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Special Case:

Economic Growth and Cultural Change

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The scope of the paper

• The scope of this empirical work is to contribute to the interpretation of gross domestic product (GDP) annual growth rates, with specific reference to the basic growth factors (capital, labour and human capital) and the cultural background as part of the “remaining factors”.

• The topic, of course, is quite old. As Acemoglu (2009) remarks, references to the general circumstances of the environment, that possibly have an impact on attitude and human conventions, can be found in Montesquieu ([1748], 1989), Machiavelli ([1519], 1987) and Marshall ([1890], 1997).

• The role of religion was stressed by Weber (1930, 1958) and also the more contemporary Harrison and Huntington (2000) and Acemoglu et al. (2005), while Putnam (1993) broadened the meaning of cultural factors and trust, as they relate to the concept of social capital.

• Culture and economics can be seen as two of the more powerful forces shaping human behaviour (Throsby 2001).

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Contribution to the literature I. It extends the growth function adding the cultural background of the

societies and interpreting its impact to the GDP annual growth rates

II. The paper considers the relationship of the cultural background in combination with the “basic growth factors” (capital, labour, human capital).

III. It contributes towards the quantification of naturally qualitative forces responsible for the growth process. Therefore, it sheds light on a very well-known and easily accepted, but not heretofore typically quantified and thus manageable, measurement and analysis -a field of the test for growth factors.

IV. The issue of endogeneity between GDP annual growth rates, the basic growth factors and the cultural background is investigated.

V. Cultural background variables are divided in two main groups. The first one, consists of the variables that represent the “Efficiency Orientation” of the societies and the second one, consists of the variables that represent the “Ethos” of the societies.

VI. Through a sensitivity analysis we look at 8 different cases of a change in the structure of the cultural background of the societies and the new conditions created for the GDP annual growth rates.

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The contribution and theoretical construction of the “remaining factors”

• In the neoclassical theoretical substratum of Solow and Romer, the uninterpreted part of growth -the rate of change of the “remaining contributing factors to growth” -is the so called Solow residual (Solow 1957).

• It constitutes the part of growth that cannot be interpreted by the contribution of capital, labour, human capital and technology.

• Usually, it is attributed to factors such as the cultural and institutional background of the growth process that characterises a society.

• It has been argued that the unexplainable part of development, excepting the contribution of capital and labour, can be attributed to technological change (Aghion and Howitt 1998; Romer 1990), to the conditions of acceptance of new technologies (Parente and Prescott 1997) or to the role of endogenous forces of growth or external economies through the accumulation of human capital (Lucas 1988; Romer 1986).

• Finally, economic policy (Easterly and Levine 2001), the degree of economic extroversion (Frankel and Romer 1999), the role of the financial system (Levine et al. 2000) and the effects of macroeconomic policies and inflation (Fischer 1993) can all have significant influence.

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The contribution and theoretical construction of the “remaining factors”

• According to the growth accounting literature and following the Cobb-Douglas hypothesis of constant returns to scale, the sum of the exponents (capital and labour elasticities) adds up to one.

• Because we know the amount by which GDP has grown and the extent of this growth that is due to capital, labour and human capital, we can interpret what remains as an effect of the “remaining contributing factors” to growth. This is the increase of total productivity (Total Productivity Factor).

• In this paper, we focus on cultural background as an influential element of growth which can be considered as “remaining factor”. Although we intuitively comprehend its importance, its quantification and formal analysis can prove challenging.

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The definition of cultural background

• “Culture is defined as a set of shared values, beliefs and expected behaviours” (Hayton et al. 2002).

• The cultural characteristics of the societies reflect psychological social stereotypes, which have been created in the long run and are prior human constructs to the current conditions of transactions and institutions.

• These characteristics present stability through time. In general, cultural stereotypes present great resistance towards change and to their own redefinition (Johnston 1996).

• Thus, cultural background is constituted by cultural syndromes that can be considered as intermediate mental constructions that originate from the distant past and connect it with the present (Hong 2009).

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The role of culture to growth

• Grief (1994) highlights the fact that different cultural values lead to different societal structures of economic relationships and affect the dynamics of wealth distribution. He examines the phenomenon of economic growth as it relates to cultural stereotypes and the effect of such stereotypes on economic transactions.

• From the late 20th century and onwards, there is a gradual emergence of literature with the use of empirical models designed to explain the impact of cultural background on growth (Hofstede και Harris Bond 1991; Harisson 1992; Granato et al. 1996; Swank 1996; Marini 2004; Noland 2005; Pryor 2005).

• Ο De Jong (2009) explain how culture affects institutions and economic activity. He considers culture as the sum of the values and attitudes that pervades a group of people who directly or indirectly affect the outcome of the economic process.

• Bucci and Serge (2011) suggest that in a world where complementarities are important (especially those involving human capital), culture is of particular interest in explaining economic growth.

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The data• The 41 countries that constitute the sample, represent 90,44% of

World GDP (2007).

• Dependent variable (GDP): The average gross domestic product annual growth rates in constant prices for the time period of 2001-2006.

• Capital: the investment rates as a GDP percentage variable for the time period 1998-2003, leaving a time delay of approximately 3 years to achieve investment returns.

• Human capital: the average years of schooling for the people aged over 25 years old (2000). Years of schooling have long been considered as a good proxy for human capital (Kyriacou 1991; Benhabib and Spiegel 1994; Alonzo 1995; Klenow and Rodriguez-Clare 1997; Browning et al. 1999; Hall and Jones 1999; Barro and Lee 2000; Pritchett 2001; Baier et al. 2002; Heckman et al. 2003; Rangazas 2005; Cohen and Soto 2007; Brunello et al. 2010).

• Labour: average working population annual growth rate for the period 2000-2005 (Owen et al. 2007).

• Cultural Background: Lastly, for the variables expressing cultural background, we use τις εννέα πολιτισμικές διαστάσεις της GLOBE study (House et al. 2004).

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The methodology employed

• The basic model examined is the following:

GDPi = β1 * CAPi + β2 * Li + β3 * HCi + β4 * Ci + εi

where the dependent variable (GDP) is the average GDP annual growth rate in constant prices, CAP (capital) is defined by the average investment rate (GDP percentage); L (labour) is the sum of “n+g+δ”, where n is the average population growth of the working population aged between 25 and 64 years; g is the growth rate of technology and δ the depreciation rate; HC (human capital) is defined by the average years of schooling of the nations in the initial year period; C is the PC that arises from the variables that represent cultural background. The subscripts i refer to the countries used.

Based on Mankiw et al. (1992), we assume that the annual rates of technology growth (g) and depreciation (δ) are constant and sum to 0.05.

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The methodology employed

• We apply Principal Component Analysis (PCA) to the group of variables expressing cultural background.

• PCA is a factor extraction method used to form uncorrelated linear combinations of the observed variables, which is then used to obtain the initial factor solution, when a correlation matrix is singular. The first principal component (PC) has a maximum variance. Successive components explain progressively smaller portions of the variance and are all uncorrelated with each other.

• The effect of the PCs on GDP is examined through a linear regression using the ordinary least squares method (OLS), as in the model presented above. In our linear regression, we use the principal components with the greatest variances (initial eigenvalues>0.91).

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The methodology employed

Endogeneity check• To check for endogeneity between the variables used, we use a

version of the Hausman test (Hausman, 1978) proposed by Davidson and MacKinnon (1989, 1993), which employs a test statistic for exogeneity by running an auxiliary regression.

• In this test, we use a set of instrumental variables that are correlated with the “suspect” variable but not with the error term of the regression that applies GDP as a dependent variable.

• Only if endogeneity is not present will the OLS estimates be consistent and unbiased.

Sensitivity Analysis• Furthermore, a sensitivity analysis on this basic scenario is

included. The scope of this experiment is to evaluate the effect of culture on GDP annual growth rates under changing circumstances in the societies.

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The methodology employed

• We divide the cultural background variables in two main groups.

• The first one, consists of the variables that represent the “Efficiency Orientation” of the societies which are the performance orientation, the future orientation, the assertiveness, the power distance and the uncertainty avoidance.

• The second one, consists of the variables that represent the “Ethos” of the societies; the attitudes and the way of living of the societies. These variables are the gender egalitarianism, the institutional collectivism, the in-group collectivism and the human orientation.

• Through sensitivity analysis we conduct, we made all possible eight different cases where the values of the variables of each group are improved, weakened or remain unchanged. To get improved/ weakened all variables are increased/ reduced by 30% for the countries scoring below/ over the average score of the sample. For power distance and uncertainty avoidance, which are adverse scored, to get improved their values are reduced by 30% for the countries scoring over the average score of the sample (and vice versa).

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The methodology employed

The Sensitivity Analysis

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The methodology employed

Structural change check

• In order to reach these goals (and apart from the description of the new findings), a structural change check is performed relating the alternative circumstances to the basic scenario.

• In effect, for each one of the cases of the sensitivity analysis, we constructed two groups of 41 observations.

• These two groups make a new variable for each of the variables used. The first (group 1) concerns the variable’s prices in the basic scenario, and the second (group 2) concerns the variable’s prices for each case of the sensitivity analysis.

• The estimates concerning the statistical importance of new factors that are created led us to some conclusions regarding the new configuration and conditions of GDP annual growth rates.

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The empirical results

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The empirical results

The basic model

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The empirical results

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Discussion of the results

• To a great degree, this paper succeed in highlighting the importance of cultural background in interpreting GDP growth rates. The empirical results are exceptionally encouraging.

• The interceptive and promoting factors of annual growth rates are defined with considerable clarity, to such an extent as to highlight the importance that the improvement of the special conditions of growth would have, in the way the growth rates are formed.

• The empirical results confirm the influence of the basic growth factors to the GDP annual growth rates.

• Regarding the cultural background, the “Ethos” of the societies has a positive impact in shaping the GDP annual growth rates, while from the “Efficiency Orientation” factors only the assertiveness of the societies seem to affect (negatively) the GDP annual growth rates.

• Investments in cultural variables representing “Ethos” in the societies may represent an important engine of long-run economic growth.

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Discussion of the results• Furthermore, through sensitivity analysis, that exhausts the

possibilities of reality, the effect of special circumstances that improve societies have been established, as far as promoting and interceptive factors are concerned.

• Statistically significant structural changes occur only in cases where cultural values that reflect the “Ethos” are reduced (Cases 1-3) and where these are kept constant (Cases 4 and 5), whatever happens to the values that reflect the “Efficiency Orientation” cultural background.

• Thus, there is a major role of “Ethos” in shaping the GDP annual growth rates. Reducing “Ethos” acts negatively on GDP annual growth rates. Simultaneously when “Ethos” is stable, the statistically significant structural change is the entry of new variables that reflect the cultural background (C4 ΄), whatever the change in “Efficiency Orientation” factors.

• In general, in almost all cases of the sensitivity analysis, the cultural background appears to act negatively in the formation of GDP annual growth rates. This, coupled with the fact that in the three cases where the “Ethos” improved by 30% were not observed statistically significant structural changes, confirms the positive effect of the “Ethos” of the societies to the GDP annual growth rates.

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Discussion of the results

• A shortcoming of the present paper could be that the sample was reduced during the effort to find common data among different countries for the variables used.

• Also, the fact that the use of the variable “years of schooling” as human capital ignores withinyear investments of time and investment in products and services that increase the quality of one year of training (Krueger and Lindahl 2001; Cohen and Soto 2007). It also ignores the dimension of learning from living in communities (Feinstein et al. 2006).

• Future research may analyze the contribution of the basic growth factors and cultural background in addition with other factors representing the remaining factors in the growth process. Such factors could be the transaction characteristics of the societies or the political and the economic institutions of the economies.