelineatetheresearchquestion,and
focusonthekeyparameterofinterest.Theexperimentalistparadigminsiststhatasatisfactory
strategymustusetheoreticalargumentsorinformalreasoningtomakeacaseforasourceof
exogenousvariationthatcanplausiblybeusedtoidentifythisparameterofinterest.Inaddition,this
modeofresearchwouldexpectrigorousempiricaltestingtodemonstrate,asfaraspossible,the
validityoftheseassumptions.Wenowconsidertheseissuesinmoredetail.

4.THEEXPERIMENTALISTPARADIGMANDSPATIALECONOMETRICS
Thediscussionsofarhasbeencriticalofthespatialeconometricsapproach,particularlyregarding
thecrucialissueofidentificationofcausalparameters.Othershavemadesimilararguments

17

Statisticaltestsforoveridentifyingrestrictions(e.g.SarganandHansentests,seeAngristandPischke(2009)
p.143146)aregenerallynotveryrobustevidenceforthevalidityofinstruments,unlesssimplyasauxiliary
supportforaconvincingcaseoftheirtheoreticalvalidity.Thesestatistics,ineffect,providetestsforequalityof
theIVestimatesfromeachpotentialinstrument,butwillbepronetoTypeIIerrors(failingtorejectthenullof
thevalidityoftheoveridentifyingrestrictions)insituations,liketheonefacedhere,whereinstrumentsare
eitherweak(becauseIVcoefficientsforeachinstrumentarethenimpreciselyestimated)orendogenousfor
similarreasons(becauseIVcoefficientsforeachinstrumentwillbesimilarlyinconsistent).

11

althoughperhapsnotasforcefully(seeforexampleMcMillen2010aand2010b).Ofcourse,any
alternativeapproachalsohastosolvetheidentificationproblemsthatplaguespatialeconomic
analysis.Ourargumentisthattheseproblemsaresofundamentalthattheymustsitatcentrestage
ofappliedwork,notbeshuntedtothesidelinesthroughtheuseofMLthatassumesknowledgeof
theappropriatefunctionalformsandspatialweights.Inthissectionwearguethatspatialresearch
wouldbebestservedbyturningawayfromtheapplicationofgenericspatialmodelsandattempts
todistinguishbetweenobservationallyequivalentmodelsusingcontestableparameterrestrictions
thatonlyemergefromtheassumedmodel.Instead,weadvocatestrategiesthatarecarefully
designedtoanswerwelldefinedresearchquestionsusinginsightsfromtheexperimentalist
paradigm.
WestartwiththesituationwhereweareinterestedinestimatingparametersinaSARorSD
specificationtotestfordirectspatialinteractionsbetweenoutcomes yi .Itishardtoimagine
situationsinwhichthisisthetruedatageneratingprocessbecausesimultaneousdecisionsbasedon

yi mustrelyonexpectations(asintheneighbourhoodseffectliterature),butletussupposethat
estimationofisthegoal.Asarguedabove,thereisacentralconceptualproblemabout
identificationofthelineardependence yi on w i' y inanSARstylespecification,whichfollowsfrom
the'reflection'problem.Specifically,ifthemodelproperlyspecifieshowyisdetermined,howcan
weinduceexogenouschangein w i' y thatisnotcausedbychangesinelementsofeither w i' X or

w i' u ?MaximumLikelihoodsolutionsseemunconvincingforreasonsdiscussedextensivelyabove.In
somesettings,thespatialeconometricsliteratureoffersinterestinginsightsintothepotentialfor
usingspecificrestrictionson w i toachieveidentification,wheretheserestrictionsarisefromthe
institutionalcontext,forexamplefromthedirectedstructureoffriendshipnetworks,orthespatial
scopeofareatargetedpolicies(e.g.seeCalvoArmengol,PatacchiniandZenou2009).Formost
appliedproblems,however,uncertaintyaboutfunctionalformsandlackofinformationonthetrue
spatialweightsmeanalternativestrategiesaremoreappropriate.
Analternativestrategyistousepaneldataandtodifferencethedataovertimetoprovidefixed
effectsor'differenceindifference'estimates.Differencingremovesunobservablesthatarefixed
overtime,andthattheresearcherconsiderstobepotentialsourcesofendogeneity.Whilethisisa
veryusefulstrategyinmanycontexts(someofwhicharementionedbelow),itdoesnot,onitsown,
offerawaytoidentifythecausaleffectsof w i' y on yi inSAR/SDtypemodelsbecausethe
'reflection'issuessimplytransfertothedifferencedspecification.Thequestionnowbecomeshowto
distinguishchangesin w i' y (i.ein w i' y )thatarenotcausedbyelementsof w i' X and/or w i' u .
Forsimilarreasons,evenrandomisationofferslimitedscopefordistinguishinggroupeffectsarising
fromthespatialinteractioninoutcomes w i' y fromthosearisingfromgroupcharacteristics

w i' X becauseifagrouphasrandomlyhigher w i' y ,itwillhaverandomlyhigher w i' X too.


Giventheselimitations,isthereanyhopefortheSARspecification,andestimationof'endogenous'
neighbourhoodeffects?Somesettingsdoappeartoofferexplicitsourcesofrandomisationin w i' y
duetoinstitutionalrulesandprocesses.Sacerdote(2001)forexample,usestherandomallocation
ofcollegedormmatestodormstobreakthecorrelationbetweenindividualstudentunobservables
12

anddormmates'groupcharacteristics,togetestimatesofpeergroupeffectsonstudents'college
achievement.DeGiorgioetal(2010)useasimilarstrategyinthecontextofrandomclass
assignments.Althoughbothpapersmakeclaimsthatareprobablytoostrongintermsoftheirability
tosolvethereflectionproblem(becauserandomisationalsochanges w i' X and w i' u asdiscussed
above),randomisationdoesatleastreducetheproblemsinducedbyselfselectionintogroupsand
consequentcorrelationbetweenindividualandgroupcharacteristics.Fieldexperimentsdesignedfor
purposearealsoclearlyveryuseful.However,bigonesliketheMovingtoOpportunityProgramme
(Kling,LudwigandKatz2005,Kling,LiebmanandKatz2007)arerare,costlyandoftensufferfrom
unavoidabledesignflaws,andsmallonessufferfromconcernsaboutexternalvalidity.Itwouldalso
beverydifficulttodesignexperimentstoanswermanyspatialquestionsandwedonotseethisasa
wayforwardformanyproblemsofinterest.
Onealternativeistoreconsiderinstrumentalvariables(IV/2SLS)estimation,eitherincrosssectional
ortimedifferencedspecifications.Asshownabove,iftheSARmodeliscorrectlyspecifiedthen w i' X
providesinstrumentsfor w i' y andthisformsthebasisforthetraditional'spatialIV'method.Most
appliedmicroeconometricresearcherswouldexpectverycarefulargumentstojustifytheexclusion
of w i' X fromtheestimatingequation.18Inpractice,manypapersthatusespatialeconometricsdo
notdothis.Totakejustoneexample,inthetaxcompetitionliteraturecharacteristicsof
neighbouringareas w i' X areoftenusedtoinstrumentforneighbours'taxrates w i' y inaregression
ofowntaxrate yi onneighbourstaxrates.Arunthroughsomeofthereferencesinarecentreview
(Revelli,2005)suggestthattheseexclusionrestrictionsreceivelittle,ifanyconsideration.Besleyand
Case(1995)appeartobeoneofthefirsttoadoptthisstrategybyusingdemographicsofneighbours
toinstrumentforneighbourstaxrate.Theydoprovideabriefdiscussionofwhetherthisrestriction
isvalid,butmostlyrelyonoveridentificationrestrictionsimposedbytheirtheoreticalmodelto
justifythisassumption.BrettandPinske(2000)useasimilarapproachandjustifytheirexclusionsby
noting:Whiletherecouldbereasonswhymunicipalbusinesstaxratesdependonwealthdirectly,
suchreasonsarelessobviousthandependencethroughtheireffectoncapitalbase.(Brettand
Pinske,2000,p.701).Buettner(2001)claimstopaycarefulattentiontowhethertheinstrumentsare
endogenous(byexaminingspatialautocorrelationintheresiduals)buthasnodiscussionofhowthis
relatestothevalidityoftheexclusionrestrictions.HayashiandBoadway(2001)donotinstrumentat
all,insteadusingrestrictionsfromatheoreticalmodeltoachieveidentification.Turningtomore
recentpapers,wefindlittleevidencethatmuchhaschanged.Leprince,MadiesandPaty(2007)has
nodiscussionoftheexclusionrestrictions.CharlotandPaty(2007)useML.EdmarkandAgren(2008)
dodiscussthestrengthoftheirinstruments,butnottheexclusionrestrictions.FeldandReulier
(2009)useIVbutdonotdiscusseitherproblem.Noneofthesepapersdiscusstheproblemspecific
tothespatialsetting,thatspatiallylaggedexogenousvariablesmaybettercapturetheconnections
betweenobservationianditsneighboursthantheincorrectlyspecifiedfirstorderspatiallagof yi .
Thislistofpapersisnotexhaustiveandinclusioninitisnotintendedasaspecificcriticismofthe

18
Ofcourse,if w i' X canbeexcludedthenthissolvestheidentificationproblemforMLaswell.Eveninthis
case,westillthinkthatthecaseforswitchingtoMLisweakbecauseitreliesonpreciseknowledgeof w i .

13

particularpaper(afterall,thesepapershaveallbeenpublishedinrespectablejournalsafterpeer
review).19Butwedothinkthatthelistservestoillustratetheproblemsthatarisewhenthespatial
IV/2SLSapproach,ofAnselin(1988),KelejianandPrucha(1998)andothers,isusedinpractice.The
sameissuesarisewithspatialGMM,whicharesimplyefficientversionsofIVestimators.
SowhatwaysforwardarethereforIVstrategies?Potentially,institutionalarrangementscanprovide
exogenousvariationinone(ormore)elementsof w i' X thathasnodirectinfluenceon yi .20For
instance,aresearchermightarguethattherearenodirectimpactsonoutcomesinadistrictfroma
policyinterventioninneighbouringdistricts(anelementof w i' X ),butthepolicydoeshaveeffects
viaitsinfluenceonneighbouringoutcomes.Asjustdiscussed,thisisthestrategyadoptedbysome
papersinthetaxcompetitionliterature(e.g.BesleyandCase1995andBrettandPinske,2000),
althoughwhetheraresearchercanconvinceothersthattherearenodirecteffectsfromneighbours
policiesdependsonthepolicyinquestion.21Sometimes,however,changinginstitutional
arrangementscanoffermoreconvincingnaturalexperiments.Aparticularlyniceexampleis
providedbyLyytikinen(2011)whoarguesthatchangesinthestatutorylowerlimittopropertytax
ratesinducesexogenousvariationintaxrates,whichcanbeusedtostudytaxcompetitionamong
localgovernmentsinFinland.Specifically,policychangestominimumtaxthresholdsinteractedwith
previoustaxrates,canbeusedtoinstrumentforthechangesintaxratesinneighbouringdistricts.In
thiscase,theexclusionrestrictionsaremoreplausible:adistricttaxauthorityisnotlikelytocare
howchangesintaxthresholdpolicyaffectedneighbours,exceptinsofarasitchangedthese
neighbours'taxrates.Particularlyinteresting,forourpurposes,isthatLyytikinencompareshis
estimatestothosebasedonspatiallagsandtraditionalspatialIVappliedtothesamedata(using
lagsofallthedeterminantsoftaxrates,notjustthepolicyinducedchanges).Whilehefindsno
evidenceofinterdependenceinpropertytaxratesfromhispolicybasedIVresearchdesign(which
contradictsmuchoftheliterature),hisspatialIVestimatesarelargeandsignificant.Heconcludes,
withadegreeofunderstatement,thatthestandardspatialeconometricsmethods[]
overestimatethedegreeofinterdependenceintaxrates.
AnotherinterestingpossibilityforSARtypemodelsemergeswhen w i' y representsexpectations
about yi insomespatialgroup,sincetheexpectationcouldbechangedbyadditionalinformation
about w i' y ,withoutchanging yi itself.Forexample,supposetheregistryofhousepricesbecomes
publicallyavailable,providingindividualswithnewinformationthatallowsthemtoreacttothesale
pricesofnearbyhouses.Orpoliceforcesintroducecrimemapping,whichallowsclosermonitoring
oftheactivitiesofcriminals.Sometimes,however,itmaystillbedifficulttojustifythatother

19

Indeed,oneoftheauthorshasatleastoneolderpaperthatsimilarlyadoptedtheKelejianandPrucha
(1998)IVapproach.
20

Inotherwords,incomponentsof w i X wherethecorrespondingelementof 0 .Analternative


'

formulationwoulduseZtodenotetheseobservablecharacteristicsthathavenodirecteffectonyotherthan
throughtheireffectonX.
21

Thatis,ofcourse,assumingthattheymakeanyattempttojustifytheexclusionrestrictionsatall!

14

neighbourhoodcharacteristicscapturedin w i' X donotsimultaneouslybecomeobservable(e.g.the


characteristicsoflocalhousesarerecordedinthelocalregistry)anddriveanyobservedchangesiny.
Unfortunately,examplessuchasthesewherethereareplausibleinstrumentsfor w i' y inSARtype
modelsarestillrare,andlookingforwaystoestimatethecausaleffectof w i' y on yi appearsto
leaveafairlylimitedrangeofquestionsthatcanbesuccessfullyanswered.Weremainmorehopeful
fortheroleofdifferencing,IVandnaturalexperimentsinisolatingexogenousvariationinoneor
moreoftheobservablefactorsthatdrivestheoutcomeofinterest,i.e.elementsof w i' X whether
directly,orindirectlyvia w i' y .But,giventhedifficultyinjustifyingtheexclusionrestrictions
on w i' X ,coupledwiththeconceptualproblemsintermsofwhattheSARmodelimpliesabout
underlyingcausalrelationships,wearguethatmanysituationsmaycallforabandoningtheSAR
modelaltogether.Inthesesituations,weadvocatethepathtakenbymostrecentneighbourhood
effectsresearchandargueforestimationofreducedformSLXmodelsin xi andspatiallagsof xi ,
ratherthandirectestimationoftheSARorSDmodel.Giventheidentificationproblemsinthe
alternativespecifications,webelievethatinmanysituationsthis'reducedform'approachissimply
morecredible.Thecompositereducedformparameterthatdescribestheinfluenceofneighbours
characteristicsoroutcomesisitselfausefulandpolicyrelevantparameter.Withthisinhand
judgementscanbemadebasedontheoryandinstitutionalcontextaboutthelikelychannels
throughwhichtheeffectsoperate.Thekeyestimationchallengethatremainsistheonediscussed
above.Thatis,thefactthat xi and w i' X areunlikelytobeexogenous,andwillbecorrelatedwith
theunobserveddeterminantsof yi viacausallinkagesorbecauseofthesortingofagentsacross
geographicalspace.EstimationofthereducedformSLXmodels,setsasidethechallengeof
estimatingdirectlyleavingtheresearcherfreetofocusontheremainingthreatstoconsistent
estimationofthecompositeparametersinthereducedform,whicharestillformidable.
Howthenshouldresearchersworkingonspatialempiricalanalysisproceed?Onepossibilityistouse
'naturalexperiments'whichofferchannelsforidentificationofinterestingspatialparameters,even
whenestimationofSARtypespatialdependenceisinfeasible.Forexample,changesovertimein
theconnectionsbetweenplacesoragentsmayallowidentificationofcausalspatialinteractions.A
goodexampleisprovidedbyReddingandSturm(2009),whousethereunificationofEastandWest
Germanytostudytheimpactofmarketaccessonoutcomes.Theideahereisthatbeforere
unifications,theEastandWestGermanborderpreventedmarketinteractionsandrestrictedthe
economicconnectionsbetweenplaces,butreunificationopenedupnewpossibilities.Reunification
thuscreatedachangeinthe w i matrixthatcanbeusedtoexploretheroleofspatialinteractions.
Similarideashavebeenusedintheliteratureonschoolsandhouseprices,usingschoolattendance
zoneboundarychanges(BogartandCromwell2001,SalvanesandMachin2010).Changestothe w i
matrixcausedbyexogenouschangesintransportnetworkshavealsobeenusedtoinvestigatethe
effectsofemploymentorpopulationaccessibilityonfirmsorhouseholds(e.g.Holl2004,Gibbonset
al2010,Ahlfeldt2011).
AsecondpossibilityistousethestandardtoolkitofIVanddifferencingbasedstrategiesemployed
byresearchersinmanyotherfieldsofappliedeconomics.Thistoolkitcanbeusedeffectively,if
15

appliedcarefullywithattentiontotheidentificationofspecificcausalparametersratherthanan
arbitrarilyspecifiedsystemofequations.ForanIVstrategytogiveconsistentestimatesofthe
parametersofinterestinthesereducedformSLXmodels,instrumentsmustsatisfytheusual
relevanceandexclusionrestrictions.Wehavesaidenoughalreadyaboutexclusionrestrictionsand
weakinstrumentproblemsforittobeclearthatwedonotthinkthatIVstrategiesbasedonusing
higherorderspatiallagsof xi asinstrumentsareaverygoodidea.22Forthesereasons,webelieve
thatstandardIVstrategieswhichpaycarefulattentiontotheomittedvariablesandclearlyjustify
thevalidityofinstrumentsrepresentamoreappropriatewaytoaddresstheproblemofspatially
correlatedomittedvariables.23ManyeffectiveIVstrategiesofthistypemakeuseofpolicydesigns,
institutionalrulesandnaturalenvironmentalfeatures(orevenbetter,changesinthesefactors).
Therearemanyexamplesofthesekindsofwellthoughtthroughinstrumentingstrategiesappliedto
spatialproblems,byresearchersworkingoutsidethetraditionalspatialeconometricmould.For
example,Michaels(2008)notesthattheUShighwaysystemwasplannedonaregularEastWest,
NorthSouthgridconnectingmajorcities,implyingthattownslocateddueEast,West,Northor
Southofamajorcityincidentallyexperiencedlargechangesintransportaccessibilitybyvirtueof
theirpositionrelativetomajorcities.Luechinger(2009)usesthesitesofinstallationofSO2
scrubbersandprevailingwinddirectionstopredictpollutionlevels,inordertoestimatetheeffects
ofpollutiononindividualwellbeing.Theideahereisthatpeoplelivingdownwindofemissions
sourcesexperiencebigimprovementsinpollutionlevelsrelativetothoselivingupwind,when
emissionsreductiontechnologiesareinstalled,butthatthesedirectionsareotherwiseunrelatedto
wellbeing.Gibbons,MachinandSilva(2008)usedistancestoschooladmissionsdistrictboundaries
topredictlevelsofchoiceandcompetitioninschoolmarkets,onthebasisthatstudentsdonot
attendschoolsontheoppositesideofdistrictboundaries,sothenumberofschoolsfromwhich
studentscanchoose(withinagivendistance)istruncated.EarlierexamplesofthecreativeuseofIV
inspatialanalysisarefoundinCutlerandGlaeser(1997)andHoxby(2000),whousethenumberof
riverscuttingacrosscitiesasinstruments.Inbothcases,riversareassumedtobisectcommunities
leadingtogreaterracialsegregationwithincities(CutlerandGlaeser1997)ormoreschooldistricts
andmorechoiceandcompetitioninschoolmarkets(Hoxby2000).
AnotheralternativetoIVisspatialdifferencingtoremoverelevantomittedvariables,e.gthrough
differenceindifference,fixedeffectsorregressiondiscontinuitydesigns.Inthiscase,thefactthat
theunobservedcomponentisspatiallycorrelatedhelpsbecausespatialdifferencing(ofobservations
withtheirneighbours)islikelytobeeffective.Holmes(1998)providesanearlyexample.Gibbons,
MachinandSilva(2009)providemorerecentdiscussion.Otherdifferencingstrategiesdrawingona
casecontrolframeworkmayalsobeappropriate,forexamplethe'milliondollarplant'analysisof
Greenstoneetal(2008)whichcomparestheeffectoflargeplantrelocationsondestination

22

Note,however,thatwhilethespatialstructureofthedatadoesnthelp,neitherdoesitespeciallyhinderthe
searchforasuitableinstrument.Ifwehaveaninstrumentthatisindependentof ui ,thenitisalso
independentof w i u ,(unlesstheweightsareendogenous)sothefactthat xi and ui arebothspatially
correlatedisirrelevant(asidefromtheimplicationsforstandarderrors).
'

23

Controlfunctionapproachesmayalsobeequallyvalid,butrequireinstrumentstoo,andgenerallyrequire
moreassumptionsthanIV.

16

counties,usingtheirsecondrankedpreferencesrevealedinarealestatejournalfeatureasa
counterfactual.BothBusso,GregoryandKline(2010)andKolkoandNeumark(2010)evaluatethe
effectsofspatialpoliciesbycomparingpolicytreatedareaswithcontrolareasthatweretreatedin
laterperiods,asameanstogeneratingplausiblecounterfactuals.Spatialdifferencingcanalsobe
combinedwithinstrumentingasdiscussedin,forexample,Duranton,GobillonandOverman(2011)
andGibbons,McNallyandViarengo(2011).LeeandLemiuex(2010)providefurtherexamplesof
regressiondiscontinuitydesigns,manyofthemrelevanttospatialresearch.
Theexperimentaliststrategiessetoutabovemaynotbewithouttheirproblems(seeforexample
Kean2010),butatleastprovidesomehopeofuncoveringcausalrelationshipsinthespatialcontext,
whichofftheshelfspatialeconometricstechniquesdonot.Onecommoncriticismofthe
experimentaliststyleofresearch,asrepresentedbytheseexamples,concernsthegeneralizabilityof
theestimates.Thesedesignsseekoutsourcesofexogenous,pseudorandomvariationinthe
variablesofinterest,andinevitablyendupestimatingcausaleffectsforsomesubgroupofthe
population,exposedto,andrespondingtoaspecificinterventionordifferenceinenvironment.If
responsesareheterogeneous,thereisthereforenoguaranteethattheestimatedresponseis
representativeofamoregeneralpopulation.ThisissueiswellknowninthecontextofIV,givingrise
toLocalAverageTreatmentEffects(ImbensandAngrist1994).Evenso,wewouldarguethatitis
bettertohaveplausiblycausalestimatesforaspecificgroupinthepopulation,thantohavenon
causalparameterestimatesofunknownmeaning,estimatedbyothermethods.Ourremarksabout
thevalidityofexclusionrestrictionsinspatialIVabovealsoapplytoexperimentalistdesigns,
becausewestillhavetobesurethatwhatevercausesrandomvariationin xi ,affects yi only
through xi andnotthroughotherchannels.Todealwiththesethreats,spatialresearchdesignsin
theexperimentalistmodemustthinkthroughthespecificinstitutionaldetailsverycarefully,and
provideclearstatementsandtestsoftheidentifyingassumptions,andbecautiousingeneralising
resultstoowidely.
Tosummarise,differenteconomicmotivationsleadtospatialeconometricspecificationsthatwillbe
veryhardtodistinguishinpractice.Addtothemixthefactthatin(nearly)allapplicationsweface
uncertaintyabouttheendogeneityof xi ,theappropriatefunctionalformandspatialweightsandit
becomesclearwhymanyappliedresearchersfindMLorIVestimationofsomeassumedspatial
econometricspecificationuninformative.Instead,wesupportafocusonattemptingtosolve
identificationproblemsusingempiricalstrategiesthathavebeencarefullydesignedforthespecific
application.Further,ifempiricalstrategiescannotbedevisedthatsatisfactorilyidentifythecausal
impactofthespatiallagintheendogenousvariable(i.e.manyappliedsituations)thenweadvocatea
reducedformapproachpayingparticularattentiontotheproblemsraisedbyendogeneityofthe xi .
Opponentsofouradvocacyofexperimentalistapproachestospatialquestionsmightarguethat
placesareuniquebecauseoftheiruniquespatialposition,andsonotamenabletothesekindsof
researchdesigns.Theymayarguethatitisinfeasibletofindacomparatorlocationforanylocation,
givendifferencesinspatiallocation.Thispositionissurelytoopessimistic,sinceitrulesoutanyform
ofcausalempiricalanalysisonspatialdata,giventhatnocounterfactualcaneverbeconstructed.On
thecontrary,inalltheseexamplesdiscussedabove,thepurposeinthinkingthroughexperimental
settingstofind'comparator'orcontrolgroupsisnotnecessarilytofindcontrolplacesthatare
17

identicalineverywaytothe'treatment'places.Noristheaimnecessarilytofindsourcesof
variationthatarecompletelyrandom(i.e.instrumentsthatareuncorrelatedwitheveryother
characteristic),althoughthismightbetheideal.Instead,thegoalismoremodesttofind'control'
and'treatment'placesthatarecomparablealongthedimensionsthatinfluencetheoutcomebeing
studied.Similarly,instrumentsshouldbeuncorrelatedwiththeunobservedfactorsthatinfluence
theoutcome.Inshort,evenwhenweareconcernedthatthereareunobservedaspectsofspatial
locationthatdoinfluenceoutcomesandmakeplacesunique,therearestillpotentiallycausally
informativecomparisonsthatcanbemadebetweenneighbouringplaces,which,whilstnotidentical
arepotentiallyverysimilaralongsalientdimensions.
Sofarwehavesaidlittleabouttheroleoftheory.Manyspatialeconometriciansaredefensiveabout
theroletheoryplaysintheconstructionoftheirempiricalmodelsandseecommentsaboutthelack
oftheoryasamisguidedcriticismoftheirwork(e.g.seeCorradoandFingletoninthisjournal
volume).Buttheroleplayedbytheoryisnotourmaincriticism,ratheritisthefailuretoadopta
carefulresearchdesignthatsolvestheproblemsspecifictotheresearchquestionbeingaddressed,
andthelackofattentiontofindingcrediblesourcesofrandomorexogenousvariationinthe
explanatoryvariablesofinterest.Thisisnottosaywedonotthinkthattheoryisveryimportant,or
thatempiricalworkthathasproperbehaviouralstructuralfoundationsisuninformative(seeHolmes
2010forexamplesinregionaleconomics).Theorising,ofaformalisticormoreheuristictype,isof
courseessentialinorganisingthoughtsabouthowtodesignaresearchstrategyandtheoryand
assumptionsatsomelevelarenecessaryforanyempirics.Theoryisalsousefulonceyouhavethese
causalparameterestimatestohand,whenitcomestomakingpredictionsaboutgeneralequilibrium
effects,aslongasitismadeclearthatthesepredictionsarevalidonlyforthattheoreticalviewof
theworld.
Consistentwithouroverallapproach,wearguethattestingtheoriesmeanscorrectlyestimatingthe
coefficientsonspecificcausalvariables(assuggestedbythetheory).Thisprovidesanotherpointof
contrasttomostappliedspatialeconometricswheretheroleoftheoryistoderiveageneric
functionalformwithMLappliedtogivetheparametersthatensurethebestfittoreadilyavailable
data.Forexample,totestthepredictionsofNEGmodels,ourapproachinsistsonaresearch
strategytoidentifywhethermarketpotentialhasacausalimpactonwageswhilerecognisingthat
nomodelisgoingtocompletelyexplainthespatialdistributionofwages.Thiscontrastsstrongly
withtheappliedspatialeconometricsapproachwhichusestheextenttowhichdifferentspatial
econometricmodelsfitthedataasawaytotestcompetingtheories.Thishastheunfortunateside
effectofencouragingtheinclusionofendogenousvariablesinempiricalspecificationsas,for
obviousreasons,thesetendtoincreasethefitofthespatialmodelwiththedata.
Inmanyspatialeconomicproblems,theorymaythusplayanimportantroleinidentifyingvariables
forwhichwewouldliketoknowthecausaleffects.Butempiricalimplementationrequirescareful
researchdesigniftheresultsaretohaveanygeneralscientificcredibilityortobeconsidered
trustworthyforpolicymaking.Itissurelywrongtousespecialisedtheoryalonetoimposespecific
restrictionontheresearchdesign(e.g.byassumingawaypotentiallyconfoundingsourcesof
variation)unlessyouhavereasonableconfidencethatthetheoryiscorrectandthatitis
demonstrablysotoageneralaudience.Unfortunately,thisistheroleplayedbytheoryinmuch
appliedspatialeconometricresearch.Theoryisusedtojustifytheinclusionofaspatiallag,
18

assumptionsaremadeabouttheformofthespatialweightmatrix(possiblyderivedfromtheory),
MLisusedtoachieveidentificationandthenmodelfitisusedasabasisfortestingtheorywhich
justifiedtheinclusionofthespatiallag.Itshouldbeclearbynowthat,formostspatialproblems,we
simplydonotfindthisaconvincingapproach.Withoutwishingtoweighfurtherintothevigorous
debateonstructuralversusexperimentalapproachestoempiricalwork(e.g.JournalofEconomic
Perspectives,Vol24(2)2010)wesimplymakethepointthatwhatevermethodisadopted
(structural,experimental,qualitativeoranyother)anyempiricalresearchthataimstofindoutifx
causesyneedstofindasourceofexogenousvariationinx!

5.CONCLUSIONS
Wehavearguedthatidentificationproblemsbedevilmostappliedspatialeconometricresearch.
Manyspatialeconometriciansaresurelyawareoftheseproblemsbuttheliterature(inadvertently)
downplaystheirimportancebecauseofthefocusonderivingestimatorsassumingthatfunctional
formsareknownandbyusingmodelcomparisontechniquestochoosebetweencompeting
specifications.Whilethisraisesinterestingtheoreticalandcomputationissuesthathavebeenthe
subjectofagrowingandthoughtfulformaleconometricliterature,itdoesnotprovideatoolboxthat
givessatisfactorysolutionstotheseproblemsforappliedresearchersinterestedincausalityandthe
economicprocessesatwork.Itisinthissensethatwecallintoquestiontheapproachofthe
burgeoningbodyofappliedeconomicresearchthatproceedswithmechanicalapplicationofspatial
econometrictechniquestocausalquestionsofspilloversandotherformsofspatialinteraction,or
thatestimatesspatiallagmodelsasaquickfixforendogeneityissues,orthatblindlyappliesspatial
econometricmodelsbydefaultwithoutseriousconsiderationofwhetherthisisnecessarygiventhe
researchquestioninhand.Whilethequestionweposeinthetitletoourpaperisdeliberately
provocativeandtongueincheek,wemaintainthatthismodeofspatialeconometricwork,whilst
maybenotpointless,isoflimitedvaluewhenitcomestoprovidingcredibleestimatesofcausal
processesthatcanguideunderstandingofourworld,andguidepolicymakersonhowtochangeit.
Weurgethoseconsideringembarkingdownthisroutetothinkagain.
Paradoxically,wethinkthatusingthestandardspatialeconometricspecifications(adapted,aswe
havedonethroughoutthetext,toreinforcethefocusonthecausalfactorsthatdriveoutcome yi )
helpsclarifyidentificationproblemsforthoseresearcherswhoareinterestedincausality.In
particular,wethinkthatcloserattentiontomodelspecificationwillbehelpfulinunderstandingthe
exclusionandrelevanceassumptionsthatunderlieIVapproaches.Spatialeconometricsalso
providesimportantinsightsonthecorrectinterpretationofmodelparametersthatmaybe
identifiedfromsomesuitableestimationstrategy.Inshort,therearelessonstobelearntfromthe
spatialeconometricsliteraturebutformostappliedeconomicresearcherstheappropriatestrategy
shouldbebasedontheexperimentalistparadigmwhichputsissuesofidentificationandcausalityat
centrestage.

19

Appendix:Spatialeconometricsasasolutiontotheomittedvariables
problem
Assume yi dependsonexogenous xi andunobservable zi .Thatis:

yi xi zi

(A1)

Further,assumethattheunobservable zi isbothspatiallycorrelatedandpartlydeterminedby xi :

zi wi' z xi vi

(A2)

substituting zi yi xi into(6)andrearranginggives

yi w i' y ( ) xi w i' x vi (A3)


From(4)and(A3)notethatthepresenceofaspatiallycorrelatederrorterm,whethercorrelated
with xi ornot,leadstotheSDmodelinvolvingaspatiallaginyandX.Itisimportanttoemphasise,
however,thatinthismotivationfortheSDmodelthespatiallagsofyandXaresimplybeingusedto
controlforspatialcorrelationintheerrorterm,sorevealsnothingaboutthecausaleffectofthe
spatiallagsonoutcomes.Thishintsattheproblemsofidentificationinspatialmodelsdiscussedat
lengthinthetext.
Iftherearestandardomittedvariablesproblems(anunobservedvariablecorrelatedwithoneor
moretheexplanatoryvariables)thenweknowestimatesofarebiased.Spatialautocorrelationin
theexplanatoryandomittedvariablesislikelytoexacerbatethisbias.Increasingly,thepresenceof
spatiallycorrelatedomittedvariablesisusedinspatialeconometricstojustifyestimationoftheSD
modeltosolvethesekindsofomittedvariableproblem(LeSageandPace,2009).Thereasoning
followsthederivationinequations(A1)(A3).However,therearesurelysomedoubtsaboutthis
methodasasolutiontoomittedvariablesproblems.Ifitwasageneralsolution,itwouldalsowork
fornonspatialpaneldata.Forexample,theequivalentofequations(A1)(A3)withpaneldatais:

yit xit zit

(A4)

zit zit 1 xit vit

(A5)

yit yit 1 xit 1 ( ) xit' vit

(A6)

ThisequationcanbeestimatedconsistentlybyMLornonlinearleastsquares,orestimatesofthe
variousparametersretrievedfromtheOLScoefficients.Althoughendogeneityproblemsofthistype
mightbemitigatedbythisstrategy,itiscertainlynotacompletefix.Toseethis,modifythesetupin
equations(A1)(A3)slightlytocopewithmoregeneralendogeneityinthat xi ispartlydetermined
bytheomittedvariable( fi ).Inthiscasewehave:

yi xi zi

(A7)
20

zi w i' z f i vi
xi fi ui

yi wi' y ( ) xi wi' x (vi ui )


Theerrortermnowhasacomponent ui thatisnegativelycorrelatedwith xi ,sothecoefficients
cannotbeestimatedconsistentlybyOLS,NLSorML.Inthismoregeneralsetting,theSDmodeldoes
notprovideasolutionthatgivesconsistentestimatesfortheparameterofinterest().See,for
example,ToddandWolpin(2003)forarelateddiscussioninthecontextofvalueaddedmodelsin
theeducationalliterature.Inshort,theSDmodelshouldnotbeseenasageneralsolutiontothe
omittedvariableprobleminspatialresearch,anditisinadvisabletoproceedasifitisone.Abetter
solutionistotreatthisasastandardendogeneityproblemthatmakes xi correlatedwiththeerror,
andtobringtobeartoolsfordealingwithsuchproblemsasdiscussedfurtherinthetext.

21

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