Institutions, Property Rights, and Growth

This paper presents a growth model in which property rights are insecure and costly to enforce. Losses of property provide the impetus to establish institutions which seek to enforce property rights. Institutions are shown to implement policies that enforce property rights. The model establishes that economies in which the institutional structure does not adequately protect property rights grow slowly, or not at all, while countries with better property rights protection grow in accordance with the standard neoclassical model. Because income inequality is a primary incentive to violate another's property rights, the model also provides a positive theory of income redistribution. Empirical tests of the model's predictions demonstrates that government expenditures that enforce property rights raise per capita income growth.Institutions, Growth, Development, Property Rights,

The Neuroeconomics of Trust

The traditional view in economics is that individuals respond to incentives, but absent strong incentives to the contrary selfishness prevails. Moreover, this “greed is good” approach is deemed “rational” behavior. Nevertheless, in daily interactions and in numerous laboratory studies, a high degree of cooperative behavior prevails—even among strangers. A possible explanation for the substantial amount of “irrational” behavior observed in markets (and elsewhere) is that humans are a highly social species and to an extent value what other humans think of them. This behavior can be termed trustworthiness—cooperating when someone places trust in us. I also analyze the cross-country evidence for environments that produce high or low trust. A number of recent experiments from my lab have demonstrated that the neuroactive hormone oxytocin facilitates trust between strangers, and appears to induce trustworthiness. In rodents, oxytocin has been associated with maternal bonding, pro-social behaviors, and in some species long-term pair bonds, but prior to the work reviewed here, the behavioral effects of oxytocin in humans had not been studied. This presentation discusses the neurobiology of positive social behaviors and how these are facilitated by oxytocin. My experiments show that positive social signals cause oxytocin to be released by the brain, producing an unconscious attachment to a stranger. I also discuss recent research that manipulates oxytocin levels, and functional brain imaging research on trust.Oxytocin, social capital, neuroeconomics, development, experiments

Genetics, Family Structure, and Economic Growth

Recent biomedical research shows that roughly three-quarters of cognitive abilities are attributable to genetics and family environment. This paper presents a theory of growth in which human capital is determined by inheritable factors and family size. The distribution of income is shown to affect the number of births, with greater inequality raising the fertility rates and reducing output growth in the transitional dynamics. If human or physical stocks are sufficiently low, the model shows that an economy can be caught in a fertility-caused poverty trap, while countries with more resources will converge to a balanced growth path where the average transmission of human capital from parents to childern determines the long-run rate of output growth.genetics; siblings; growth; fertility; human capital

Building trust: public policy, interpersonal trust and economic development

Zak & Knack (2001) demonstrate that interpersonal trust substantially impacts economic growth, and that sufficient interpersonal trust is necessary for economic development. To investigate the ability of policy-makers to affect trust levels, this paper builds a formal model characterizing public policies that can raise trust. The model is used to derive optimal funding for trust-raising policies when policy-makers seek to stimulate economic growth. Policies examined include those that increase freedom of association, build civic cultures, enhance contract enforcement, reduce income inequality, and raise educational levels. Testing the model's predictions, we find that only freedom, redistributive transfers, and education efficiently and robustly stimulate prosperity. They do this by strengthening the rule of law, reducing inequality, and by facilitating interpersonal understanding, all of which raise trust.trust, growth, inequality, rule of law, property rights, development

Growth of Government And The Politics of Fiscal Policy

U.S. government expenditures increased rapidly during the post-war period, then slowed in the 1980s and began falling in 1992. To examine the dynamics of the growth and subsequent reduction in government spending, we present a dynamic general equilibrium model in which politicians choose government spending to maximize support by their constituents. The model predicts that government expenditures will initially mimic Wagner's law - the tendency for government spending to increase with GDP - but eventually diverge from output due to the growth of the welfare state. After government expenditures become large, we identify an endogenous threshold on the economy's growth path where it is optimal for politicians to shrink the welfare sate, cut taxes, and stimulate output growth. We show that the policies chosen by politicians are Pareto suboptimal and cause endogenous cycles in output. Such cycles are of several types, and we characterize when the equilibrium growth path will result in a reduction in the size of the welfare state, as well as when the welfare state cycles between small and large.government expenditures; growth; Wagner's Law; endogenous cycles

Political Risk and Capital Flight

Capital flight often amounts to a substantial proportion of GDP when developing countries face crises. This paper presents a portfolio choice model that relates capital flight to rate of return differentials, risk aversion, and three types of risk: financial risk, political risk, and policy risk. Estimating the equilibrium capital flight equation for a panel of 47 developing countries over 16 years, we show that all three types of risk have a statistically significant impact on capital flight. Quantitatively, political risk is the most important factor causing capital flight. We also identify several political factors that reduce capital flight by signaling market-oriented reforms are imminent.capital flight; political risk; policy risk; portfolio choice

Political Risk and Capital Flight

The Rule of One-Third guaranteed wives one-third of their husband's estate upon marital dissolution through death or divorce. We document the historical ubiquity of this legal construct and show that without a wife's residual claim on her husband's estate, children's outcomes are imperiled. Using ancient Roman law as an example, we argue that the patriarch, or paterfamilias is the main legal entity with an interest in creating and enforcing the Rule of One-Third. Then, in a game-theoretic model, we demonstrate that the Rule of One-Third obtains when mothers' and fathers' marginal impacts on their children's human capital are equal. We conclude that the Rule of One-Third arose in many societies because it places the cost of marital dissolution on the household rather than society and solves a complex contracting problem between the husband and wife when each is specialized in tasks the other cannot perform well.marriage; divorce; human capital; institutions

The Choice of Institutions: The Role of Risk and Risk-Aversion

Institutions can affect individual behavior both via their efficiency impact and via their risk reducing mechanisms. However there has been little study of the relative importance of these two channels in how individuals choose between simultaneously extant institutions. This paper presents a simple model of institutional choice in a labor market when there is a risk/reward trade-off, and tests the predictions of the theory. Using a novel empirical approach that adapts an ARCH-in-mean to cross-sectional survey data from China, we find that risk and risk aversion are strongly related to the choice of a labor market institution. Further, risk and risk aversion are quantitatively more important than the sectoral wage differential in explaining employment institution choices. Specifically, we find that wage risk has two orders of magnitude greater impact on labor market institutional choice than the wage difference, with a one standard deviation increase in earnings risk reducing the number of workers choosing jobs in the private (risky) sector by 22%.Institutions, Risk, Labor Market, Risk Aversion

Endogenous Growth Through Government Policy

This paper illustrates two reasonable political decision mechanisms by which fiscal policy generates endogenous growth under a constant returns to scale production technology, absent externalities. Based on the dynamics induced by various policy choices, we demonstrate that policies that maximize capital deepening generate balanced growth and are Pareto optimal. In contrast, policies chosen by the median voter produce balanced growth, but are suboptimal.public investment; positive political economy; median voter theorem; endogenous growth

The Path to Prosperity: A Political Model of Demographic Change

This paper presents a formal model that characterizes the political mechanisms of demographic change, establishing a critical link in economic development. We demonstrate that fertility decisions are determined by three fundamental political variables: political stability, political capacity and political freedom. Modeling strategic multi-objective policy setting by the government, we derive a set of equilibrium conditions that enable poor nations to escape a poverty trap and to successfully develop. Empirical tests for a sample of 100 countries from 1960 to 1990 provide strong support for the propositions of the formal model. In particular, we show that political stability, political capacity and political freedom all lead to reductions in birth rates. We conclude that politics can be either a stimulant or barrier to economic development.