Endogenous Institutions and Economic Outcomes

Abstract

To evaluate the relative importance of a culture of cooperation and inclusive political institutions, I divide Europe into 120 km×120 km grid cells, and exploit the exogenous variation in both institutions created by medieval history. I document strong first‐stage relationships between present‐day norms of respect and trust and the severity of consumption risk—i.e. climate volatility—over the period 1000–1600 and between the inclusiveness of present‐day regional political institutions and the factors that raised the returns on elite‐citizenry investments—i.e. terrain ruggedness and direct access to the coast. Building on these first stages, I show that only culture has a first‐order effect on income, even after controlling for country fixed effects, proxies for the alternative roles of the excluded instruments, factors modulating the roles of institutions, and intermediate outcomes. Two possible explanations for these results are that more inclusive regional political institutions might have impeded, in the early modern era, state‐building and market integration, and that in modern representative democracies, they are irrelevant in easing the monitoring of politicians by voters when the latter are not morally compelled to punish political malfeasance or the former have weak civic virtues. Macro and micro evidence supports these ideas.