Within Variation and Fixed Effects

i.e. one thing to do when measurement eludes you

Check-in
So far we've been learning about how to set up, run, and interpret an ordinary least
squares regression
This is a key skill for anyone doing anything with data - even if you never run a regular
OLS linear regression again, pretty much everything else in applied stats builds off of it
in some way
Another thing we've been doing is thinking about how to design and add controls to
that regression to identify our effect of interest

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The Measurement Problem...
And this has led us to some issues that have already popped up!
For this approach to work, we need to not only figure out what we need to control for,
using our diagram, but we need to actually control for it
A lot of the time we don't have that data!
And thus all the skeptical comments we had about the designs we came up with

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Today
Today, we will be talking about within variation and between variation, and the ability to
control for all between variation using fixed effects

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Panel Data
We are working now in the domain of panel data
Panel data is when you observe the same individual over multiple time periods
"Individual" could be a person, or a company, or a state, or a country, etc. There are N
individuals in the panel data
"Time period" could be a year, a month, a day, etc.. There are T time periods in the data
For now we'll assume we observe each individual the same number of times, i.e. a
balanced panel (so we have N × T observations)
You can use this stuff with unbalanced panels too, it just gets a little more complex

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Panel Data
Here's what (a few rows from) a panel data set looks like - a variable for individual
(county), a variable for time (year), and then the data

County Year CrimeRate ProbofArrest

1 81 0.0398849 0.289696

1 82 0.0383449 0.338111

1 83 0.0303048 0.330449

1 84 0.0347259 0.362525

1 85 0.0365730 0.325395

1 86 0.0347524 0.326062

1 87 0.0356036 0.298270

3 81 0.0163921 0.202899

3 82 0.0190651 0.162218

9 rows out of 630. "Prob. of Arrest" is estimated probability of being arrested when you
commit a crime 6 / 38
Between and Within
Let's pick a few counties and graph this out

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Between and Within
If we look at the overall variation, just pretending this is all together, we get this

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Between and Within
BETWEEN variation is what we get if we look at the relationship between the means of
each county

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Between and Within
Only look at those means!
The individual year-to-year variation within county doesn't matter.

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Between and Within
Within variation goes the other way - it treats those orange crosses as their own
individualized sets of axes and looks at variation within county from year-to-year only!
We basically slide the crosses over on top of each other and then analyze that data

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Between and Within
We can clearly see that between counties there's a strong positive relationship
But if you look within a given county, the relationship isn't that strong, and actually
seems to be negative
Which would make sense - if you think your chances of getting arrested are high, that
should be a deterrent to crime
But what are we actually doing here? Let's think about the causal diagram / data-
generating process!
What goes into the probability of arrest and the crime rate? Lots of stuff!

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The Crime Rate
"LocalStuff" is just all the things unique to that area
"LawAndOrder" is how committed local politicians are to "Law and Order Politics"

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Between and Within
For each of these variables we can ask if they vary between groups and/or within
groups

LocalStuff is all the stuff unique to that county - geography, landmarks, the quality of
the schools, almost by definition this only varies between groups. It's not like the things
that make your county unique are different each year (or at least not very different)

Whether the county has LawAndOrder and how many CivilRights you're allowed might
change a bit year to year, but in general, political climates like that change pretty slowly.
At a bit of a stretch we can call that something that only varies between groups too

Police budgets (and thus number of police on the streets) and Poverty (which varies
with the economy) vary both between counties, but also within counties from year to
year

Variables with between variation only (by our assumption): LocalStuff, LawAndOrder,
CivilRights

Variables with both between and within variation: Police, Poverty

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Between and Within
Let's simplify our graph!
Some of the variables only vary between counties
So, we can replace those variables on the graph with the variable County
Right? That's where all the variation is anyway

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The Crime Rate
"LocalStuff" is just all the things unique to that area
"LawAndOrder" is how committed local politicians are to "Law and Order Politics"

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Between and Within
Now the task of identifying ProbArrest → CrimeRate becomes much simpler!
(based on the diagram, all we need to control for is County and Poverty!)
Conveniently, we can control for County just like it was any other variable!

Controlling for County , we automatically control for all variables that only have
between variation, whatever they are, even if we can't measure them directly or didn't
think about them

All that's left is the within variation

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Concept Checks
For each of these variables, would we expect them to have within variation, between
variation, or both?
(Individual = person) How a child's height changes as they age.
(Individual = person) In a data set tracking many people over many years, the variation
in the number of children a person has in a given year.
(Individual = city) Overall, Paris, France has more restaurants than Paris, Texas.
(Individual = genre) The average pop music album sells more copies than the average
jazz album
(Individual = genre) Miles Davis' Kind of Blue sold very well for a jazz album.
(Individual = genre) Michael Jackson's Thriller, a pop album, sold many more copies
than Kind of Blue, a jazz album.

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Removing Between Variation
Okay so that's the concept
Remove all the between variation so that all that's left is within variation
And in the process control for any variables that are made up only of between variation
How can we actually do this? And what's really going on?
Let's first talk about the regression model itself that this implies
There are two main ways: de-meaning and binary variables (they give the same
result, for balanced panels anyway)

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Estimation vs. Design
To be clear, this is exactly 0% different from what we've done before in terms of
controlling for stuff
And in fact we're about to do the exact same thing we did before by just adding a
categorical control variable for county or whatever
(and in fact the "within" thing holds with other categorical controls - a categorical
control for education isolates variation "within education levels")
The difference is the reason we're doing it. It's fixed effects because a categorical
control for individual controls for a lot of stuff, and we think closes a lot of back doors
for us, not just one, and not just ones we can measure

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The Model
The it subscript says this variable varies over individual i and time t

Yit = β0 + β1 Xit + εit

What if there are individual-level components in the error term causing omitted
variable bias?
Xit is related to LocalStuff which is not in the model and thus in the error term!
Regular ol' omitted variable bias. If we don't adjust for the individual effect, we get a
biased β^1
(this bias is called "pooling bias" although it's really just a form of omitted variable bias)
We really have this then:

Yit = β0 + β1 Xit + (αi + εit )

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De-meaning
Let's do de-meaning first, since it's most closely and obviously related to the "removing
between variation" explanation we've been going for
The process here is simple!

1. For each variable Xit , Yit , etc., get the mean value of that variable for each individual
¯ ¯
Xi , Y i

2. Subtract out that mean to get residuals (Xit ¯ ¯

− X i ), (Yit − Y i )

3. Work with those residuals

That's it!

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How does this work?
That αi term gets absorbed
The residuals are, by construction, no longer related to the αi , so it no longer goes in
the residuals!

¯
(Yit − Y i ) = β0 + β1 (Xit − X̄ i ) + εit

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Let's do it!
We can use group_by to get means-within-groups and subtract them out

data(crime4, package = 'wooldridge')

crime4 <- crime4 %>%
# Filter to the data points from our graph
filter(county %in% c(1,3,7, 23),
prbarr < .5) %>%
group_by(county) %>%
mutate(mean_crime = mean(crmrte),
mean_prob = mean(prbarr)) %>%
mutate(demeaned_crime = crmrte - mean_crime,
demeaned_prob = prbarr - mean_prob)

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And Regress!
orig_data <- feols(crmrte ~ prbarr, data = crime4)
de_mean <- feols(demeaned_crime ~ demeaned_prob, data = crime4)
etable(orig_data, de_mean)

## orig_data de_mean
## Dependent Var.: crmrte demeaned_crime
##
## (Intercept) 0.0118* (0.0050) 1.41e-18 (0.0004)
## prbarr 0.0486** (0.0167)
## demeaned_prob -0.0305* (0.0117)
## _______________ _________________ _________________
## S.E. type IID IID
## Observations 27 27
## R2 0.25308 0.21445
## Adj. R2 0.22321 0.18303
## ---
## Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1

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Interpreting a Within Relationship
How can we interpret that slope of -0.03 ?
This is all within variation so our interpretation must be within-county
Or if we think we've causally identified it (and want to work on a more realistic scale),
"raising the arrest probability by 1 percentage point in a county reduces the number of
crimes per person in that county by .0003".
We're basically "controlling for county" (and will do that explicitly in a moment)
So your interpretation should think of it in that way - holding county constant
i.e. comparing two observations with the same value of county
i.e. comparing a county to itself at a different point in time

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Concept Checks
Why does subtracting the within-individual mean of each variable "control for
individual"?
In a sentence, interpret the slope coefficient in the estimated model
(Yit − Y i ) = 2 + 3(Xit − X i ) where Y is "blood pressure", X is "stress at work", and
¯ ¯

i is an individual person

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The Least Squares Dummy Variable
Approach
De-meaning the data isn't the only way to do it!
You can also use the least squares dummy variable (another word for "binary variable")
method
We just treat "individual" like the categorical variable it is and add it as a control! Again,
the regression approach is exactly the same as with any categorical control, but the
research design reason for doing it is different

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Let's do it!
lsdv <- feols(crmrte ~ prbarr + factor(county), data = crime4)
etable(orig_data, de_mean, lsdv, keep = c('prbarr', 'demeaned_prob'))

## orig_data de_mean lsdv

## Dependent Var.: crmrte demeaned_crime crmrte
##
## prbarr 0.0486** (0.0167) -0.0305* (0.0124)
## demeaned_prob -0.0305* (0.0117)
## _______________ _________________ _________________ _________________
## S.E. type IID IID IID
## Observations 27 27 27
## R2 0.25308 0.21445 0.94114
## Adj. R2 0.22321 0.18303 0.93044
## ---
## Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1

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The same!
The result is the same, as it should be
Except for that R2 - What is that "within R2"?
Because de-meaning takes out the part explained by the fixed effects ( αi ) before
running the regression, while LSDV does it in the regression
So the .94 is the portion of crmrte explained by prbarr and county , whereas the .21 is
the "within - R2 " - the portion of the within variation that's explained by prbarr
Neither is wrong (and the .94 isn't "better"), they're just measuring different things

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Why LSDV?
A benefit of the LSDV approach is that it calculates the fixed effects αi for you
We left those out of the table with the coefs argument of export_summs (we rarely want
them) but here they are:

## OLS estimation, Dep. Var.: crmrte

## Observations: 27
## Standard-errors: IID
## Estimate Std. Error t value Pr(>|t|)
## (Intercept) 0.045631 0.004116 11.08640 1.7906e-10 ***
## prbarr -0.030491 0.012442 -2.45068 2.2674e-02 *
## factor(county)3 -0.025308 0.002165 -11.68996 6.5614e-11 ***
## factor(county)7 -0.009870 0.001418 -6.96313 5.4542e-07 ***
## factor(county)23 -0.008587 0.001258 -6.82651 7.3887e-07 ***
## ---
## Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1
## RMSE: 0.001933 Adj. R2: 0.930441

Interpretation is exactly the same as with a categorical variable - we have an omitted

county, and these show the difference relative to that omitted county

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Why LSDV?
This also makes clear another element of what's happening! Just like with a categorical
var, the line is moving up and down to meet the counties
Graphically, de-meaning moves all the points together in the middle to draw a line,
while LSDV moves the line up and down to meet the points

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Why Not LSDV?
LSDV is computationally expensive
If there are a lot of individuals, or big data, or if you have many sets of fixed effects (yes
you can do more than just individual - we'll get to that next time!), it can be very slow
Most professionally made fixed-effects commands use de-meaning, but then adjust the
standard errors properly
(They also leave the fixed effects coefficients off the regression table by default)

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Going Professional
Applied researchers rarely do either of these, and rather will use a command
specifically designed for fixed effects
Like good ol' feols() ! (what did you think the "fe" part stood for?)
Note there are also functions in fixest that do fixed effects in non-linear models like
logit, probit, or poisson regression ( feglm() and fepois() )
Plus, it clusters the standard errors by the first fixed effect by default, which we usually
want!

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Going Professional
library(fixest)
pro <- feols(crmrte ~ prbarr | county, data = crime4)
etable(de_mean, pro)

## de_mean pro
## Dependent Var.: demeaned_crime crmrte
##
## (Intercept) 1.41e-18 (0.0004)
## demeaned_prob -0.0305* (0.0117)
## prbarr -0.0305* (0.0064)
## Fixed-Effects: ----------------- -----------------
## county No Yes
## _______________ _________________ _________________
## S.E. type IID by: county
## Observations 27 27
## R2 0.21445 0.94114
## Within R2 -- 0.21445
## ---
## Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1

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Limits to Fixed Effects
Okay! At this point we have the concept behind fixed effects, can execute them, and
know what they're good for
What aren't they good for?

1. They don't control for anything that has within variation

2. They control away everything that's between-only, so we can't see the effect of anything
that's between-only ("effect of geography on crime rate?" Nope!)
3. Anything with only a little within variation will have most of its variation washed out too
("effect of population density on crime rate?" probably not)
4. The estimate pays the most attention to individuals with lots of variation in treatment

2 and 3 can be addressed by using "random effects"

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Concept Checks
Why can't we use individual-person fixed effects to study the impact of race on traffic
stops?
The within R2 from is .3, and the overall R2 is .5. Interpret these two numbers in
sentences
In a sentence, interpret the slope coefficient in the estimated model
(Yit − Y i ) = 1 + .5(Xit − X i ) where Y is "school funding per child" and X is
¯ ¯

"population growth", and i is city

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Swirl
Open up the Fixed Effects Swirl and let's do it!

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