Why Do Some Countries Produce So Much More Output Per Worker Than Others?

1. Why Do Some Countries Produce So Much More Output Per Worker Than Others? Robert E. Hall and Charles I. Jones

2. Institutions Affecting Income Level

3. Findings • Many growth theory predictions can be considered in a CROSS-SECTION context by examining income levels across countries • Large output per worker variation across countries ONLY PARTIALLY explained by differences in physical capital and educational attainment. • Differences in SOCIAL INFRASTRUCTURE across countries cause LARGE DIFFERENCES in capital accumulation, educational attainment and productivity and thus LARGE DIFFERENCES in income across countries. • Using distance from the equator and language data, they conclude that their finding that DIFFERENCES IN SOCIAL INFRASTRUCTURE CAUSE LARGE DIFFERENCES IN INCOME is robust to measurement error and endogeneity concerns.

4. Hypothesis • Differences in capital accumulation, productivity and output per worker are fundamentally related to differences in social infrastructure

5. Why Levels? • Levels capture differences in LR economic performance most directly relevant to welfare • Easterly, Kremer, Pritchett and Summers: Low correlation of growth rates across decades (suggest growth rates across countries may be mostly transitory) • Growth regressions in Mankiw, Romer and Weil and Barro and Sala-i-Martin motivated by neoclassical growth model where LR growth rates are the same across countries/regions

6. Output per Worker Inputs, Productivity Social Infrastructure

7. Levels Accounting • Three approaches. Use simplest Cobb-Douglas Approach

9. Productivity and Output per Worker • Figure I

10. Table I

11. Observations • Output per worker in the five countries in 1998 with highest levels of output per worker was 31.67 times higher than in the five lowest countries… most of this difference due to differences in productivity (a factor of 8.3) • With no differences in productivity output per worker in the five richest countries would only be 4 times larger than in the five poorest countries

12. Incentives • The fundamental determinant of a country’s LR economic performance is its social infrastructure (the institutions and government policies that provide the incentives for individuals and firm in an economy) • Incentives can encourage productive activities and predatory behavior • Benefits of social control of diversion: • Productive units rewarded for the full account of their production

13. Diversion • Where social control of diversion is effective, individual units need not invest resources in avoiding diversion • The suppression of diversion central element of favorable social infrastructure • Some diversion (taxation) to carry out deterrence • Rent-seeking (diversion in all countries and major diversion in advanced economies) • Successful economies limit scope of rent-seeking

14. ESTIMATING EFFECT OF SOCIAL INFRASTRUCTURE • Measurement of Social Infrastructure • Ideal: wedge between private return to productive activities and social return to productive activities • Practice: Wedges not quantifiable. Must rely on proxies for social infrastructure and recognize potential for measurement error

15. Government Antidiversion Policies) • Index of GADP created by Political Risk Services. Rates 130 countries in 24 categories. Use the average of 5 categories: • Law and order • Bureaucratic quality • Corruption • Risk of expropriation • Government repudiation of contracts • Index scale 0 to 1 (higher values for govts with more effective policies)

16. Extent to which a country is open to international trade • Sachs and Warner 1995 index measures the fraction of years during 1950-1994 that the economy has been open • [0, 1] scale • 5 criteria for being open

17. Structural Model

18. Proxies • They use proxies for social infrastructure • Proxy related to TRUE social infrastructure through random measurement error

20. Instruments • Distance from equator (Absolute value of latitude in degrees divided by 90 to place it on a 0 to 1 scale) • Extent to which primary languages of Western Europe spoken as first languages today • 1. Fraction of a country’s population speaking one of the five primary Western European languages as a mother tongue (incl. English) • 2. Fraction of population speaking English as mother tongue • (Log) Predicted trade share of an economy (Frankel and Romer)

21. IVs • Positively correlated with social infrastructure • Lack of correlation with error (Was European influence more intensively targeted toward regions of the world more likely to have high output per worker today?)

22. Figure II

23. Table II

24. Observations • A DIFFERENCE OF .01 IN SOCIAL INFRASTRUCTURE IS ASSOCIATED WITH A DIFFERENCE IN OUTPUT PER WORKER OF 5.14 PERCENT. • TESTING THE OVERIDENTIFYING RESTRICTIONS OF THE MODEL: restrictions not rejected • TESTING FOR EQUALITY OF TWO VARIABLES OF SOCIAL INFRASTRUCTURE INDEX: restriction not rejected • MAIN RESULT ROBUST TO MORE LIMITED IVs AND USING ONLY 79 COUNTRIES (complete date set)

25. HOW MUCH VARIATION IN TRUE SOCIAL INFRASTRUCTURE ACROSS COUNTRIES?

26. Observations • Assuming no true simultaneity problem, (error uncorrelated with S~) we can calculate the standard deviation of TRUE SOCIAL INFRASTRUCTURE • Measured social infrastructure ranges from a low of .1127 in Zaire to a high value of 1.0000 in Switzerland. • THE DIFFERENCES IN SOCIAL INFRASTRUCTURE CAN ACCOUTN FOR A 25.2 fold difference in output per worker across countries. • Output per worker in the richest country (US) an din the poorest country in our data set (Niger) differ by a factor of 35.1

27. COUNTRIES MOST INFLUENCED BY EUROPEANS IN PAST CENTURIES HAVE SOCIAL INFRASTRUCTURES CONDUCIVE TO HIGH LEVELS OF OUTPUT PER WORKER AND HAVE HIGH LEVELS OF OUTPUT PER WORKER. This means that INFRASTRUCTURE IS A POWEERFUL CAUSAL FACTOR PROMOTING HIGHER OUTPUT PER WORKER.

28. Reduced-Form Results • RF equations document close relationship between instruments and actual social infrastructure. • Combined, they explain a substantial fraction of the variance of the social infrastructure index • The IVs are closely related to LR economic performance

29. Table III

30. Table IV

31. Table V

32. Observations • Differences in social infrastructure are sufficient to account for the bulk of the observed range of variation in capital intensity, human capital per worker, and productivity. • (Interpreted through an aggregate production function, these differences account for MUCH of the variation in output per worker)

33. Table VI