OBSERVED CHOICE AND OPTIMISM IN ESTIMATING THE EFFECTS OF GOVERNMENT POLICIES

A policy will be used more heavily in a time and place where its cost is lower. The analyst who treats times and places as identical will ov erestimate the policy's net benefit, especially for policy intensities greater than exist in his sample. In regression analysis, the problem can be solved by instrumental variables. Using state-level data, the technique substantially increases the estimated responsiveness of ille gitimacy to transfers.