Institutions and Cultural Heterogeneity as Determinants of National Income: A Random‐coefficients Stochastic Frontier Model

• Published date: 01 August 2015
• Author: Takanori Ida,Toshifumi Kuroda,Maria Baquero Forero
• Date: 01 August 2015
• DOI: http://doi.org/10.1111/rode.12153

Institutions and Cultural Heterogeneity as

Determinants of National Income:

A Random-coefficients Stochastic Frontier Model

Maria del Pilar Baquero Forero, Takanori Ida, and Toshifumi Kuroda*

Abstract

Previous research on total factor productivity (TFP) shows that cross-country differences in income cannot

be fully explained by stocks of capital (K), labor (L) and human capital (E). In addition, the omission of

major production inputs or the use of proxies to estimate unobservable inputs leads to biased estimation

results. This study addresses the above issues by employing a novel econometric approach and provides

empirical evidence that a fixed production input, and therefore a country’s income, is positively correlated

with the existence of British-style institutions and negatively correlated with cultural heterogeneity and

Spanish-style institutions. Our methodology is twofold. First, using data for 62 countries from 1980 to 2004,

we regressed a random-coefficients stochastic production frontier that allows estimating a fixed unobserv-

able production input without using proxies. Second, the estimated fixed production input is shown to be

related to colonial institutions and cultural heterogeneity by means of ordinary least squares and feasible

generalized least squares regressions.

1. Introduction

Differences in income levels across countries have been commonly explained by

stocks of physical capital (K), labor (L) and human capital (E). However, production

functions accounting only for K,Land Ehave two main shortcomings. First, these

traditional inputs cannot fully explain cross-country differences in income and eco-

nomic growth. Empirical research has found that output growth unexplained by the

said inputs, known as total factor productivity (TFP), reaches approximately 50% for

Organisation for Economic Co-operation and Development (OECD) countries and

30% for Latin American countries (Easterly and Levine, 2001). Second, lack of

control for important determinants of income other than K,Land Elead to omitted-

variable bias. The above points suggest the importance of conducting studies that

account for major determinants of TFP or its main components, technical efficiency

(TE) and technological change.

In this study, we investigate whether time-invariant factors such as institution type

(British style vs Spanish style) and degree of cultural (ethno-linguistic and religious)

heterogeneity in a given country determine national TE levels. We also argue that

geographical location in the tropics is not a relevant factor once the above variables

are controlled for in the empirical regression.

Our analysis focuses on colonial institutions as important time-invariant determi-

nants of income because they are slow to change, and even if they do, they remain

* Kuroda: Communication Arts & Sciences Building, Room 538, Michigan State University, 404 Wilson

Road, East Lansing MI 48824, USA and Faculty of Economics of Tokyo Keizai University, 1-7-34, Minami-

cho, Kokubunji-shi, Tokyo 185-8502, Japan. Tel: +1-312-619-8412 (USA) and +81-42-328-7886 (Japan);

E-mail: kuroda@tku.ac.jp. Baquero Forero and Ida: Kyoto University, Yoshida, Sakyo, Kyoto 606-8501,

Japan. This study was supported by the Monbukagakusho scholarship from the Ministry of Education,

Culture, Sports, Science and Technology (MEXT) of the Government of Japan.

Review of Development Economics, 19(3), 710–724, 2015

DOI:10.1111/rode.12153

© 2015 John Wiley & Sons Ltd