The role of cultural values in the formation and survival of pro-growth institutions.

Author:Vachris, Michelle Albert
  1. Introduction

    In The Road to Serfdom, Hayek explains how markets (economic freedom) will lead to a higher standard of living than central planning because the price system incorporates a lot of decentralized information--more information than a central planner could possibly obtain and employ. Hayek maintains that political freedom and economic freedom are linked, describing economic freedom as "the prerequisite of any other freedom." To Hayek, "only within this [capitalist] system is democracy possible. When it becomes dominated by a collectivist creed, democracy will inevitably destroy itself." Likewise, in Capitalism and Freedom, Friedman stresses the importance of property rights and describes a link between economic freedom and political freedom. He maintains that free enterprise is "a necessary condition for political freedom" and that free enterprise leads to economic growth.

    This focus on institutions is an important component of the growth theory developed by North (1990), who asserts that institutions "are the underlying determinant of the long-run performance of economies." North's theory fits well with the growth theory of Kuznets (1973), which specifically includes technology, institutions, and people's attitudes as important factors in sustained economic development. Kuznets (1973) states that growing economic capacity is "based on advancing technology and the institutional and ideological adjustments that it demands." The importance of people's attitudes is further explored by McCloskey (2010), who explains that the explosion of economic growth in the Western world beginning in the late eighteenth century (the Great Divergence) was due to increased respect for commerce. Hence, culture and the presence of certain institutions matter for growth, as do the evolution and adaptation of these institutions over time.

    This paper examines the link between culture and the formation of institutions that promote economic growth. Specifically, we analyze the role that cultural norms play in the change and volatility of economic and political freedoms. We employ several measures of culture, (1) as well as several empirical specifications, to investigate the impact that informal cultural norms have on the permanence of economic and political institutional change when controlling for existing levels of economic output, international trade, and educational attainment. (2)

    To better analyze the relationship between culture and progrowth institutions, we turn to Williamson's (2000) "hierarchy of levels of social analysis" that provides insight into the degree to which formal and informal institutions should play a role in economic analysis (see table 1). Williamson contends that the higher the level of social analysis, the more permanent are the associated characteristics. Further, each level imposes constraints on the levels below it. For example, a society's embedded informal institutions (level 1), which can take 100 to 1,000 years to change, will constrain the nature of the formal rules of the game (level 2). The formal rules, in turn, may constrain institutions that may lead to economic growth and political stability (level 3). These institutions will ultimately affect the allocation of resources (level 4).

    Guiso, Spaienza, and Zingales (2006) describe informal cultural institutions similarly, by differentiating between traits that are "inherited" (such as religion and ethnicity) and those that are "learned" (such as nationalism and culture). The authors note, however, that causality may work both ways. While the permanence of cultural institutions should affect formal institutions that lead to political stability and resource allocation, formal institutions should also have a reverse impact on the informal institutions. Coyne and Williamson (2012), for example, show that openness to trade significantly impacts the cultural institutions associated with exchange and entrepreneurship, such as trust and self-determination.

    Using Williamson's hierarchy, the permanence of inherited cultural traits enables us to use the deeper aspects of ethnic and religious heterogeneity across countries (level 1) to analyze differences and variability in trust and beliefs about the rule of law and the polity (level 2). It follows from this general concept that differences in the more permanent informal institutions (levels 1 and 2) play a role in the persistence and survival of formal and less permanent institutions (level 3 and 4). To accomplish the latter, we take a broader interpretation of culture than Guiso, Sapienza, and Zingales (2006). As Alesina and Giuliano (2015) explain, a theoretical line can be drawn between values and beliefs, but most empirical studies combine the two. Our definition of culture includes both traditional, incredibly permanent values such as religiosity, ethnicity, and language as well as beliefs more associated with social capital, such as trust, self-reliance, and rationality. In essence, we are collapsing Williamson's first two levels into one category. This simplification allows us to view these more permanent institutions as fixed and exogenous at any point in time so that we can focus on the implications of these "cultural" values on the permanence of shocks to formal economic institutions.

    The next section reviews some of the earlier attempts to investigate the relationships among culture, institutions, and economic growth. We then review various measures of culture and explain the specific measures that we employ in this study before describing our empirical model and econometric results. Finally, we offer some concluding insights into the importance of culture in economic development.

  2. Literature Review

    A cannon of empirical literature clearly demonstrates the link between prosperity and institutions, particularly the institutions that foster economic freedom and political freedom. (3) De Haan, Lundstrom, and Sturm (2006) survey studies investigating the link between economic freedom and growth. They conclude that generally, economic freedom is an important determinant of economic growth, and that political freedom also contributes to economic freedom, though economic freedom may not contribute to political freedom. Aron's (2000) survey of the literature on political institutions and growth concludes that higher quality institutions are linked to economic growth, "but the evidence is by no means robust." A recent study by Hall and Lawson (2014) surveys the literature that cites the economic freedom index and concludes that higher economic freedom is overwhelmingly correlated with positive outcomes, including economic growth and other indicators of quality of life, such as happiness. The general conclusion of the institutions literature, then, is that economic freedoms, political freedoms, and civil liberties help to describe cross-country differences in economic growth, but that the link is stronger for the economic freedoms.

    This explosion of work on economic institutions since the 1990s encouraged economists to go beyond studying formal institutions into studying informal institutions, which took them into the nature and role of culture. Economists such as Landes (1998) and Guiso, Sapienza, and Zingales (2006) emphasize the links from culture to beliefs and values, as well as from beliefs and values to economic outcomes (see also Temple and Johnson 1998; Whiteley 2000; and Knack and Keefer 1997).

    The "cultural values" literature shows that measures of trust, self-determination, respect for others, and openness also facilitate growth. Guiso, Sapienza, and Zingales (2006) provide a broad analysis of these conclusions. The authors demonstrate in various settings the role that inherited cultural norms such as religiosity and ethnicity play on institutional formation and the desire for government redistribution and general economic welfare. The authors, however, are quick to point out the inherent endogeniety problem that exists among institutional formation, cultural norms, and economic growth. In addition, Boettke, Coyne, and Leeson (2008) and Williamson (2000) argue that for formal institutions to survive, they must be rooted in informal institutions, indicating that informal institutions underlie certain formal institutional arrangements. Although formal institutions can be changed statutorily, constitutionally, or through other political means, informal institutions tend to change slowly because they are embedded in culture, norms, and traditions (Williamson 2000; North 1990). Therefore, informal institutions are likely to be much more permanent, but play an important role in the less permanent, but very important, formal institutions. Coyne and Sobel (2011), for example, show that changes in economic and political freedom indexes are cointegrated, suggesting that changes in one form of institution are accompanied by similar changes in other institutions. In addition, the authors find that indexes that measure economic institutions are nonstationary, suggesting a permanence to changes that is not found in measures of political freedom. This finding supports the hypotheses of Williamson's (2000) institutional hierarchy. Williamson suggests that informal institutions such as religiosity and ethnicity are the most permanent, while economic and political institutions are less permanent.

    One view of the relationships among culture and economic and political institutions is offered by the modernization theory developed by Lipset (1959) and used by Inglehart and Welzel (2005) and others. This theory hypothesizes that as countries develop economically, the increased wealth causes cultural changes. According to Inglehart and Welzel (2005), technological and scientific progress leads not only to industrialization, but also to a secularized world view. Second, as industrialized economies transform into service-based economies, they increasingly rely on creativity and knowledge in...

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