We investigate the consequences of using time-invariant individual effects in panel data models when the unobservables are in fact time-varying. Using data from the British Offending Crime and Justice panel, we estimate a dynamic factor model of the occurrence of a range of illicit activities as outcomes of young peoples development processes. This structure is then used to demonstrate that relying on the assumption of time-invariant individual effects to deal with confounding factors in a conventional dynamic panel data model is likely to lead to spurious gateway effects linking cannabis use to subsequent hard drug use.
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