Trust and the Benefit of the Doubt

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This is going to go off the rails quickly, so hang on. First, read this classic Douglas Adams story, and pay attention to what you think this tells you about English culture:

This actually did happen to a real person, and the real person was me. I had gone to catch a train. This was April 1976, in Cambridge, U.K. I was a bit early for the train. I’d gotten the time of the train wrong. I went to get myself a newspaper to do the crossword, and a cup of coffee and a packet of cookies. I went and sat at a table.

I want you to picture the scene. It’s very important that you get this very clear in your mind. Here’s the table, newspaper, cup of coffee, packet of cookies. There’s a guy sitting opposite me, perfectly ordinary-looking guy wearing a business suit, carrying a briefcase. It didn’t look like he was going to do anything weird. What he did was this: he suddenly leaned across, picked up the packet of cookies, tore it open, took one out, and ate it.

Now this, I have to say, is the sort of thing the British are very bad at dealing with. There’s nothing in our background, upbringing, or education that teaches you how to deal with someone who in broad daylight has just stolen your cookies.

You know what would happen if this had been South Central Los Angeles. There would have very quickly been gunfire, helicopters coming in, CNN, you know. . . But in the end, I did what any red-blooded Englishman would do: I ignored it. And I stared at the newspaper, took a sip of coffee, tried to do a clue in the newspaper, couldn’t do anything, and thought, what am I going to do?

In the end I thought, Nothing for it, I’ll just have to go for it, and I tried very hard not to notice the fact that the packet was already mysteriously opened. I took out a cookie for myself. I thought, That settled him. But it hadn’t because a moment or two later he did it again. He took another cookie. Having not mentioned it the first time, it was somehow even harder to raise the subject the second time around. “Excuse me, I couldn’t help but notice . . .” I mean, it doesn’t really work.

We went through the whole packet like this. When I say the whole packet, I mean there were only about eight cookies, but it felt like a lifetime. He took one, I took one, he took one, I took one. Finally, when we got to the end, he stood up and walked away. Well, we exchanged meaningful looks, then he walked away, and I breathed a sigh of relief and sat back.

A moment or two later the train was coming in, so I tossed back the rest of my coffee, stood up, picked up the newspaper, and underneath the newspaper were my cookies.

The thing I like particularly about this story is the sensation that somewhere in England there has been wandering around for the last quarter-century a perfectly ordinary guy who’s had the same exact story, only he doesn’t have the punch line.

You’re welcome for funny story and lack of math. Now, is there something to make out of this story regarding cultural explanations for economic growth? (If you answered no, let me remind you that this is the internet, so yes, of course every anecdote has deep meaning.)

Think about Adams and the other man bumbling around England on a day to day basis, taking advantage of a culture in which trust is high. They make anonymous transaction after anonymous transaction with strangers every day: buying the cookies, buying the newspaper, getting a train ticket, etc.. They never really question that the other party will come through with the cookies, the newspaper, or the train ride. It saves them all the time and effort of either providing these things themselves, or of spending their time and effort enforcing their implicit contracts (perhaps through physical coercion). Trust also implies that property rights will be respected. People will not arbitrarily steal my things, and I will not arbitrarily steal theirs. So I am willing to undertake transactions, because I know I can retain the profits/goods/utility from that transaction.

But in the story, *both* Adams and the stranger think the other has deviated from that norm. He stole the cookies!

And what do they do about it? Nothing! Nothing happens. This violation of the culture of trust does not cause Adams or the other man to play “deviate” and assault the other, or demand the cookies, or even so much as mention it. So this got me to think about what exactly is the important element of the norm of trust.

Perhaps it is really just the benefit of the doubt. Adams says nothing because he trusts that the other man wouldn’t deliberately violate the norm. As it turns out, this is correct; the man did not. So does trust mean that even if there is a deviation from the norm, you act as if there was not? You allow for the possibility or likelihood that it was accidental. This allows you to avoid confrontation, cost, and a breakdown of trust. Does trust matter because it makes you wait a minute, a day, or whatever before acting to punish someone who deviates? And in so doing ensures that you only punish those who actually deviate? Which means you can expect the same consideration, and so are willing to undertake transactions, because you know you won’t be falsely accused if you are acting in good faith? Let’s call this “Type II trust” in that you want to avoid falsely rejecting the null of cooperation by the other person. I think Adams and the other man display Type II trust: they is incredibly unwilling to reject the null. So unwilling that one of them even walks away having literally been cheated out of his cookies (and Adams walks away with a great story).

This is differentiated from “Type I trust”, where you want to avoid falsely accepting the null of cooperation when in fact you are being cheated. Type I trust is pretty naive: assume that everyone will cooperate with you, and occasionally you’ll be wrong. Type I trust would be like the other man pushing the box of cookies over to Adams and offering him one explicitly, perhaps on the assumption that Adams would return the favor. But that is clearly not what Adams is describing.

Perhaps the cultural advantage of the Western economies in economic transactions is that they have a particularly large amount of Type II trust, but not necessarily more Type I trust. That is, Western economies are just as suspicious of new transactions with strangers, and usually need some third-party reference to undertake them in the first place. However, once convinced to transact with a stranger, they have a higher tolerance for apparent deviation, willing to wait it out to see if in fact they were cheated. More transactions take place successfully, and more people are able to acquire trustworthy reputations, because there is no rush to judgement. More trustworthy reputations means more transactions, and so forth.

Yes, I know that’s a lot to suck out of a Douglas Adams anecdote. And I’m certain that somewhere, someone has written something about these varying shades of trust before. So feel free to school me up in the comments.

Research on Persistent Roots of Development

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A few papers of interest regarding the persistent effect of historical conditions (geographic or not) on subsequent development:

1. Marcella Aslan’s paper on the TseTse fly and African development is now out in the American Economic Review. I believe I’ve mentioned this paper before, so go read it finally. Develops an index of suitability for TseTse flies by geography, then shows that within Africa higher TseTse suitability is historically associated with less intensive agriculture, fewer domesticated animals, lower population density, less plow usage, and more slavery (If you are queasy about using Murdock’s ethnographic atlas, then avoid this paper). Marcella shows that TseTse suitability is currently related to lower light intensity (everyone’s favorite small-scale measure of development), *but* this effect disappears if you control for historical state centralization. The idea is that the TseTse prevented the required density from forming to create proto-states, and that these places remain underdeveloped. Great placebo test in this paper – she can map the TseTse suitability index of the whole world, and show that it has no relationship to outcomes. The TseTse is a uniquely African effect, and she is not picking up general geographic features.
2. James Ang has a working paper out on the agricultural transition and adoption of technology. Simple idea is to test whether the length of time from when a country hit the agricultural transition is related to their level of technology adoption in 1000 BCE, 1 CE, or 1500 CE (think “did they use iron?” or “did they use plows?”). Short answer is that yes, it is related. Places that experienced ag. transition sooner had more technology at each year. Empirically, he uses instruments for agricultural transition that include distance to the “core” areas of transition (China, Mesopotamia, etc..) and indexes of biological endowments of domesticable species (a la Jared Diamond, and operationalized by Olsson and Hibbs). The real question for this kind of research is the measure of technology adoption. We (meaning Comin, Easterly, and Gong) retrospectively code places as having access to technologies in different years. A worry is that because some places are currently poor (for non-agricultural reasons) the world never bothered to adopt their particular technologies, but that doesn’t necessarily mean they were technologically unsophisticated for their time.
3. Dincecco, Fenske, and Onorato have a paper out on historical conflict and state development. The really interesting aspect here is how Africa differs from other areas of the world. Across the world and over history (meaning from 1400 to 1799) wars are associated with greater state capacity today. That is, places that were involved in conflicts in the past are now stronger states (measured as their ability to tax) than those without conflict. The basic theory is that wars allow states to concentrate their power. However, historical conflict is unrelated to current civil conflicts…except in Africa. In Africa, historical wars are correlated with current civil conflicts, and this is associated with poor economic outcomes today, so things are bad on multiple fronts. Here’s my immediate, ill-informed, off-the-cuff analysis: In non-African places, wars generated strong states who were able to use their power to completely and utterly eliminate ethnic groups or cultural groups that were alternative power centers. They don’t have armed civil conflicts today because the cultural groups that might have agitated conflict were wiped out or so completely assimilated that they don’t exist any more. In Africa, central states were just not as successful in eliminating competing cultural groups, so they remain viable sources of conflict. Africa’s problem, perhaps, was a lack of conclusive wars in the past.

Trust, Familes, and Growth

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Warning: this post is too long and wildly speculative.

Culture has (re)-emerged as one of the proposed “deep determinants” of economic development. A good place to get a feel for this literature is a piece in J. of Economic Perspectives by Guiso, Sapienza, and Zingales (GSZ). They define culture as “those customary beliefs and values that ethnic, religious, and social groups transmit fairly unchanged from generation to generation.” Keep in mind, this is what GSZ a narrow definition of culture. Culture is like institutions; we seem to know it when we see it, but can’t define it.

Regardless, one of the stronger results that pops up in the culture literature that GSZ review (and often authored in the first place) is the relationship of “trust” and economic success. Population groups that tend to trust others also tend to be economically successful.

This one figure from GSZ is particularly striking. Using data from the U.S. and self-reported ethnic backgrounds, they plot “trust” for each group relative to people who report as being descended from British ancestors. Trust is measured by asking individuals if “most people can be trusted (yes/no)”. The way to interpret the figure is that the percentage of Japanese-descended answering “yes” is 24.7 percentage points higher than whatever the British-descended answered.

What do we see? The Japanese and Scandanavians are must more trusting than the British, while other Western Europeans are just about as trusting as the British. Southern Europeans are less trusting, and as we get to African and Indian-descended Americans, trust falls off a cliff. Patterns like this show up if you alternatively look at the World Values Survey at individual countries. In general Western Europeans (and their descendants in places like the US and Australia) report a higher degree of trust than other regions of the world. They also tend to have much more economic success wherever they live – see my recent post on population groups and development.

Now, there is no way for me to tell you that this is causal. It could well be that a lack of economic success leaves you less likely to trust others. But pending a definitive study on this, let me leap ahead on the assumption that there is a strong relationship of trust to economic success.

Why? The basic model here would be that economic exchange is a repeated game you play with strangers. In each round, you can either cooperate or cheat (you can pay your bar tab or you can slink out the back). Everyone is better off if you and all the strangers you interact with continually play “cooperate”. But at any given moment, you could take a stranger for a sucker by playing “cheat”. Once someone plays “cheat”, though, everyone plays “cheat” and we are all worse off. A culture of trust – and in particular trust in non-kin strangers – means that people take “cooperate” as their default option. We grab all the win-win exchanges possible.

Trust in non-kin strangers is such a powerful force for economic success because it scales so well. There are a nearly limitless number of strangers to make win-win trades with. If you restrict yourself to only your kin-group, the number of trades is severely limited. How do you build up complex networks of exchange and division of labor with, at best, a few hundred people you trust? Trust opens up economic possibilities.

So where did Western Europeans get this culture of trust, and in particular trusting non-kin? (If you already thought this post was highly speculative, then buckle up). Let me propose that the origins of this may be located in the re-organization of northwestern European society that occurred around 800-1100 AD. There was a fundamental shift away from kin-groups as the organizing principle for families towards households in this period. The alternative that arose was a “household” that centered around a smaller core of kin (the nuclear family) but also included non-kin members. This meant that NW European households were constantly exposed to, and interacting with, non-kin “strangers”. The NW European “culture of trust” was built on that foundation.

There are two books that I’ll suggest you read on this if you want to get some real depth on this idea. Whatever I say after this is culled in large part from these works.

1. The First European Revolution: c. 970-1215 (The Making of Europe) by R.I Moore. This tends to be more about the changes taking place at the top levels of the aristocracy and church.
2. Why Europe?: The Medieval Origins of Its Special Path by Michael Mitterauer. This gets more finely into the changes in economic organization occurring at the “low” levels that led to changes in family structure for the peasants. Chapters 1-3, in particular.

Mitterauer lays out the basic concept (p. 96):

The fundamental form of the European family is not the lineage group but the household. Its members do not necessarily have to be related through descent or marriage. This makes the system very flexible and adaptable to other situations.

He also makes the case that this was a particularly important social change (p. 93):

The loosening of lineage ties created some leeway for striking up new social relationships beyond the family circle. Ties to people other than one’s kin played an important part in European social history and made a major contribution to Europe’s social dynamics.

Moore finds this same process going on in the upper reaches of society (p. 70):

Upon his accession the eldest son became head of what was now conceived as a dynastic family, capable of being depicted by the diagram or `tree’ in which the European aristocracy has invested its identity ever since. The dynastic family…gradually superseded the more loosely articulated kinship group in much of northwestern Europe for the purpose of controlling and transmitting landed property.

We’ve got a process going on by which the wider kin-group is being put aside in favor of nuclear families, and these nuclear families are incorporating non-kin strangers into their households.

Why was this happening? Let’s start with the peasants. The non-kin strangers tended to be young adults. They were farm hands (both male and female), apprentices, or servants in the manor house, and they left these positions once they married. “Working as a life-cycle servant…seems to have been the defining experience of European youth” (Mitterauer, p. 94). This was not just a case of young adults working as servants for a lord. Farm hands were prevalent on most of the smaller hides (farms) that made up a lords estate.

The origin of this structure for households is located by Mitterauer in the particular agricultural system that developed as NW Europe went from being a frontier to being settled. This “cerealization” of NW European agriculture was most productive in the hide system. Simply put, there is an efficient scale to operate at if you are growing rye and oats (“Rye and Oats” is the title of Mitterauer’s first chapter). That scale is fit best by a nuclear family accentuated by some farm hands. Most importantly, you want to keep the scale of the hide constant, so you cannot have families splitting them up across children. But you need something for all those children to do, so the lords shuffled them around as farm hands and apprentices and servants between households. This is an atrocious over-simplification of Mitterauer’s argument, but I think it gets the main points right. The non-kin-based families of NW Europe arose because of a peculiar agrarian system in that area. The lingering effect of these families was to build up trust in non-kin strangers.

At the top end, a similar change was taking place. Moore does not place as much weight on the nuances of agricultural production as he does on the closing up of the frontier. He paraphrases George Duby (p. 63, no cite given, but I think he means this book):

..described the social history of this period as one of disorder in transition between two ages of order, that of the Carolingian world where a large but loosely defined and structured nobility supported itself with a haphazard combination of plunder and booty….and that of the precisely articulated society of orders, sustained by legal and social domination…which..remained familiar in western Europe until the age of revolution.

Once you could not keep you wider kin-group happy by plundering some new corner of France, you had to get serious about dividing up what you did have.

As Moore notes (p. 66), the crisis arising from having multiple kin-group claims to inheritance was not unique to NW Europe. It happens everywhere. It was not this problem that made Europe unique, it was the solution. Europe honed in on strict dynastic succession, eliminating disputes over inheritance by telling everyone in the extended kin-group (uncles and male cousins in particular) to go f*** off. Moore does a nice job of explaining how this was accomplished with the collusion of the Church. This post is already too long, so I’ll push you off to his book for the details.

The end result was that at the top level of society, the households of kings, dukes, and such were no longer kin-based. Sure, they were gigantic. But they were filled with non-kin “strangers”. Pages and servants and advisors and priests who were not related by blood or marriage, but owed their allegiance to the lord nonetheless.

So at both top and bottom levels of society in NW Europe in the years between 800-1100 we have all of these people learning to trust non-kin strangers. Perhaps unwillingly at first, but the mere exposure to non-kin strangers in economic relationships would have to build up some trust over time. Once that trust is built into these households, it gets passed on. It becomes “culture” as GSZ would describe it. But that culture of trust allowed the populations of NW Europe to take advantage of more win-win exchanges between strangers, and contributed to their on-going economic advantage.

Populations, not Nations, Dictate Development

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One of the more intriguing empirical regularities in recent growth research involves population origins. Rather than thinking about rich and poor countries, work by Louis Putterman and David Weil tells us to think about rich and poor population groups (Europeans and Native Americans, for example). Countries are rich if their population is made up of rich population groups, and vice versa. The U.S. is rich because it has lots of European descendants, and relatively few Native American descendants. Mexico, in contrast, is relatively poor because it has a few European descendants but lots of Native American descendants.

The interesting aspect of these findings is that they suggest we are looking at the wrong units of observation, so to speak, in studying economic growth and development. We should be studying the characteristics of population groups, not countries, and looking at the characteristics that make those groups prosperous relative to others.

I pulled two sets of results out of the survey by Spolaore and Wacziarg (2013), which is a great introduction to this material if you want more depth. The first are regressions of output per worker in 2005 on either years since agriculture first began or years of “state history” (i.e. how long organized political regimes have existed) for each country. Columns (1) and (3) show that the country-level measures of agriculture or state history are not relevant. But if you weight the years since agriculture began or state history by population composition, you get a different story. As an example, the weighted state history for the U.S. is a weighted average of the state history of England, Germany, Italy, etc.. (quite long) as opposed to the state history of North America (quite short).

The length of time that populations have had settled agriculture and organized states is highly correlated with output per worker today. Countries that have more history with economic organization are richer today.

Spolaore and Wacziarg’s next table shows that even holding those features constant, the share of Europeans in the population of a country is highly correlated with output per worker today. The upshot is that Europeans and their descendants are rich (as a group), wherever they are in the world, but not so for other population groups. See Easterly and Levine (2012) for more robustness checks on this result.

This idea that some population groups are the source of economic success leads to reactions that run from raised eyebrows to accusations of racism. But let’s be very clear that this finding regarding population groups implies nothing about any kind of inherent superiority to Europeans as a group.

We need only a few things to hold for these patterns to arise:

• First, economic organization has to be subject to some kind of cumulative process. Whether you want to call it tacit knowledge, acculturation, or learning-by-doing, successful economic organization must be something that cannot just be snatched out of the ether. Each generation builds upon the prior’s organization to become a little more advanced.
• Second, that cumulative knowledge is passed on more easily the more closely related – culturally, linguistically, genetically – are two groups. The English and French can benefit from each others accumulating knowledge more easily than the English and Chinese for example.
• Finally, you need Europe to “get started” earlier than other regions.

With those three elements, you get Europeans with an advantage today in economic organization. They simply got rolling earlier than other areas with figuring things out, and because it is much easier for Europeans to learn from Europeans, they maintain this early advantage over long periods of time.

Further, because economic organization is something accumulated within a cultural group, it moves with them. Hence the United States gains the benefits of the long European history with economic organization, while Mexico does not to the same extent.

Does that mean European-descended places are permanently entrenched as the richest places in the world? It might. The outcome depends on whether other population groups can improve their economic organization faster than Europeans. And this in turn depends on how fast the organization ideas of Europeans spill over or get transmitted to other groups. If other population groups are both learning on their own *and* are acquiring new ideas from Europeans, then they should be catching up. Maybe slowly, but they should catch up.

On the other hand, there could be some kind of increasing returns to scale here, with Europeans getting even better and better at economic organization as they get richer. Combine that with slow spillovers, and the European population lead could not only persist, but widen as time goes on.

If you want to avoid this spiral of divergence, then this literature implies three possible actions. (1) import Europeans, (2) export your people to European places, or (3) assimilate European culture.

Not sure of many places that are actively trying to recruit European settlers (although Paul Romer’s whole charter city thing sort of falls in this arena). Lots of developing country citizens do actively try to export themselves to European countries every year.

The last one is probably the most controversial. We can’t really tell people in poor countries to “act European”? The whole point is that European culture is this accumulated body of tacit knowledge that is not readily translatable. So how would you actually “assimilate European culture” even if you wanted to? It can obviously happen over time – there are 736 Kentucky Fried Chicken outlets in South Africa – but is this something you can actively manage?

Finally, this means the really interesting question is: how did Europeans get a head start in the first place? The research that Spolaore and Wacziarg review suggests that the advantages go back deep in time. It could be the nature of their agricultural endowments (as in Jared Diamond), or their optimal mix of diversity across groups (Ashraf and Galor), or pure un-adultered luck.

Regardless, studying development in light of this research implies studying population groups or cultures as the units of analysis, rather than confining ourselves to borders that may not have any information content about the economic organization of the populations inside of them.

Cochrane on Growth and Macro

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John Cochrane recently ran a little review of his experience at NBER (h/t to Noah Smith). It’s got a really interesting observation on growth versus macro.

A last thought. Economic Fluctuations merged with Growth in the mid 1990s. At the time there was a great confluence of method as well as interest. Growth theorists were studying growth with Bellman equations, dynamic general equilibrium models of innovation and transmission of ideas, thinking about where productivity shocks came from. Macroeconomists were using Bellman equations, and studying dynamic general equilibrium models with stochastic technology, along with various frictions and other propagation mechanisms.

That confluence has now diverged. I enjoyed spending an hour or two thinking about how religion has blocked or adapted to ideas over the centuries, and Paul’s view on social norms or neuroeconomics. But I don’t really have any expertise to contribute to that debate. Questions like whether young CEOs head more innovative companies, or whether, like deans, what matters is the age of the faculty are a little closer to home, since I spend a lot of time consuming corporate finance. But the average sticky-price macro type does not. Likewise, when Daron Acemoglu, who seems to know everything about everything, has to preface his comments on macro papers with repeated disclaimers of lack of expertise, it’s clear that the two fields really have gone their separate ways. Perhaps it’s time to merge fluctuations with finance, where we seem to be talking about the same issues and using the same methods, and growth to merge with institutions and political or social economics.

This is similar in flavor to John Seater’s comment that I wrote about here. Has growth economics become different enough from mainstream macro that we should separate them from one another?

I’d argue yes. Growth is about development now – meaning that it’s motivating question is “Why are some countries rich and some poor?”. (See my earlier post on this topic here). The exploration of answers to this question are much more about big static differences in institutions, cultures, technologies, and the like, and less about transition paths and dynamics.

On what growth would look like if it did separate (literally at NBER and intellectually as a field) from macro, Cochrane gave us perhaps a pointer:

I’m not sure in the end though whether Paul[Romer] was approving or bemoaning the shift back towards literature in economic analysis. Certainly his vision for the future of growth theory, centered on values, social norms, biology, and so forth, does not lend itself easily to quantification.

Is this a feature or a bug? Perhaps the big question of “Why are some countries rich and some poor?” is not answerable in any solid empirical way. Perhaps the highest achievement here is “literature” in the sense of some overarching theory that one uses to examine history. Think of Pomeranz’s The Great Divergence or Robert Allen’s The British Industrial Revolution in Global Perspective as examples. While both books certainly appeal to economic intuition and occasionally something approaching formal theory, neither considers anything like a Bellman equation.

The counter would be that we can do better than just “literature” in growth by writing down model (perhaps static models, but no matter) that allow us to quantify the forces that people like Pomeranz and Allen propose as relevant. That is, write down an explicit model, and calibrate or simulate it to assess whether a proposed explanation has a plausibly large quantitative effect on output per worker. The issue here is, as Cochrane says, it’s essentially impossible to quantify religion or values. What is the parameter you stick in your quantitative model that captures the effect of a belief in the afterlife on your willingness to work today? If you cannot possibly hope to measure that parameter, then you cannot quantify it’s effect on output per worker.

So if we’ve entered the world where we think that values (or culture or religion) are fundamental to development, then we may be left with “literature” as the only valid form of research output. My guess is that growth economists will resist this kind of transition, mainly because we’ve invested a lot in knowing fancy dynamic models and calibration techniques, and we don’t want those skills to become worthless.

Does Culture Matter for Economic Growth? Part Deux.

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I ended up getting a lot of feedback (pushback?) on my post regarding culture and economic growth. The TL;DR version is this: if culture influences utility functions, then comparing economic development levels between cultures not very interesting because it doesn’t ultimately inform us about welfare.

Several people got back to me about ways that culture could matter for economic development without necessarily implying differences in utility functions. While not doing full justice to each comment, I think the common thread was this: coordination failures.

Perhaps you have some cultural norm that says to distrust strangers. In some kind of repeated dynamic game, your first choice is to deviate/defect/cheat, and this leads to a bad equilibrium where everyone continues to deviate/defect/cheat. This means you do not take advantage of mutually beneficial transactions. In contrast, a culture that says to trust strangers will choose to cooperate as a first choice, and this leads to a good dynamic equilibrium where everyone continues to cooperate (lend to each other, transact with each other, make long-term contracts with each other) and allows for greater economic specialization.

Now, if the cultural norm of distrusting strangers is there to minimize the utility loss (shame?) from being cheated, then its still just a utility function difference, and we can’t really say that people are worse off from distrusting strangers. They are, after all, avoiding something that hurts them very badly. But if the cultural norm of distrusting strangers is just some odd historical outcome, then I could see how this cultural norm is really affecting not just economic development, but also welfare. People would like to coordinate on “cooperate” and achieve the good long-run equilibrium, but no one has any incentive to act alone.

That said, cultural norms of distrusting strangers (or trusting them) aren’t random. They must have some basis in past cultural experience, and so I’d be worried that it directly influences utility in some manner. But as a general proposition, the idea that culture has an influence on economic development and welfare because of coordination failures seems like a good avenue to pursue.

The idea that culture is tied up with solving coordination problems runs through a lot of the work of Avner Greif. His 1994 paper on cultural beliefs and economic outcomes compares an individualist culture (Genoese traders) with a collectivist one (Maghribi traders) in how they dealt with severe principal-agent issues. Summarizing, the Genoese developed a vertical structure that relied on formal institutions to mediate disputes, while the Maghribi developed a horizontal structure that relied on intra-group cooperation to mediate distputes (i.e. punish cheaters).

Greif does not explain why the Genoese or Maghribi adopted these different attitudes, he just documents that the choice of vertical versus horizontal structure makes sense given their cultural attitudes. He’s also clear about ranking these systems:

Hence although in the long run the Italians drove the Muslim traders out of the Mediterranean, the historical records do not enable any explicit test of the relative efficiency of the two systems (p.942-43)

So it’s not immediately obvious whether the collectivst culture was worse for economic outcomes (perhaps the Genoese had other advantages we don’t know about). But to my prior point, even if the collectivist culture was demonstrably worse for the economic outcomes, we don’t know anything about how individualism and collectivism entered the utility functions of these groups. Hence we don’t know whether the Genoese or the Maghribi were better off with their system.

The one way I see that you could definitively argue that the collectivist culture was “worse” was if the Genoese and Maghribi shared a common utility function, and the move to collectivism by the Maghribi was the result of a random historical event unassociated with that utility function. By random I mean, if we re-ran world history 1000 times, then in about half of them we should see the Genose ending up with collectivist institutions and the Maghribi with individualistic ones.

That seems like a tall order. I’d be shocked if the Maghribi’s collectivist culture, and hence adoption of a horizonatal structure that (might have) had a detrimental effect on their economy, was just random noise.

Obviously world history didn’t start with the Genoese and Maghribi, and their predisposition for collectivism and individualism was the result of historical events leading to that specific time and location. So perhaps there were a series of random occurrences over history that snowballed into the collectivist culture of the Maghribi and the individualist of the Genoese.

Which is a long way of saying that countries could share a common utility function (making GDP or income comparisons meaningful), have different cultures due to a series of historical contingencies, and that those cultural traits could have meaningful economic effects because of how they influence coordination problems. In that case, then it would be meaningful to talk about culture’s effect on GDP, because culture is essentially capturing some kind of historical path dependence.

Does Culture Matter for Economic Growth?

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There’s been an increasing number of papers concerned with culture and its relationship to economic growth. I happened to just see this working paper by Di Tella and MacCulloch (2014), but the idea of culture being an important determinant of economic development levels has been hanging out there in the literature for a long time. Weber’s theory of the Protestant work ethic is probably the starting point for any discussion of this topic. More recent work tends to try and be more empirical than Weber, often using World Values Surveys as a means of measuring cultural elements. This is what Di Tella and MacCulloch do in their working paper. [If you’d like a good introduction to the culture literature, check out James Fenske’s course materials, in particular his “Foundations of Development” course].

I think this is pretty interesting reading, but I’m starting to get a little antsy about the use of the cross-country empirical work. Not in a standard “Identification!!” way, although that’s an issue, but in a slightly deeper way. In particular, why bother regressing GDP per capita (or growth, or any measure of economic activity) on cultural variables at all?

Culture affects economic activity through the choices that people make about how to allocate scarce resources. In other terms, while culture may be a fundamental determinant of economic activity, it acts through proximate factors like (but not exclusive to) the accumulation of capital, the adoption of technology, or labor market participation decisions. So if we are going to describe how culture influences economic activity, we need to describe how culture influences those proximate factors.

The decisions regarding saving, technology adoption, and labor market participation are similar in that they involve some sort of constrained optimization problem. That is, there is some budget constraint and some utility function, and people do the best they can to maximize utility while keeping within that budget. I have some income, for example, and I need to decide how much of it to consume and how much to save. I have some profits as a firm, and I need to decide whether to invest in a new technology, or distribute the profits to my stockholders. I have a finite amount of time, and I need to decide whether to stay home and raise my kids or put them in day care and go back to work. All constrained optimization problems.

So if culture is going to influence economic activity, it has to influence those constrained optimization problems. And there are really only two options then. Either culture influences budget constraints, or it influences utility functions. I haven’t seen any argument that culture actually changes the budget constraints of people, firms, or governments. Finite resources are finite no matter what you believe. So culture probably acts through utility functions, changing people’s preferences towards the future, or towards education, or towards material success, or towards the environment, or whatever.

Maximizing utility does not mean that people are individualistic money-grubbers. You can write down a utility function where someone cares about other people’s welfare, or a function where someone really enjoys free time with their kids, or highly values the environment, or values the success of their group. Culture, if it has economic effects, would presumably act by changing exactly what is valued in the utility functions of people or households.

Take as an example the common cultural distinction that Americans are more individualistic than Europeans. This would manifest itself in a utility function in the U.S. that is heavily weighted towards individual income, say, versus any measure of community income. In Europe, the opposite would apparently hold. Then, given the same budget, Americans would make choices aimed towards better personal outcomes (e.g. low tax rates and social safety nets) while Europeans wouuld makes choices aimed towards better group outcomes (e.g. high tax rates and social safety nets).

So here’s the issue that I mentioned at the top. If culture leads to different utility functions, which in turn lead to different measurable economic outcomes, then why should we bother with measuring economic outcomes? Let me take this from the opposite angle. If everyone has identical utility functions, then measurable economic outcomes (GDP, average wages) have some information about relative welfare across countries. But if everyone has a different utility function, then measurable economic outcomes don’t necessarily provide any information about relative welfare. If one culture derives utility from having massive families with lots of kids, and doesn’t really care about consumption goods, then what does their low GDP per capita tell me? Nothing. It doesn’t tell me they have lower welfare than a high GDP per capita culture.

If you tell me that culture is important for economic outcomes, then you’re telling me that utility functions vary across cultures. But if utility functions vary across cultures, then cross-culture comparisons of economic outcomes don’t imply anything about welfare. So aren’t the regressions with culture as an explanatory variable self-defeating, even if they are econometrically sound?

I could well be over-thinking this, and I’d be happy to hear a good argument for what the culture/growth or culture/income regressions are supposed to be telling me.