Lecture5and6 Institutions Culture 6

EC2B1: MACROECONOMICS
Week 5 & 6
Institutions and Culture
Wouter Den Haan
1
Required Readings
• Weil – Chapter 12 (book has a different structure than the

slides but has lots of excellent examples).
• Guiso, L., P. Sapienza, and L. Zingales, 2006, Does

Culture Affect Economic Outcomes, Journal of
Economic Perspectives 20, pp. 23-48. Available here.
!!!! You do not have to remember details. Focus on main

channels and what supports those arguments.
2
Overview
1. Introduction and motivation.

2. Different types of institutions.
3. Institutions and economic development.
4. Different types of cultural traits.
5. Cultural traits and economic development.
6. Focus on an important cultural trait: Trust.
7. A bit of a case study: Botswana & Sierra Leone.
Big Theme: Filling the gap between real world

observations and the Solow/Romer view of the world. 3
How to improve your overall LSE
educational experience the most?
1. Faculty who are better in research.
2. Better teachers.
3. More contact time with faculty/teachers.
4. Better transparency of the rules; less uncertainty.
5. Less bureaucracy.
6. More respect for each other.
7. Trusting each other more (e.g. in deferral requests).
8. Students having more input in decision making.

4
Thinking about Growth: Timeline
1. Solow (1956): Growth through capital accumulation (savings

key).
• Could be in response to exogenous technology changes.
2. Romer (1990): Growth through endogenous technological

improvement.
5
Thinking about Growth: Timeline
3. 90s and after
• Academic profession and policy makers realize that the Solow &
Romer models cannot be the full story. Why?
– ”Knowledge” how to produce GDP best (i.e., A) is key according to Romer.
– But knowledge of the frontier country is not that difficult to copy.
– Why doesn’t state of the art knowledge spread faster from frontier to poor countries?
– This could very well be a good model for the frontier country, but not clear this is a
good model for other countries since they could copy instead of invent themselves.
(Note that countries can decide not to respect patents of inventions in other countries.)
• Role of institutions is brought into the analysis.

• Institutions are not the complete panacea either
⇒ role of culture is investigated
6
a bit of a warning/reminder
1. Growth is complex.
2. Lots of things are related to each other.
3. What supports sustained growth in rich countries may
not work in poor countries.
4. Interactions are likely to be important. That is, impact
may crucially depend on presence of other factors.
5. Effects may very well be nonlinear.
6. Direction of causation not always clear.
• Exogenous events and instrumental variables (IV) essential in
applied work.
7
Empirical Evidence
• Knowledge on the role of institutions and cultural traits
on economic development is mainly based on empirical
evidence.
• Empirical evidence in economics is made difficult
because of endogeneity. X ⇒ Y but also Y ⇒ X.
• Dealing with endogeneity requires estimation with
instrumental variables (which you will learn in EC2C1).
• 100% certainty in empirical work is not possible and
definitely not when dealing with endogeneity issues.
• So it is important to keep an open mind.
• BUT there is a big difference between knowledge
corroborated by robust empirical research and views that
are based on beliefs or anecdotes. 8
Institutions - Definitions
Broad definition of Nobel prize winner Douglas North:
“The humanly devised constraints that structure human
interactions. They are made up of formal constraints (rules,
laws, constitutions), informal constraints (norms of behaviour,
convention, and self-imposed codes of conduct), and their
enforcement characteristics.”
• This includes formal AND informal constraints on
political, economic, and social interactions.
• Current terminology, which we will use:
• Institutions include the more formal aspects, such as organizational
entities, procedural devices, and regulatory frameworks.
• Culture: the more informal aspects.
9
“Rules of the Game”
• This set of slides focuses on how the “rules of the game”
affect economic development.
• “Rules” include many things.
• Not just formal institutions like laws!
• Also the credibility of the system to implement them.
• Also customs.
• Peer pressure.
• Etc.
• Economics comes from the Greek word Oikonomos

• Oikos: Home or household.
• Nomos: Manage (and managing could mean setting rules).
10
Six Types of Institutions
11
Governments
How are governments selected/chosen, monitored, and
replaced?
1. Voice and Accountability (VA) – capturing
perceptions of the extent to which a country's
citizens are able to participate in selecting their
government, as well as freedom of expression,
freedom of association, and a free media.
2. Political Stability and Absence of
Violence/Terrorism (PV) – capturing perceptions
of the likelihood that the government will be
destabilized or overthrown by unconstitutional or
violent means, including politically‐motivated
violence and terrorism.
12
Voice and Accountability
Source: https://info.worldbank.org/governance/wgi/Home/Reports 13
Voice and Accountability
Some examples (scores range from -2.5 to 2.5)
2010 2015 2020

Afghanistan -1.40 -1.12 -1.08
Armenia -0..85 -0.54 0.04
North Korea -2.23 -2.20 -2.16
Political Stability
Political Stability
2010 2015 2020

Afghanistan* -2.58 -2.57 -2.73
Armenia 0.07 -0.25 -0.57
North Korea -0.30 -1.15 -0.40
* Scores exceed standard minimum

Governance
The capacity of the government to effectively
formulate and implement sound policies:
1. Government Effectiveness (GE) – capturing
perceptions of the quality of public services, the
quality of the civil service and the degree of its
independence from political pressures, the quality
of policy formulation and implementation, and the
credibility of the government's commitment to
such policies. Includes degree of politization.
2. Regulatory Quality (RQ) – capturing perceptions
of the ability of the government to formulate and
implement sound policies and regulations that
permit and promote private sector development.
17
Government Effectiveness
Government Effectiveness
2010 2015 2020

China 0.09 0.41 0.65
United Kingdom 1.62 1.74 1.38
United States 1.56 1.46 1.32
Regulatory Quality
Regulatory Quality
2010 2015 2020

United Kingdom 1.73 1.85 1.48
United States 1.45 1.26 1.24
Venezuela -1.62 -1.88 -2.23

Respect/Confidence
The respect of citizens and the state for the institutions
that govern economic and social interactions among
them:
1. Rule of Law (RL) – capturing perceptions of the
extent to which agents have confidence in and abide
by the rules of society, and in particular the quality of
contract enforcement, property rights, the police, and
the courts (independent judges), as well as the
likelihood of crime and violence.
2. Control of Corruption (CC) – capturing
perceptions of the extent to which public power is
exercised for private gain, including both petty and
grand forms of corruption, as well as "capture" of the
state by elites and private interests.
22
Rule of Law
Rule of Law
2010 2015 2020

Hungary 0.78 0.41 0.51
Iraq -1.56 -1.42 -1.75
Poland 0.69 0.78 0.54
Control of Corruption
Control of Corruption
2010 2015 2020

Hungary 0.31 0.15 0.10
Iraq -1.26 -1.37 -1.28
Poland 0.52 0.72 0.65

Institutions and
Economic Development
27
Why do Institutions Matter?
1. Provide incentives.
• To invest/save.
• To work.
• To intermediate financial flows.
2. Improve efficiency/productivity.
• Allocation of resources.
• Financing of investment.
3. Reduce uncertainty.
• E.g., insurance against disasters and recessions.
4. Control inflation.
5. Affect international flows of people, goods, services,
money, debt, equity, knowledge, ideas, etc.
Assignment challenges you to think how these are

affected by institutions. 28
The Case for/against
Government Intervention
For:
1. Market failures
• Public goods such as defence
• Externalities as in Romer model.
• Monopolies
• Coordination failure (drive on same side of road)
2. Income distribution
Against: Government may be inefficient/corrupt.

29
ctrum, and giving more specific shape to
oad concept of institutions, would be par-
organizational entities, procedural
and regulatory frameworks. Such institu-
fect performance primarily by fostering
Institutions Matter!
policy choices. Examples include commit- Figure 3.2. Relationship Between Income and
evices such as central bank independence Institutions
anced budget amendments; the existence
sign of international trade agreements; Real income per capita is closely correlated with institutional quality.
gulations governing the functioning of
Advanced economies Developing economies
roduct, and financial markets.
h of the recent research into determi-
12
f economic development—including this
—follows an approach that lies between
wo perspectives. This work tends to focus 10
ptions and assessments of public institu-
Log of real GDP per capita in 1995

especially about how well they function
at their impact is on private sector behav- 8
particular, the empirical analysis below
ree measures of institutions. These indi-
st, the quality of governance, including 6
ree of corruption, political rights, public

efficiency, and regulatory burdens;2 sec-
4
e extent of legal protection of private
y and how well such laws are enforced;
rd, the level of institutional and other 2
laced on political leaders. (See Appendix -2.0 -1.6 -1.2 -0.8 -0.4 0.0 0.4 0.8 1.2 1.6 2.0
further details on these indicators.) The Aggregate governance measure1
ions of the political, economic, and pol-

Sources: Kaufmann, Kraay, and Zoido-Lobatón (1999); World Bank, World Development
ate embodied in the institutional meas- Indicators (2002); and IMF staff calculations.
1This index measures the overall quality of governance, including the degree of
e likely to be of key importance in
corruption, political rights, public sector efficiency, and regulatory burdens (for further
g overall conditions for investment and details, see Appendix 3.1).
Given the mobility of international capi-
example, such assessments may play a
Source: IMF - World Economic Outlook 2003
ole in determining a country’s ability to
30
and retain investment inflows.
31
32
Figures on
previous
slides raise
which
obvious
question?
33
34
How to Determine Causation?
• Economic growth is likely to affect institutions.

• So we need two countries that have different
institutions for exogenous reasons.
Examples
1. Split of North & South Korea in 1948.
2. Different institutions following colonization.
3. Different legal origin.
35
North & South Korea
D.Acemoglu er al.
GDP per capita
Figure 3. GDP per capita in North and South Korea, 195CL98.
institutions on prosperity. Korea was split into two, with the two halves organized in
radically different ways, and with geography, culture and many other potential determi-
Source: Acemoglu, Johnson,
nants of economic Robinson
prosperity held fixed.(2005)
Thus any differences in economic performance 36
can plausibly be attributed to differences in institutions.
North & South Korea from Space
37
Colonization Americas by Europeans
Acemoglu, Johnson, and Robinson (2002)

• Initial population and urbanization high
⇒ worse (= extractive) institutions.
• Initial population and urbanization low
⇒ Europeans moved in and created better institutions.
• Thus, institution imposed centuries ago are not caused

by subsequent amount of economic growth.
38
Colonization by Europeans
Ch. 6: Institutions as a Fundamental Cause of Long-Run Growth
SGP
HKG
I NZL
MEX
MYS
COL w
DOM DZA
JAM
PHL IDN
MAR
SLV BOL EGY
NIC
VNM
HTI
LAO
BGD
I
0 5' 10
I
1 5
Urbanization in 1500
Figure 5. Urbanization in 1500 and log GDP per capita in 1995, among former European colonies.
Source: Acemoglu, Johnson, Robinson (2005) 39

Colonization by Europeans
CHL 8R8
TUN
JAM
Swz
EGY
LSO
1I
TZA SCE
6
I I I
-5 0 5
Log Population Density in 1500
Figure 6. Log population density in 1500 and log GDP per capita in 1995, among former European colonies.
Source: Acemoglu, Johnson, Robinson (2005) 40

Key Insight
Impact of institutions must be

incredibly persistent.
41
Legal Origin
La Porta, Lopez-de-Silanes and Andrei Shleifer (2008)

• Countries have legal systems that are different
AND the differences started centuries ago, that is, are
also NOT due to subsequent economic growth.
42
Legal Origin
• The big systems
• French civil law (originating in Roman law).
• Letter of the law quite important.
• Less protective of outside investors.
• Common law (originating in English law).
• Meaning of the law important and evolves through
jurisprudence (judges interpreting the law)
• More protective of outside investors
• German and Scandinavian versions closer to civil law.
• Important for lots but especially financial development.
43
Legal Origin
La Porta, Lopez-de-Silanes, and Shleifer: Economie Consequences of Legal Origins 289
Legal Origins
English
I French
German
V/A Scandinavian
HI Socialist
Figure 1. The Distribution of Legal Origin
The civil law tradition is the oldest, the 44

it did because the revolutionary generation,
most influential, and the most widely dis and Napoleon after it, wished to use state
Observations 71 49 130 85 74
La Porta, Lopez-de-Silanes,
45% and Shleifer: Economie Consequences
0.45 0.57 of Legal
37%Origins 295
K-squared
Step 1: Determine Exogenous Bit
Financial Institutions andInstitutions
of current TABLE 1
Capital Markets Development
Panel B: Financial Institutions and Capital Markets Development
(1)
Panel A: Financial Institutions (2)
and Legal (3)
Origin (4) (5) (6)
(1) (2)
Stock-market-to- Ln(Firms/Pop) Ownership (3)Control (4)
Private-credit-to- (5)
Interest spread
GDP (1999-2003) (1999-2003) Concentration Premium GDP (1999-2003) (1970-95)
Anti-Self-Dealing Prospectus Creditor Rights Debt Bank Government
Index
Anti-self-dealing 0.8940b Disclosure -0.1277e'Index (2003)
0.8004e Enforcement Owernship (1970)
Index (0.3674) (0.4750) (0.0724)
French Legal -0.3334a -0.3298a -0.8394a
-0.3254a -13.6361b 0.3316a
Prospectus
Origin
Disclosure (0.0511) (0.0577) (0.2251)
(0.0807) (5.6535) (0.0755)
German Legal Index -0.3454a -0.2370b -0.1714 -8.8577
0.0645e 0.3456a
Credit Rigths
Origin (0.0736) (0.0966) (0.2579) (5.8022)
(0.0336) (0.1060)
Scandinavian
Debt Enforcement -0.3820a -0.2867d -0.9435e 5.2707
0.0053a 0.3109
Legal Origin (0.0642) (0.0478) (0.4865) (5.8212)
(0.0015) (0.1545)
Ln (GDP perOwnership
Government 0.0728a 0.0618b 0.2022b 19.8980a -0.1808a
22.0813a
of Banks?1970
capita) (0.0263) (0.0261) (0.0875) (2.7517) (0.0377)
(7.3675)
Constant
Ln (GDP per capita) 0.3204a
0.0177 0.2102 -0.0495b 0.6043
0.9794a -0.0273 0.2546a
-124.6692a 1.8522
1.6206a
(0.0601)
(0.2433) (0.2422) (0.0200) (0.7560)
(0.1346) (0.0238) (0.0604)
(26.9421) (3.0169)
(0.2876)
Constant -2.7604a -6.9496a 0.9844a 0.5524b -2.1494a -4.4219
Observations 71
(0.5558) (1.2352)49 (0.1761) 130(0.2202) 85
(0.4912) (23.0311)74
K-squared 45% 0.45 0.57 37%
Observations 72 72 49 37 85 57
fi-squared 40% 47% 20% 36% 52% 10%
Notes: a Significant at the 1 percent level.

Panel B:bFinancial
Significant at the 5 percent level.
Institutions and Capital Markets Development
e Significant at the 10 percent level.
(1) (2) (3) (4) (5) (6)
Stock-market-to- Ln(Firms/Pop) Ownership Control Private-credit-to- Interest spread
0.8004e -0.1277e' 45
Anti-self-dealing 0.8940b
Index (0.3674) (0.4750) (0.0724)
Constant 0.0177 0.2102 0.6043 -124.6692a 1.6206a
(0.2433) (0.2422) (0.7560) (26.9421) (0.2876)
Step 2:
Observations
K-squared
Estimate
71
45%
Impact
0.45
of Exogenous
85
0.57
Part
74 of
37%
49 130
Institutions on Financial Development.

Panel B: Financial Institutions and Capital Markets Development
(1) (2) (3) (4) (5) (6)
Stock-market-to- Ln(Firms/Pop) Ownership Control Private-credit-to- Interest spread
Anti-self-dealing 0.8940b 0.8004e -0.1277e'

Index (0.3674) (0.4750) (0.0724)
Prospectus -0.3254a
Disclosure (0.0807)
Credit Rigths Index 0.0645e
(0.0336)
Debt Enforcement 0.0053a
(0.0015)
Government Ownership 22.0813a
of Banks?1970 (7.3675)
Ln (GDP per capita) 0.3204a 0.9794a -0.0495b -0.0273 0.2546a 1.8522
(0.0601) (0.1346) (0.0200) (0.0238) (0.0604) (3.0169)
Constant -2.7604a -6.9496a 0.9844a 0.5524b -2.1494a -4.4219
(0.5558) (1.2352) (0.1761) (0.2202) (0.4912) (23.0311)
Observations 72 72 49 37 85 57
fi-squared 40% 47% 20% 36% 52% 10%
Notes: a Significant at the 1 percent level.

b Significant at the 5 percent level.
e Significant at the 10 percent level.
46
Institutions ⇔ economic
development
• Clearly: Economic Growth ⇒ institutions ↑.

• Examples above: Institutions ↑ ⇒ economic development.
• But, economic growth may occur even when institutions
are somewhat problematic (see Section 12.4 in Weil).
• However, several obvious examples of ways governments
can kill growth.
47
How Governments Kill Growth
1. High Inflation.
2. Black Market Premium (e.g., restrict purchase foreign
currency at below market price).
3. Long-term high budget deficits.
4. Kill banks through financial repression (e.g. restrict
nominal interest rate when inflation is high).
5. Blunt protectionism.
6. Don’t provide basic services.
7. Corruption.
See Easterly (2002) for examples in different countries.
48
Which institution hasn’t explicitly been mentioned?
(at least not on its own)
Which word haven’t you seen yet?
????????????????????????????
49
How to Improve Institutions?
1. Political process including revolutions.
2. Competition and trade openness.
• This weakens vested interest and reduces rents.
3. Information and transparency.
• Press freedom.
• Reduce corruption and increase government
effectiveness.
4. External anchors.
• European accession process.
• World Trade Organization (WTO). E.g.,
important for reform efforts in China.
• New Partnership for Africa’s Development
(NEPAD).
• IMF (bailout conditions).
50
Something To Think About
51
• (Formal) institutions matter, but they are not the whole story.
• For example,
• there are strong similarities between the 1853 Argentine
constitution and that of the US.
• See: Linares Quintana (1949).
• But impact on economic development seems quite
different.
52
Culture
53
The Hippo Theory
• Institutions: The bit that you see.
• Culture: Everything else.
54
Culture: “Definition”
Guiso, Sapienza, and Zingales (2006):
Culture: “Those customary beliefs and values that ethnic,

religious, and social groups transmit fairly unchanged from
generation to generation.”
The literature also uses a concept called “Social Capital.” For our purpose, the
difference isn’t important. Both are informal whereas institutions are not.
55
Social Capital: “Definition”
Social capital: ”[the] combination of values (people feel a
moral duty to go and vote) and beliefs (people expect to be
ostracized by their community if they behave in an uncivic
way).”
For us the difference is not that important. But the idea is:
• social capital not necessarily linked to ethnic, religious,
and social groups.
• Individuals have less control over culture than other
social capital.
• Social capital could just be being part of a (business)
network.
56
Beliefs & Values; Examples
Value component: Second-generation immigrants have views on

redistribution similar to country of origin NOT of current country.
Why focus on second-generation immigrants?
Belief component: When preference for redistributions are affected by

political regime or macroeconomic developments.
Distinction more clear in theory than in practice.
In theory:
• Beliefs are shaped by experience and values are taken as given.
• This can lead to multiple equilibria.
• No trade ⇒ don’t learn you can trust ⇒ no trade.
• Trade ⇒ you do learn you can trust ⇒ trade.
57
Cultural Traits
1. Generalized Trust
• Generalized means also towards strangers.
2. Individualism versus Collectivism.
3. Family Ties.
4. Attitudes towards work and perception of poverty.
5. Religion.
See Alesina and Giuliano (2015) for a detailed discussion

and references for results given below.
58
Generalized Trust
Arrow (1972): “Virtually every commercial transaction has
within itself an element of trust, certainly any transaction
conducted over a period of time.”
• Measured through surveys and lab experiments.
• Positively correlated with age and education.*
• Quite persistent over people’s life.
• Lower in ethnically diverse cities.
• Historically discriminated-against minorities have less
trust.
* For example, see Algan and Cahuc (2014).

59
Generalized Trust
Alesina and Giuliano: Culture and Institutions 913
Panel A. Generalized trust
Trust
(0.4639733,1]
(0.3163583, 0.4639733]
(0.1946096, 0.3163583]
[0, 0.1946096]
No data
Panel B. Individualism
Source: Alesina and Giuliano (2015).
60
Generalized Trust
Countries in the top Countries in the bottom
Norway (best) Philippines
Sweden Liberia
Denmark Brazil
China Northern Cyprus
Saudi Arabia Rwanda
Vietnam Trinidad & Tobago (worst)
This is just a selection in the tail and not the top/bottom 7.
61
1. Norwegians just trust others more.
2. Norwegians interact with people who really are more
trustworthy.
62
!!! #1 and #2 could interact and causation could go both ways.
63
Individualism versus Collectivism
• Personal freedom ensured

⇒ Pro: Incentives for innovation,
⇒ Con: Pursue individual interests without
considering interest of others.
• Collectivism
⇒ Pro: Collective action easier,
⇒ Con: Innovation may be hampered.
64
Trust
(0.4639733,1]
(0.3163583, 0.4639733]
(0.1946096, 0.3163583]
[0, 0.1946096]
Individualism
No data
Panel B. Individualism
Individualism
(0.7294118,1]
(0.4411765, 0.7294118]
(0.1647059, 0.4411765]
[0, 0.1647059]
No data
Panel C. Family ties
65
Family Ties
• Regions with strong family ties:
⇒ Good conduct within the family,
⇒ Selfish behaviour outside the family more
acceptable.
• Shown to be important for
• Labour force participation of women and elderly,
• Political participation,
• Generalized trust,
• Household production,
• Geographical mobility. 66
Individualism
(0.7294118,1]
(0.4411765, 0.7294118]
(0.1647059, 0.4411765]
[0, 0.1647059]
No data Family Ties
Panel C. Family ties
Family ties
(0.8077196, 1]
(0.6565442, 0.8077196]
(0.4523764, 0.6565442]
[0, 0.4523764]
No data
Figure 1. Geographical Distribution of Cultural Values (Continued )
67
Family Ties
• Weak levels:
• Finland, Germany, Netherlands.
• Middle range:
• France, UK, US.
• More familistic:
• Italy, Brazil, Columbia, Peru.
• Very familistic:
• Guatemala, Venezuela; Egypt & Zimbabwe,
Indonesia, Vietnam & Philippines.
!!! This is about means. Within each country there can
be a considerable amount of variation.
68
Attitudes towards work & perception of poverty
Possible views:
• “The devil finds work for idle hands.” (Proverbs 16:27)

• Success depends on hard work vs success depends on
luck and personal connections.
• Being poor is the poor person’s own fault or bad luck.
69
Generalized morality
(0.4877727, 1]
(0.3426272, 0.4877727]
(0.2580903, 0.3426272]
[0.0476627, 0.2580903]
No data
Work-Luck Beliefs
Panel E. Work–luck beliefs
Work–luck
(0.5767357, 1]
(0.460053, 0.5767357]
(0.3106456, 0.460053]
[0, 0.3106456]
No data
Figure 1. Geographical Distribution of Cultural Values (Continued )
redistribution, the difference could be due links between parents and children. Indi-
to the vastly differing US and European wel- vidualism is particularly high in the United
fare systems
Source: (Alesina
Alesina andand Glaeser (2015).
Giuliano 2004). States, Australia, and Northern Europe.39
The Scandinavian countries exhibit the low- Within each country, there is often sub-
est measure of family ties while the measures stantial heterogeneity across regions. For
for African, Latin American, and some Asian instance, Guiso, Sapienza, and Zingales 70
countries are among the highest. Southern (2004), Tabellini (2010), and Alesina and
Luigi Guiso, Paola Sapienza and Luigi Zingales 41
Religion and Redistribution Preferences
Figure 4 US DATA
Religion and Preferences for Redistribution
Others 1.2%
Catholic !4.7%
Religion
Jewish !5.6%
Protestant !6.0%
!6.5% !5.5% !4.5% !3.5% !2.5% !1.5% !0.5% 0.5% 1.5%

As percentage of average effect
The patterns denote: Significant Not significant
Source:General Social Survey.
Note:The bars represent estimated effects of various religious affiliations on preference for redistribu-
• Religious people less keen for redistribution by government.

tion in percent of the average value of the dependent variable and relative to “no religious affiliation,”
the excluded group. Besides dummies for religious affiliation, the regression also included demographic
• Regression does also contain lots of controls.
controls (health, gender, age, education, and race).
• a Question: How to
more negative attitude compare
toward a large
redistribution than but
thoseinsignificant
with no religion, al-
though the coefficient on Jewish respondents is not statistically significant. Follow-
erscoefficient with
of other religions are a smaller
more in favorsignificant one?
of redistribution, albeit the effect is not
statistically different from zero. 71
Figure 5 repeats the same exercise, except, instead of using the dummy
It isn’t getting easier with culture
ECONOMIC DEVELOPMENT
INSTITUTIONS CULTURE
• And interaction may matter as well. That is effect of a culture trait

on economic development may depend on institutions in place.
• Alesina & Giuliano (2015): detailed overview on interplay of
institutions and culture.
• Guiso, Sapienza, and Zingales (2006): for further discussion of
relationship culture and economic development.
• Weil (2016, Ch 12): interplay institutions & economic
72
development.
Trust and Economic Development
73
Trust: “Definition”
Gambetta (2000):
“the subjective probability with which an agent assesses

that another agent or group of agents will perform a
particular action”
74
1 2 3 4
75
Source: https://ourworldindata.org/trust
76
77
78
79
80
81
WHY???
Why did interpersonal trust in the US go down?

1. Watching television/Netflix etc. increased.
2. People get married at a later age.
3. People have less children.
4. Per capita income has increased.
5. People are less religious.
82
What Determines Trust?
1. Historically-discriminated Þ less trust.
2. Trust lower in ethnically diverse environments.
3. Education is positively correlated with trust.
4. Climate/environment. If collaboration is necessary Þ
more trust (e.g. if farmers cultivate scattered plots
irrigated by communally maintained ditches).
5. Effects very persistent effects (i.e., many generations)
a. Italian cities that did or did not achieve a form of
participatory self-government.
b. Slave trade (which did at times include being sold into
slavery by inhabitants of the same region)
Þ less trust even in relatives.
• Nunn (2008) finds that a country’s current
economic performance is negatively affected by
number of slaves exported. 83
Does Culture Affect Economic Outcomes? 31
Role of Ethnic Background in US on Trust?
Figure 2
Effect of Ethnic Background on Trust Relative to those with UK background
Japan 24.7%
Norway, Finland, Sweden 20.7%
Ireland !3.0%
Germany, Switzerland, Austria, Netherlands !6.5%
China !6.6%
France and Belgium !6.6%
Ethnic background
Canada !7.2%
Romania, USSR, Yugoslavia !14.8%
Hungary, Lithuania, Poland !16.5%
Other Americans !23.4%
Italy, Spain, Portugal, Greece !25.0%
Native Americans !25.2%
Philippines and other Asians !25.3%
Mexico, Puerto Rico, West Indies !29.6%
Africa !38.5%
India !40.8%
Afro-Americans !47.1%
!55% !45% !35% !25% !15% !5% 5% 15% 25%
Trust as percentage of average trust
The patterns denote: Significant Not significant
Source:General Social Survey

Note: The bars represent the effect of different ethnic background on trust in percent of the sample
mean of trust and relative to “people with ancestors from Great Britain,” the excluded group. Effects are
obtained from a regression where the dependent variable is “trust in others,” which is a dummy variable
Source: Guiso, Sapienza, Zingales (2006). These are regressions coefficients.
equal to one if the respondent answered that most people can be trusted. Besides the ethnic origin
84
Regression also includes religion and demographic controls.
dummies, the regression also includes demographic controls (health, gender, age, education, race), and
religious affiliations (the omitted category is no religion and atheists). To identify the origin of the
32 Journal of Economic Perspectives
Trust is persistent
Figure 3
Correlation between Trust of Country of Origin and Trust of Immigrants Relative
to Great Britain
0.20
Trust of immigrants in United States relative to British
0.15
Norway, Finland,
immigrants in the United States
0.10 Sweden
0.05
France, Belgium Japan Ireland Canada China
0.00
!0.40 !0.30 !0.20 !0.10 0.00 0.10 0.20 0.30 0.40
Germany, Switzerland,
Romania, USSR,
Austria, Netherlands
!0.05
Yugoslavia
Philippines, Hungary, Lithuania,
other Asians Poland
!0.10
Italy, Spain,
Mexico, Puerto Rico, Portugal, Greece
W. Indies
!0.15
Africa
India
!0.20
!0.25
Trust of nationals in country of origin relative to trust level of British nationals
Source: World Values Survey, General Social Survey.
Note: On the horizontal axis we report the difference between the average trust of each group of
Source: Guiso,
countries in FigureSapienza, Zingales
2 and the average (2006).
trust of Great Britain, computed using data from the World Value
85
Survey. On the vertical axis we report the estimated effect of each ethnic group on trust, as reported in
Figure 2.
What Does Trust Affect?
1. Economic development
• Algan and Cahuc (2014) argue one-fifth of cross-
sectional difference in pc income is related to trust.
2. Individual performance/becoming an entrepreneur
3. Innovation.
4. Financial development.
5. Participation in the stock market.
6. Trade.
7. Firm organisation/productivity.
86
87
90
Trust and Economic Outcomes Yann Algan and Pierre Cahuc
Figure 2.10 Financial development and generalized trust in 88 countries. Sources: Financial develop-
ment: Private credit by deposit banks and other financial institutions as a percentage of GDP, obtained
from the World Bank Indicators (1980–2010). Generalized Trust is taken from the World Values Survey
(1981–2008).
Source: Algan and Cahuc (2014).

88
As well as the composition of assets and volume of credit, trust can influence the
92 Trust and Economic Outcomes Yann Algan and Pierre Cahuc
Figure 2.11a Total factor productivity and generalized trust in 62 countries. Sources: Total Factor Pro-
ductivity is taken from Hall and Jones (1999). Trust is measured from the World Values Survey (1981–2008).

89
ductivity is taken from Hall and Jones (1999). Trust is measured from the World Values Survey (1981–2008).
Trust and Economic Outcomes
Figure 2.11b R&D expenses and generalized trust. Sources: R&D expenses as a percentage of GDP over
the period 1980–2010 are taken from the World Bank Development Indicators. Trust is measured from the
World Values Survey (1981–2008).

90
Trust, Growth, and Well-Being: New Evidence and Policy Implications 93
Figure 2.11c Cross US states correlation between R&D ((ln)-number of patents over the period
1980–2010) and generalized trust (1976–2008). Sources: Income data is taken from the US Census
Bureau and averaged for the years 1972–2011. The proportion of people that trust is taken from the
General Social Survey (1973–2006). The trust measure is computed as the state average from responses
to the question “Generally speaking, would you say that most people can be trusted or that you need to
be very careful in dealing with people?” Trust is equal to 1 if the respondent answers “Most people can be
trusted” and 0 otherwise.
the ones with elevated R&D,in point of fact,the Anglophone and Nordic countries.Trust
Source:
onAlgan
its own and Cahuc
explains more (2014).
than a third (37%) of the dispersion of rates of expenditure on
R&D across countries.This relationship remains statistically significant at the 5% level after 91
controlling for initial income per capita, population density, and education. Figure 2.11c
the firm size distribution away from the smallest units toward firms in higher size classes.

Their estimated relationships are not only statistically significant but also economically
meaningful when compared to such other determinants of industry specialization and
Figure 2.12 Cross-country correlation between decentralization of firms and trust. Sources: Firm decen-
tralization is measured by the following question from the Global Competitiveness Report 2009 (GCR):
“In your country, how do you assess the willingness to delegate authority to subordinates?” Answers
range from “1 = low: top management controls all important decisions, ” to “7 = high: authority is mostly
delegated to business unit heads and other lower-level managers.” Generalized trust is measured as the
country average from WVS 1981–2009.

92
Trust, Growth, and Well-Being: New Evidence and Policy Implications 95
Figure 2.13 Product market regulation and trust in 73 countries. Sources: Product market regulation
is measured as the (ln)-number of steps for opening a business, taken from the World Bank (2009).
Generalized trust is measured as the country average from WVS 1981–2009.
firm organization as human capital, physical capital, or judicial quality. For example, they
imply that increasing trust by an amount corresponding to the inter-quartile range of
its distribution across Italian regions would raise value added in a delegation-intensive 93
industry (such as manufacture of machinery and equipment) relative to a less intensive
100
Trust and Institutions Yann Algan and Pierre Cahuc
Figure 2.14 Quality of the legal system and trust in 100 countries. Sources: The Quality of the Legal
System is taken from the Economic Freedom of the World Index (2007). Generalized trust is measured as
the country average from WVS (1981–2009) and EVS (1981–2008).

94
the country average from WVS (1981–2009) and EVS (1981–2008).
Trust and Institutions
Figure 2.15 Quality of governance and generalized trust in 163 European regions. Sources: The Quality
of Governance is taken from the Quality of Government Index (2010). Generalized trust is measured as the
country average from the WVS (1981–2009) and EVS (1981–2008).

95
Trust & Economic Theory
Kazu and Martha are engaged in a joint project.
Payoffs
Kazu gets Martha Gets

Both cooperate 100 100
Kazu cheats, Martha cooperates 150 0
Kazu cooperates, Martha cheats 0 150
Both cheat 40 40
96
Trust & Economic Theory
Payoff Martha/Payoff Kazu
Kazu cooperates Kazu cheats
Martha cooperates 100,100 0,150

Martha cheats 150,0 40,40
• Junyi is a potential trading partner next period.

• Junyi is watching?
• Junyi will not deal with cheaters.
• How does that affect strategies.
• And after next period there are even more periods
opportunities.
97
What
about
Africa?
98
Some Obvious Challenges
Are part of the story
• Climate
• Only 7% of Sub-Saharan Africa is NOT tropical and are
those are the richer regions.
• Lower quality soil.
• Natural environment (ecology). Remember Jared Diamond.
• Diseases: Ebola, Malaria, & AIDS.

• Landlocked. Many countries far away from the sea.
• Artificial borders ⇒ ethno-linguistic diversity ⇒
higher chance of civil war.
99
Africa & Couple Misperceptions
• African people and its countries were not backward, not

isolated, and not stagnant before colonisation/slavery.
• They actively contributed and were part of the
development of technology and interacted with the rest of
the world.
• Check out:
• https://www.ferris.edu/HTMLS/news/jimcrow/timeline/
africa_before.htm.
• https://www.wheelerafricacourse.org/_files/ugd/1833dd
_a278784c12c04574a1ab4b1a5dcc591f.pdf .
100
Africa & Institutions
• Key points of next couple slides:

• Institutions in Africa not that great.
• At least in part because of changes made during
colonial era because then institutional changes
were made (e.g., autocratic government) and
cultural traits affected (e.g., slavery) and both
can be very persistent.
• Two case studies:
• Botswana, an African success story.
• Sierra Leone, a country with very low growth.
101
Africa & Institutions
• Key points of next couple slides:

• Institutions in Africa not that great.
• Colonial powers are at least in part to blame (recall
that institutions/culture are very persistent).
• Two case studies:*
• Botswana, an African success story.
• Sierra Leone, a country with low growth
* This material is based on lectures by Elias Papaioannou as well as

Acemoglu, Johnson, and Robinson (2003) and Acemoglu, Reed, and
Robinson (2014). 102
How Colonial Powers Ruled
• Oppression with direct rule.
• India.
• Indirect rule using natives.

• Using pre-existing political structures and chief (Nigeria,
Botswana/India).
• Appointing new chiefs or giving ruling families more power
(e.g., Sierra Leone).
• Appointing chiefs from other ethnic groups or regions (e.g.,
Senegal)
• Private Concession companies.

• Belgian Congo, Rhodesia, Liberia.
103
Extractive Aspects of Colonial Rule
• Labour arrangements.
• Slavery
• Forced labour.
• Serfdom.
• High taxation.
• Peasant economy with monopsonists
• Goods produced could only be bought by private
companies or administration at fixed prices.
• Large plantations.
104
Story Summarized
• Research indicates institutions/culture persists.

• Survives (in part) civil war, regime changes, time.
• Institutions varied in how extractive they were installed by

colonial powers.
• Different degrees of extractive nature still observed today.
• And impact on economic development also persists.
105
Africa: Variation in Extractive Nature
• Closer to Europe ⇒ typically more extractive.

• Milder climate ⇒ typically more extractive.
• High urbanization ⇒ typically more extractive.
(less urbanization ⇒ Europeans moved in themselves)
106
Botswana - A Success Story
Important source: Acemoglu, Johnson, and Robinson (2003)

107
Botswana. An African Success Story
An Illustrative Case
And the winner is …
Some slowdown in the last decade though.

108
Botswana: Cons & Pros
• Landlocked.
• No conflict since independence (1966).
• Democratic since independence.
• Natural resources (diamonds) have been used
efficiently and has been a plus which is unusual.
109
Why Are Natural Resources Problematic?
• Dutch disease.
• Civil war.
• Corruption.
• Wars with neighbouring countries.
• Autocratic regimes become even more autocratic.
Source: Caselli and Tesei (2016).
110
Why Are Natural Resources Problematic?
• Dutch disease.
• Natural resources ⇒ exchange rate ↑ ⇒ bad for export of
other goods.
• Civil war.
• Corruption.
• Wars with neighbouring countries.
• Autocratic regimes become even more autocratic.
Source: Caselli and Tesei (2016).

111
Before and During Colonization
• Precolonial Political Institutions in Tswana Kingdom

• Kgotla assembly of adult males debating politics.
• Centralized.
• Checks and balances on chiefs, dispersed political power.
• Private ownership of cattle (public ownership of land).
• Colonization light.
• 1895: Three Tswana chiefs (Dikgosi) travelled to Britain to
plea with Queen Victoria to ask that Cecil Rodes would not
control the protectorate as he did in Rhodesia (now
Zimbabwe).
• Tswana chiefs (with legitimacy) and institutions (debate
and representation) persisted.
112
Tswana Chiefs in London
Tswana Chiefs inAnLondon 1895
Illustrative Case
↑ Chiefs Khama, Sebele and Bathoen with

Reverent W.C. Willoughby of the London
Missionary Society.
The three Dikgosi monument at Gaborone, →

Botswana.
113
Why Colonization Light ?
• Landlocked.
• British were not really interested except using
Botswana as a labour reserve for South Africa
(even seat of government was in South Africa).
114
Why Success Story?
• Pre-colonial institutions good.

• Not changed much during colonial era.
• Good institutions after independence.
!!! And yes this is very simplified.
115
Sierra Leone – Not a Success Story
Important source: Acemoglu, Reed, and Robinson (2014).

116
Sierra Leone: Pros and Cons
• On the Ocean.
• Close to Europe and Americas.
• Virtually no growth since independence (1961).
• History of slave trade.
• Decades-long civil conflicts.
• Politically unstable.
• Blood diamonds.
117
Before and During Colonization
• Before Colonization
• More localized rule by local families.
• During Colonization.
• Indirect rule using local chiefs.
• Gave the local chiefs more power. No accountability
except to British.
• Big difference in number of chiefs across regions
(inherited from history).
118
At the Start of Colonization
338 journal
119
chiefs and civil society in sierra leone 343
Persistence
F IG . 2.—Number of ruling families and the Herfindahl index of the concentration of

power. The fitted curve corresponds to the model in column 3 of table 2, which includes
the log number of ruling families and controls for district effects, the number of seats
observed, and an amalgamation dummy.
• y-axis: current concentration of power

that the causes of differing numbers of families were largely idiosyn -
(higher
cratic, number
we now investigate meansmore
this possibility more concentration)
systematically. Table 3 pre-
sents regressions of the form
• x-axis: y 5 d historic
c 1 a ! F 1 g concentration
d fam ! N 1 g ! Amalgamation
c n c a
of1power
ε; c
ð2Þ c
(less chiefs more concentration)

where y is the dependent variable of interest. Specifications include our
c
120
baseline controls for amalgamation and the number of ruling families
Persistence
chiefs and civil society in sierra leone 353
TABLE 6
Economic Outcomes, Results
Dependent Variable Current LHS
Nonagricultural Housing variable
Historical RHS Employment Asset Wealth Asset Wealth
Census
Quality
Index DHS Index NPS Index NPS
variable ð1Þ ð2Þ ð3Þ ð4Þ
A. Baseline Specification
lnðnumber of ruling familiesÞ .016 .260 .028 .058
ð.008Þ ð.136Þ ð.010Þ ð.023Þ
x2 test p -value ½.068$ ½.011$
R2 .051 .057 .063 .094
B. Baseline Specification with Additional
Geographic Controls
lnðnumber of ruling familiesÞ .012 .199 .025 .038
ð.006Þ ð.131Þ ð.010Þ ð.020Þ
x2 test p -value ½.067$ ½.026$
R2 .052 .080 .066 .105
Observations 2,790,000 4,994 5,054 5,077
Chiefdoms 149 117 149 149
District fixed effects Yes Yes Yes Yes
Demographic controls Yes Yes Yes Yes
Note.—Standard errors ðin parenthesesÞ are robust to heteroskedasticity and are clus-
tered at the chiefdom level. All specifications include number of chiefs recalled and an
*amalgamation
Source: Acemoglu,
dummy.Reed, and Robinson
Demographic (2014).
controls are age, age squared, and gender and eth- 121
nicity dummies. The specifications in panel B, in addition, include six geographic controls:
Why NOT a Success Story?
• Pre-colonial institutions already not that great.

• Institutions made worse during colonial era.
• Slavery worsened cultural traits.
• Bad institutions after independence.
!!! And yes this is very simplified.
122
Key Lessons
• There is a lot more to economic development than investing in
physical capital and acquiring knowledge in a frictionless
world.
• Institutions and cultural traits matter.
• Institutions and cultural traits persist and so does their impact.
• Lots of interaction and reverse causation.
• But careful empirical work exists using exogenous events and
instrumental variables.
• And yes it is at times a bit fuzzy.
123
Additional Resources
• Acemoglu, D., J.A. Robinson, and Simon Johnson, 2005, Institutions as a
fundamental cause of long-run growth. Handbook of Economic Growth, pp. 386-
472. Available here. (This contains a description of the 2002 paper).
• Alesina, A. and P. Giuliano, 2015, Culture and Institutions, Journal of Economic
Literature 53, pp. 898-944.
• Algan, Y., and P. Cahuc, 2014, Trust, Growth, and Well-Being: New Evidence
and Policy Implications, Handbook of Economic Growth. (Sections 1, 2.4, 2.5.1
& 2.6.1)
• Easterly, W., 2002, The Elusive Quest for Growth, chapters 11 & 12.
• La Porta, R., Florence Lopez-de-Silanes and Andrei Shleifer, 2008, Journal of
Economic Literature 46, pp. 285-332.
124
References
• Acemoglu, D., S. Johnson, and J.A. Robinson, 2002, Reversal of fortune: Geography and
institutions making of the modern world income distribution, Quarterly Journal of Economics
118, 1231-1294.
• Acemoglu, D., S. Johnson, and J.A. Robinson, 2003, An African Success Story. In Search of
Prosperity: Analytic Narratives on Economic Growth, edited by D. Rodrik, pp. 80-119.
Princeton University Press.
• Acemoglu, D. T. Reed, and J.A. Robinson, 2014, Chiefs: Economic Development and Elite
Control of Civil Society in Sierra Leone, Journal of Political Economy 122, pp. 319-368.
• Arrow, K.J., 1972, Gifts and Exchanges, Philosophy and Public Affairs 1, pp. 343-362.
• Caselli, F., and A. Tesei, 2016, Resource Windfalls, Political Regime, and Political Stability,
Review of Economics and Statistics 98, pp. 573-590.
• Gambetta, D., 2000. Can We Trust Trust?, in Trust: Making and Breaking Cooperative
Relations. Gambetta, Diego, ed. Oxford: Blackwell, pp. 213–237.
• Nunn, N. 2008, The Long Term Effects of Africa’s Slave Trades, Quarterly Journal of
Economics 123, pp. 139-176.
• Guiso, L. P. Sapienza, and L. Zingales, 2006, Does culture affect economic outcomes, Journal
of Economic Perspectives.
• Linares Quintana, 1949, Comparison of the Constitutional Basis of the United States and
Argentine Political Systems, University of Pennsylvania Law Review, pp. 641-664.
125

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EC2B1: MACROECONOMICS

Wouter Den Haan

• Weil – Chapter 12 (book has a different structure than the

• Guiso, L., P. Sapienza, and L. Zingales, 2006, Does

!!!! You do not have to remember details. Focus on main

1. Introduction and motivation.

Big Theme: Filling the gap between real world

1. Faculty who are better in research.

3. More contact time with faculty/teachers.

4. Better transparency of the rules; less uncertainty.

6. More respect for each other.

7. Trusting each other more (e.g. in deferral requests).

8. Students having more input in decision making.

1. Solow (1956): Growth through capital accumulation (savings

2. Romer (1990): Growth through endogenous technological

• Role of institutions is brought into the analysis.

• Economics comes from the Greek word Oikonomos

2010 2015 2020

2010 2015 2020

* Scores exceed standard minimum

2010 2015 2020

2010 2015 2020

* Scores exceed standard minimum

2010 2015 2020

2010 2015 2020

* Scores exceed standard minimum

Assignment challenges you to think how these are

Against: Government may be inefficient/corrupt.

Log of real GDP per capita in 1995

ree of corruption, political rights, public

further details on these indicators.) The Aggregate governance measure1

ions of the political, economic, and pol-

• Economic growth is likely to affect institutions.

GDP per capita

Figure 3. GDP per capita in North and South Korea, 195CL98.

Acemoglu, Johnson, and Robinson (2002)

• Thus, institution imposed centuries ago are not caused

Source: Acemoglu, Johnson, Robinson (2005) 39

Source: Acemoglu, Johnson, Robinson (2005) 40

Impact of institutions must be

La Porta, Lopez-de-Silanes and Andrei Shleifer (2008)

Figure 1. The Distribution of Legal Origin

The civil law tradition is the oldest, the 44

Notes: a Significant at the 1 percent level.

Institutions on Financial Development.

Anti-self-dealing 0.8940b 0.8004e -0.1277e'

Notes: a Significant at the 1 percent level.

• Clearly: Economic Growth ⇒ institutions ↑.

Culture: “Those customary beliefs and values that ethnic,

Value component: Second-generation immigrants have views on

Belief component: When preference for redistributions are affected by

Distinction more clear in theory than in practice.

See Alesina and Giuliano (2015) for a detailed discussion

* For example, see Algan and Cahuc (2014).

Panel A. Generalized trust

Source: Alesina and Giuliano (2015).

This is just a selection in the tail and not the top/bottom 7.

• Personal freedom ensured

Panel C. Family ties