One of the best tools in the toolkit of a high-quality thinker is the ability to correctly define the “counterfactual.” The Wikipedia page is interesting but misses the point I want to make.
The (or a) counterfactual is what the world would have been like if instead of X happening, Y happened. This makes me think of Christ’s words: “Woe to you, Korazin! Woe to you, Bethsaida! If the miracles that were performed in you had been performed in Tyre and Sidon, they would have repented long ago in sackcloth and ashes” (Mt. 11:20). Christ in his perfect knowledge knew what would have happened in a different situation where miracles were performed in Tyre and Sidon (Y) instead of in Korazin and Bethsaida (X). He knew perfectly the counterfactual.
Of course, we can never know truly what a counterfactual is because we can only see one version of history. However, we can try to construct a counterfactual to help evaluate policies or other interventions. Sometimes we mentally construct the counterfactual and sometimes we generate data on a counterfactual.
When you run a science fair experiment you always want to have a treatment and control group. In 7th grade I wanted to find out whether electromagnets affected how beans grew. So, I grew one set of beans inside a home-made electromagnet and one without the electromagnet. I tired to keep everything else exactly the same. Turns out electromagnets make beans grow curly. How do I know – because the control group grew straight. I constructed a counterfactual to compare worlds with and without electromagnetic wavers. This was really a quasi-counterfactual though. A true counterfactual would be if I grew the beans with an electromagnet and then went back in time and grew the SAME beans without the electromagnet. I’ll let the reader figure out the problem with such an approach.
In economics we try to construct counterfactuals all the time. If we want to know the impact of the minimum wage (MW) we might compare places that do and don’t have minimum wages (or have higher and lower MWs). The thorny problem of course is that such places might be very different all sorts of other ways. It wouldn’t make much sense to compare the US (has MW) and Hong Kong (no MW) to determine the effects of the MW. There are too many other differences. Comparing different minimum wages in, say, New Jersey and Pennsylvania might be better but even this could have problems.
So how will the counterfactual make you a better thinker? The key is to ask, “What things would change if instead of X we had Y?” Maybe X is rent control and Y is no rent control. Maybe X is capitalism and Y is socialism or communism. Maybe X is the Endangered Species Act and Y is no ESA.
I find that many people fail to construct a good counterfactual. Let’s take the policy of rent control. Housing costs in a city may be rising, leading to a lack of affordable housing in certain areas. To counteract this many will propose rent controls – some limit on how much rents can be or increase each year. Many advocates will construct the following (incomplete) counterfactual: if we have rent control then current citizens will still be able to afford to live in this area.
Here is why this is at best incomplete. A good counterfactual construction considers how the incentives of all involved will change. If landlords cannot charge the market rate for apartments, they will not want to fully maintain the property. Quality falls. Over time a nice area can become bad area. This lowers property values which means fewer taxes collected. The city may no longer be able to provide as many services. Eventually the well-to-do may flee the city. CEOs may move companies to better places. This means the dry cleaners, and restaurant owners, and house keepers will be left with less income they once received from the workers at the company that left. They might not even be able to afford the rent-controlled apartment, and the city might not be able to afford social assistance programs for those who have less income.
Also, since the price is below market, demand will outstrip supply. Landlords will use other criteria for choosing who gets to rent. This is the dark side of rent control. Landlords may choose renters of a preferred race or gender or those without kids. Some renters will offer non-monetary favors to the landlord. Some will simply make under-the-table payments. The rental market becomes a place of discrimination where only those willing to break the law can find a decent apartment. This is a much better counterfactual since it considers many of the other outcomes of rent control above and beyond the housing short-run affordability of housing.
Lastly, the movie Sliding Doors gets at the idea of a counterfactual too. It is almost like what economists would call a Regression Discontinuity design.