1. Guido Tabellini (IGIER,Bocconi University) April 2007
Culture and institutions: economic development in the regions of Europe
Guido Tabellini
(IGIER,Bocconi University)
April 2007

2. Abstract Does culture have a causal effect on economic development?
Culture is measured by indictors of individual values and beliefs, such as trust and respect with others and confidence in individual self determination
Two historical measures: literacy rate at the end of 19th century and political institutions in place over past several centuries

3. Introduction
Since the seminal work of economic historians like North(1981), it has become almost commonplace to view history as main determinant of current economic development
A widespread interpretation is that history shapes current economic performance through “institutions”
The fact that same institutions function so differently in different environments suggests that informal institutions play an important role

4. Culture Like institutions, it is a vague concept
Specific indicators of culture, that can be interpreted either as social norms or as individual values, are correlated both with historical patterns and with current economic development

5. Introduction
Previous research schematically shows: Historical institutions => Contemporary institutions => Economic Development
This paper instead uses within country variation at the regional level to explore:
Historical Institutions => Culture => Economic Development

6. How does Tabellini measure culture?
By aggregating at the regional level individual responses collected in opinion polls of World Value Surveys in the 1990s
Specific indicators of values and beliefs: trust, respect for others, confidence between individual effort and success
After controlling for country fixed effects, regional education and urbanization rates, it’s related with two historical variables: regional literacy rates and indicators of political institutions in the period from to 1850

7. Related Literature
Greif (1994) – emphasizes the interaction between culture and institutions, he points out how the different cultures of Maghribi and Genoese traders in the late medieval period led them to develop different institutions
Glaeser et al. (2004) – effect of history on current economic development reflects the accumulation of human capital which influences institutional outcomes

8. Related Literature More related to this study are:
Barro and McCleary(2003) provide evidence that religious beliefs are correlated with economic growth in a sample of countries
Guiso, Sapienza and Zingales(2004) study the effect of social capital on individual financial habits
Spolaore and Wacziarg(2005) find that income differences between countries are positively correlated with genetic and geographic distance, and interpret this evidence as suggestive of cultural barriers to the diffusion of innovations across countries

9. Data on Output, Education, Urbanization and Culture
Sample consists of 69 regions in 8 European countries: France, Germany, UK, Italy, Netherlands, Belgium, Spain and Portugal
Per Capita Output: Current economic development is measured by per capita gross value added (GVA) in international prices, focused on after 1990 period where culture measure is available. Variable, yp9500 is dependent variable in analysis

11. Education
The goal is the study the direct link between culture and economic development, so Tabellini wants to avoid using culture just as a proxy for human capital in the region. Thus, always controls for regional differences in education of adult population measured by enrolment in primary and secondary schools in percent of the population of relevant age group
This variable is called school

12. Urbanization in 1850
As a proxy for regional economic development in previous centuries, past urbanization rates are used
To measure it variable urb_rate1850 is constructed, defined as fraction of regional population that lived in cities with more than individuals around 1850

13. Culture
World Value Surveys are designed to measure a variety of cultural traits. Four cultural traits: 1) mutual trust and 2) respect for others. These encourage welfare enhancing social interactions. 3 and 4) confidence in virtues of individualism. Symptomatic of an entrepreneurial environment where individuals seek to take advantage of economic opportunities

14. Trust
Considered the following question in the survey: “ Generally speaking, would you say that most people can be trusted or that you can’t be too careful in dealing with people?”
The level of trust in each region is measured by the percentage of respondents who answer that “Most people can be trusted” (the other possible answers are “Can’t be too careful” and “Don’t know”). This variable is called trust

15. Respect and Obedience
“Here is a list of qualities that children can be encouraged to learn at home. Which, if any, do you consider to be especially important? Please choose up to five”. The variable respect is defined as the percentage of respondents in each region that has mentioned the quality “tolerance and respect for other people” as being important
Lack of trust and lack of respect for others are typical of hierarchical societies, where the individual is regarded as responding to instinct rather than reason, and where instinct often leads to a myopic or harmful course of action
The variable obedience is defined as the percentage of respondents that mention “obedience” as an important quality that children should be encouraged to learn

16. Control
To measure this cultural trait we construct a variable, called control, from the following question in the survey: “ Some people feel they have completely free choice and control over their lives, while other people feel that what we do has no real effect on what happens to them. Please use this scale (from 1 to 10) where 1 means “none at all” and 10 means “a great deal” to indicate how much freedom of choice and control in life you have over the way your life turns out”. The variable control is defined as the unconditional average response in each region (multiplied by 10)

17. pc_culture
Thus have four related but distinct measures of culture: three indicators expected to promote economic development (trust, control, respect), and one that might hurt it (obedience)
pc_culture, is a summary measure of these cultural beliefs
Since this principal component is negatively correlated with obedience, while it is positively correlated with trust, control and respect, we take it to be a net measure of the aspects of regional culture that favour economic development

18. Other summary measures of culture
To facilitate the interpretation, we have also extracted the first principal component from the positive beliefs only (trust, control and respect), called pc_culture_pos, as well as the first principal component from the two questions on the desirable qualities of children (obedience and respect), called pc_children. Since this variable is positively correlated with respect and negatively correlated with obedience, it is once more a net measure of the aspects of norms that favour economic development
Finally, since the principal component only captures the variation that is common to all beliefs, while these norms could have more than one relevant dimension of variation, I have also computed an alternative summary measure called sum_culture, defined as the sum of the three positive beliefs (trust, control, respect) minus the negative belief (obedience)

24. Output and Culture
Some of the correlation between per capita output and culture apparent from Figures 1 and 2 can simply reflect the influence of other common determinants, such as education, historical levels of economic development or national institutions
To remove the effect of these other variables, we have regressed per capita output (yp9500) on a set of dummy variables (one per country), school enrolment in (school), urbanization rates in (urb_rate1850) and the various measures of culture

27. Output and Culture
Naturally, we cannot safely assume that culture is independent of current levels of economic development. On the contrary, all our variables measuring culture are likely to be influenced by the current economic situation. Controlling for current education in each region (the variable school) and for past economic development as measured by past urbanization rates (the variable urb_rate1850) removes some of this correlation
Nevertheless, reverse causation remains a fundamental concern. Hence, the estimated coefficients reported in Table 3 could be biased and cannot be interpreted as reflecting a causal effect of culture on output. To cope with this problem, in the remainder of the paper we rely on instrumental variable estimation, using other historical variables as instruments for culture

28. Indicators of Culture
How do these cultural indicators relate to the measures of institutions widely used in existing cross-country analysis? And do they explain cross country differences in per- capita income?
A recent wave of the World Value surveys, conducted in and covering a larger sample 15 of countries, is made available. From this third wave, Tabellini constructed the same indicators of culture at the country (rather than regional) level, for almost 50 countries

30. Indicators of Culture
Even without suggesting a causal interpretation, these regressions are nevertheless remarkable. They show that these cultural indicators are meaningful, and highly correlated with variables that have attracted so much interest in the recent analysis of cross country differences in economic development
But separating the effect of culture from that of institutions is more credibly done in the sample of European regions, where one can control for common political and economic institutions at the national level, and where unobserved heterogeneity is less problematic. This will be the focus of remainder

31. Identification of the model
Y = regional per capita output
C = culture
Yo = urbanization in 1850
X = school enrollment in 1960 and institutions
e = error term
Problem: C and e are likely to be correlated!

32. Possible solution: instruments
Cov(z,x) ≠ 0
Cov(z,e) = 0
Cov(z,y) = 0

33. Culture can be viewed as shaped also by cultural features of earlier generations, denoted by Co
Co is reasonably excluded from (1), but unfortunately we don’t observe it
Yet, we can apply the same logic to Co , which refers to past social interactions and hence is influenced by historical features

34. λi = parameters
Xo = literacy rate around 1880 and constraints on the executives in
v = error term
The instruments we use isolate the variation in culture that is exogenous, from the possibly endogenous variation in culture due to v. Now δ only exploits this exogenous variation in culture

35. The issue has now been shifted away from whether culture is endogenous to whether our historical variables are valid instruments
Our estimation strategy rests on two premises
History shapes culture
Literacy and institutions are assumed as valid (rather strong assumption)

36. IDENTIFICATION of ESTIMATION and HISTORICAL DATA
Instruments are very important for understanding the economic models.They help us to learn the current economic situation of a country. Literacy and institution are most importants according to Tabellini

37. Literacy In 1880
To capture regional differences in educational histories, Tabellini collected data on the literacy rate around 1880 by region
Literacy changes from region to region.Except Netherlands and Portugal because Tabellini only found national data of these two countries

39. Early Political Institutions
If we look to institutions of countries, we can see differences because of “Constraints of Execuive”. Constraints of Executive means democracy. Without it a country will be dictatorship
In table 6 we see data about years 1600s, 1700s, 1750, 1800 and 1850

43. The Effect of Culture on Output

47. HOW CREDIBLE IS THE IDENTIFICATION?
Past literacy rates could be linked with current per capita output, if for instance regions mostly illiterate specialised in agricolture
The over-identified model with the two historical variables and the orthogonality test could not be sufficient
Instruments can have a direct effect on current development through omitted variables (like capital stock)

48. Controlling for the sectoral composition of employment
To rule out the suspition that literacy rates affect current output we add another variable, the employment share in agricolture in 1977, as an additional control. agr_share is treated as exogenous and is negatively correlated with pc_culture
As shown in the table, the estimated coefficient of agr_share is significantly different from zero in the output regression, but not in the equation for culture
This give strenght to the validity of past literacy rates as an instrument for culture

49. Table 13 or link to it

50. Just-identified models
As a further check of the orthogonality test on the validity of the two historical variables, we add them to the second stage regressions one at time, then in a just-identified model
If the instruments are valid, the estimated coefficients ought to be close to zero
The results are displayed in the table and confirm Sargan over-identified test
Yet, we notice also that the coefficients of pc_culture changes across the two specifications

51. Table 13 again, circles on the results

52. Controlling for the capital stock
Capital stock could be an omitted variable with a direct effect on current development
We use the capital stock data of some regions of Italy in 1979
As a result, culture retains a positive and significant estimated coefficient on the second stage, while initial capital, even if positive, is not statistically significant in the output regression
We can conclude from the Italian sample that capital stock probably doesn’t affect current output

54. Orthogonality test
With the Sargan statistic we failed to reject the null hypothesis and demonstrated with good approximation that our instruments are valid
The next step is a further check to examine three of the possible errors the Sargan statistic could not find:
Bootstrapped statistic
Montecarlo simulation
Different model

55. #1
The failure to reject the null hypotesis of exogenous instruments could be not so robust if due to specific features of the sample
In order to test this, we bootstrap the Sargan statistic randomly replacing one observation from the sample with a random draw from a similar sample. Then we replicate the instrumental variables estimates 1000 times
From the figure we can see that only in about 70% of the replications the statistic does not reach the threshold of 3.84
Therefore, the rejection of the over-identifying restrictions may not be very robust

56. Figure 7

57. #2
To check the power of the Sargan statistic and control if both the instruments are actually valid we run a Montecarlo simulation setting the coefficient of culture on output first at 0.21 and then at 0.86
We consider four different cases: both historical variables are valid instruments, only one of them a time, or none
The next step is to implement the Sargan statistic to detect if one of the two instruments is not valid
The test turns to be quite reliable more if we consider literacy and not pc_institutions as valid and also when the bias in the instrumental variable estimates is large

58. Table 14

59. #3
Sargan test is not able to detect if the assumptions at the base of the model are wrong, or more precisely
Hypotethical model: Historical institutions => Culture => Economic development
True model: Historical institutions => Economic development => Culture
In addition, income and culture are measured at the same point in time. Because of there are no available measures of culture for earlier time periods at a European level and much of the relevant variation come from Italian regions, we take into consideration a particular example occured in Italy

60. In 1946, Italy held a popular referendum in favour or against the monarchy. It’s easy to say that a vote in favour of the monarchy was likely to reflect backward cultural values and mistrust for democratic institutions
The percentage of regional votes in favour of the monarchy is taken as a measure of cultural backwardness in the immediate post-war period

61. Data in the table show that votes are strongly correlated both with literacy and institutions and with contemporaneous measures of culture
When entered separately, both historical variables have a negative and significant estimated coefficient and the same negative relationship stands between pro_monarchy and pc_culture
Despite the small number of observations, we can affirm the persistence in cultural traits, due to the worse nowadays cultural attitudes of the regions that voted in favour of the monarchy. The evidence supports the view that history has an effect on culture and this is possibly independet from development

62. Table 15

63. Conclusion
If past political institutions and past literacy rates are valid instruments for culture in the output regression, this historical variables are correlated with some specific measures of regional culture: trust and respect for others and confidence in individual self-determination
Distant history appears to be an important determinant of current economic performance. Thus, early historical institutions have shaped current institutions
On the other side, formal institutions seem in same cases less important than informal. In fact we still find an economic legacy of early institutions in regions that have been ruled by the same formal institutions for centuries

64. MAIN FINDINGS:
Early political institutions emerge as a significant source of current economic performance, also in regional comparisons
The component of culture explained by the historical variables is an important determinant of regional economic performance

65. CHALLENGES:
It’s not possible to reject that culture entirely explains the economic legacy of history
Both culture and formal institutions are likely to shape the functioning of institutions and the behavior of agents, but culture is still largely a “black box”
The low labor productivity of economically backward regions won’t go away soon, indeed it is connected with the persistence of culture and institutions. This means income transfers and public investment are not a solution, while governments should take into consideration long-term investments like education and lower real wages in regions with lower productivity

66. Thank you for your attention 