ECON 450 Development Economics Long-Run Causes of Comparative Economic Development and University of Illinois at Urbana-Champaign Summer 2017
Outline 1 Introduction 2 3 4
Introduction The most crucial question in the field of economic growth and development is: Why are some countries much poorer than others? Traditional Neoclassical Economic Growth models explain the proximate causes of comparative development: different paths of factor accumulation. In these models, cross-country differences in factor accumulation are due to: saving rates or other exogenous parameters.
Introduction In this lecture, we try to provide a fundamental explanation for economic growth. In other words, what are the long-run causes of comparative development?
Introduction As we will see, there is no agreement on one single factor explaining differences in development levels. Research on this important subject is still at a relatively early stage, and new findings are being reported regularly.
Three Fundamental Causes Since neoclassical theory can only provide proximate causes of comparative development, what types of explanations would constitute fundamental ones? There are three main set of theories that are commonly accepted: Institutions But before this, let s discuss some important statistical concepts to better understand the paper we ll address next class!
Outline 1 Introduction 2 3 4
Instrumental Variables and Endogeneity In many economic situations we are interested in finding a causal relationship such as y = α + β 1 X 1 + β 2 X 2 +... + β p X p + ɛ Using OLS to estimate this equation assumes that this is the TRUE causal relationship.
Instrumental Variables and Endogeneity However, this assumption may be violated in several different contexts. For example, suppose y is wage, X 1 is education and the remaining X s are other observable variables that affect y. OLS estimates would not capture the true causal effect since X 1 is correlated with the unobservable ability, which might affect y as well. Therefore, the estimated β would not reflect the isolated effect of education on wages. This is what we call the omitted variable bias.
Instrumental Variables and Endogeneity In other situations, the causality effect might be running in the opposite direction. That is, y could be determining X 1. For example, what is the effect of health on income? Is the relationship in only one direction? This is what we call the reverse causality problem.
Instrumental Variables and Endogeneity Finally, in other situations the variables may be recorded with some measurement error. For example, suppose X 1 is income and the data is self-reported. Do we really know our current income? Or, do we really want to provide this information to some stranger? This is what we call the measurement error bias.
Instrumental Variables and Endogeneity In all these three situations, we have the endogeneity issue. That is, the true relationship between X 1 and y is not what we assumed to be. Therefore, the coefficient of interest β 1 will be wrongly estimated.
Instrumental Variables and Endogeneity What to do to remedy this problem? That is, how can we estimate β 1 better than by OLS? One of the answers to this question is: by the Instrumental Variables approach.
Instrumental Variables and Endogeneity The idea of this approach is quite simple. Suppose we are trying to estimate the relationship y = α + β 1 X 1 + β 2 X 2 +... + β p X p + ɛ where β 1 is the coefficient of interest. The other variables X 2,..., X p are called control variables. The only reason they are in the model is to control for their effects on y. We are not directly interested in their relationship.
Instrumental Variables and Endogeneity Suppose we know X 1 is endogenous. That is, we know that OLS estimates would give us biased β 1. We would need to find a variable Z, an "instrument", satisfying the following conditions: 1 Z is correlated with X 1 ; 2 The only way Z affects y is through its effect on X 1.
Instrumental Variables and Endogeneity We then estimate the equation X 1 = γ + ηz + β 2 X 2 +... + β p X p + ε and obtain the predicted values of X 1. Next, we use these predicted values as regressors in the equation of interest y = α + β 1 ˆX1 + β 2 X 2 +... + β p X p + ɛ
Instrumental Variables and Endogeneity In this situation, we use the strictly exogenous variation in X 1 as independent variable and the coefficient β 1 is no longer biased. This estimation procedure is called "Two-Stage Least Squares (2SLS)", where the first stage is estimating X 1 as a function of y and the second stage is the estimation of y.
Outline 1 Introduction 2 3 4
There are two main versions of the " Hypothesis", each emphasizing a different mechanism for how geography affects prosperity.
First, climate may be an important determinant of work effort, incentives, and productivity. According to French philosopher Montesquieu in his famous book "The Spirit of the Laws":
"The heat of the climate can be so excessive that the body there will be absolutely without strength. So, prostration will pass even to the spirit; no curiosity, no noble enterprise, no generous sentiment; inclinations will all be passive there; laziness there will be happiness," and "People are... more vigorous in cold climates. The inhabitants of warm countries are, like old men, timorous; the people in cold countries are, like young men, brave."
More recent views of this theory add two main components to the discussion, other than the direct effect of climate conditions: First, tropical diseases, particularly malaria, have very adverse consequences for health and therefore labor productivity. Second, tropical soils do not allow for productive agriculture. The conclusion is that temperate climates have a relative advantage over tropical and semitropical areas.
The second version and the most commonly supported by the " hypothesis" advocates is that geography may determine the technology available to a society, especially in agriculture. The most prominent scholar supporting this theory is the ecologist and evolutionary biologist Jared Diamond.
Diamond s Hypothesis
Diamond s Hypothesis According to Diamond, the origins of intercontinental inequality at the start of the modern period rested in different historical endowments of plants and animal species, which subsequently influenced agricultural productivity. The timing of the transition from hunter-gatherer of different societies is determined by this availability of species capable of being domesticated. According to Diamond, civilizations of the Eurasian continent encountered a greater number of different species of animals and plants than in the Americas, for instance.
Diamond s Hypothesis As a consequence, farming developed earlier in Europe. Population density grew, allowing specialization of labor, trade, urbanization, and political development. But why did the Eurasian continent have so much more diversity in terms of environment?
Diamond s Hypothesis The answer lies on the format of the continents. Eurasia s main axis is East-West. Species of plants and animals can spread more easily to other areas in the continent without substantial climate variations. The Americas and Africa, by their turn, are on a North-South axis. In this case, the spread of different species through different areas of the continent are harder, since several species cannot survive in different environments.
Diamond s Hypothesis
Diamond s Hypothesis In conclusion, in places where farming dominated, technological innovation took place much more rapidly than in other parts of the world. Thus, the differential availability of animal and plant species created differential intensities of farming, which led to different paths of technological change and prosperity across different continents.
Diamond s Hypothesis In general terms, Diamond addresses the question: Why did the Europeans colonized the America and not the opposite? The schematic diagram next presents the summary of the argument.
Diamond s Hypothesis
Diamond s Hypothesis What about income differences today? Diamond s hypothesis does not explain why France and China are so much different nowadays. The former is richer than the latter despite the fact that both share the same geographic factors exposed by Diamond. This hypothesis cannot alone be used to explain today income differences. We ll discuss the culture hypothesis next. The institutions hypothesis is the theme of the next class.
Outline 1 Introduction 2 3 4
is viewed as a key determinant of the values, preferences and beliefs of individuals and societies. The culture explanation for long-run comparative development emphasizes the idea that different societies have different cultures, because of different shared experiences or different religions. According to this theory, these differences play a key role in shaping economic performance.
The "father" of the culture hypothesis is the German sociologist Max Weber. He argued that the Protestant Reformation and the Protestant ethic, which advocates hard work and acquisition of wealth, has facilitated the rise of modern industrial society in Western Europe. "...Unwillingness to work is symptomatic of the lack of grace"
Thus Protestantism led to a set of beliefs which emphasized hard work, thrift, saving, and where economic success was interpreted as consistent with (if not actually signaling) being chosen by God. Weber contrasted these characteristics of Protestantism with those of other religions, such as Catholicism, which he argued did not promote capitalism. For instance on his book on Indian religion he argued that the caste system blocked capitalist development.
Ideas about how culture may influence growth are not restricted to the role of religion Within the literature trying to explain comparative development there have been arguments that there is something special about particular cultural endowments, usually linked to particular nation states. For instance, Latin America may be poor because of its Iberian heritage, while North America is prosperous because of its Anglo-Saxon heritage.
More Examples Poverty of Southern Italy is believed to be due to the fact that people had adopted a culture of "amoral familiarism" where they only trusted individuals of their own families and refused to cooperate or trust anyone else.
More Examples
More Examples
More Examples In German business culture, when an employee is at work, they should not be doing anything other than their work. Facebook, office gossip with co-workers, trolling Reddit for hours, and pulling up a fake spreadsheet when your boss walks by are socially unacceptable behaviors. When a German is at work, they are focused and diligent, which in turn leads to higher productivity in a shorter period of time.
...Whereas in Brazil...
...Whereas in Brazil... " The moment you land in Brazil you start wasting time, laments Mr Watkins, who moved to the country three years ago after selling a fast-food business in New York. To be sure of having at least ten temporary workers at Lollapalooza (festival), he hired 20 (sure enough, only half of them turned up)."
...Whereas in Brazil... "Lu Bonometti, who opened a cookie shop 18 months ago in a posh neighbourhood of São Paulo, has commissioned four different firms to fix her shop sign. None has come." "Few cultures offer a better recipe for enjoying life. But the notion of opportunity cost seems lost on most Brazilians."
So, do differences is culture cause long-run differences in income per capita? According to Acemoglu, Johnson and Robinson (AJR) s view, evidences suggesting the correlation cannot be regarded as a causal effect. They argue that differences in beliefs, cultural attitudes, and values are not a cause but a consequence of different institutions and institutional histories.