earlier we looked at a paper iii Johnson and Robinson who
asked what's the effect of having strong property rights on economic
development?
And in the data we saw the countries with strong property rights
tended to have higher economic development but we know that might not
be a causal effect because of compounding variables and other
things, so in fact in the papers the authors write to estimate the
impact of the institutions on economic performance we need a source
of exogenous variations in institutions.
So what are they going to do? They are going to do an
instrumental variables analysis.
Now remember the unit analysis is countries.
Their outcome variable is the measure of economic development.
GDP per capita in the year 1995.
Their treatment variable is a measure of property rights, the average
protection against appropriation risk.
So
we need a third variable the instrument, to do an instrument of variables
analysis what are they going to use, European settler mortality
during the colonial era.
So what do I mean exactly and what's their idea? Well in the years
1600 to 1800 European countries were sailing around the world and colonizing
various parts of the world.
Some of these places had more diseases and other things that made
it more hostile environment to live in, and so mortality was higher
in these places.
So in the places that had lower settler mortality where it was more
likely For the European settlers to stay alive, they were more likely
to get permanent European establishments, and those places then
imported institutions from Europe that protected property rights
that then persisted to the year 1995.
So that first argument suggests that the relevant assumption holds,
that places with lower settler mortality in the colonial era 1600
and 1800 actually implied that those countries have higher property
rights in the year 1995.
So the Instruments settler mortality actually affects the treatment
variable property rights, that's the first assumption we needed.
The second assumption is that settler mortality the instrument does
not directly affect economic development in 1995 GDP.
So that is plausible because you think that well although
the institutions persisted over hundreds of years, GDP today probably
doesn't depend directly on whether settlers were dying in the year
1600 or not.
So finally the third assumption they need is
exogeneity. And they argued that this holds because the fact that some parts
of the world had higher risk of disease and some parts of the world
had lower risks is just unrelated to other factors that would affect
GDP in the year 1995.
So that suggests that the third assumption
exogeneity holds.
So with all of this assumptions they can then proceed to do an instrumental
variables analysis to learn about the effect of property rights
on economic development.
So before we go there I just note that this paper is very well known
and also is quite contentious and that's pretty common with an instrumental
Variables analysis because as we've talked about in another module
two of the three assumptions are irrefutable.
You can't refute them with the data you have.
You have to use other arguments to show that they hold.
Another issue that arises here is how do we even measure this instruments?
How do we measure settler mortality in the year 1600,
1700 or 1800 that was a long time ago.
So there are issues with this analysis but it's been very influential
and we'll put this issues aside and just see what they get.
So the first thing remember the main idea behind instrumental variable
analysis is that we look at the correlation between the instrument
and the outcome and that correlation reflects the true causal effect
of the treatment on the outcome.
So here on the horizontal axis, we've plotted the instruments, log settler
mortality.
So countries with higher mortality are over here like Mali Countries
with lower settler mortality are over here like Australia and
US.
On the vertical axis we've plotted our outcome variable.
Log GDP per capita in 1995 so countries down here like Mali have
lower GDP per capita in 1995.
Countries up here have higher GDP per capita in 1995, like Australia
and the US and you can see there is a correlation between this two
variables countries that have lower mortality tended to have higher
GDP in 1995.
Now remember this is a variable that's measured in the year 1600
to 1800, this is a variable that's measured in the year 1995.
So, assuming that this instrumental variable satisfies those three
assumptions, we know that this co-relation here reflects the true
causal effect of property rights on economic development.
So in the next module we'll see how they compute that exact effect
by using two stage least squares
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