Question 1: Political and cultural change (20 points)
10 points for the first part of the question: “What empirical strategies do they use in the paper and how
do they argue for the internal validity of the results?”
For full points they should describe that they use a diff in diff, the potential problem of omitted variables
bias in the sense that something else drives both cable and the effects, e.g. modernity or income.
They should write that the authors account for this by investigating what determines cable and that they
then control for these things.
The main argument for a causal effect is the precise timing of the effects. This is shown both graphically
and in regressions in the paper. For full points they should write that the placebo test of introducing
cable in the future is rejected.
10 points for the second part of the question: “Shortly discuss their findings and the external validity of
the results.”
They should know what effects cable had on the different aspects. For full points, they should know what
is measured: Son preference, Domestic violence, Autonomy, and Fertility. They should also know that
the results were in the expected direction.
External validity: To other countries (e.g. would the results be the same in Canada) and within India: The
dataset only includes households with old people, no men were interviewed so we do not know much
about the mechanisms which would have been good for generalization etc. They could also mention that
it is very short term effects.
Question 2: Institutions (40 points)
40 points if all papers are described well and correctly, and if they relate the papers to each other.
Main points of the papers:
AJR: Idea is to use potential settler mortality as an instrument for settlements. The theory is that settlers
brought with them institutions and that these institutions persisted. The 2 criteria for using IV: Relevance
and validity. They argue that the exclusion criterion is satisfied but what they really only show is that
settlements are important, not really institutions.
G: Argue that the measurement of institutions commonly used is flawed since they are not stable over
time and since they do not measure anything fundamental. They have other “objective” measures in the
sense that they use rules written in constitutions and show that these are not correlated with the
commonly used measures. Furthermore, settler mortality is not correlated with these measures. Then
they show that the exclusion restriction in AJR is problematic. We do not know that it was institutions
the Europeans brought with them, it may be something else. They elaborate on the possibility that it was
human capital.
NW: Look at the long run effects of the slave trade on trust. In relation to the previous papers this is
important since it argues that culture is important for long run development. The theory is that people
use rules of thumb and that once these rules have changed, they are very persistent. The empirical
strategy uses historical data and distance to the coast is used as an instrument. The exclusion restriction
for the instrument is argued for by showing that distance to the coast is not correlated with trust in areas
not affected by the slave trade. For full points, they should also write something about that NW test the
mechanisms internal vs external transmission over time and find that it is mostly driven by the internal
channel. I.e. it is not only driven by the fact that bad institutions were created in areas affected by the
slave trade, but by personal trust in other people.
MP: The connection of the MP paper to the previous ones is that it investigates even longer term
institutional differences, i.e. the ones that existed before colonialization. They find that current day
national level institutions are not important for economic development. The empirical strategy consists
of using historical data as in NW, but also connect it to nighttime light. The advantage of using nighttime
light is that it exists on a fine level of aggregation so areas close to the border can be compared. The
main innovation of the paper is to use ethnicity based fixed effects and thereby comparing the same
historical groups but across national borders. They also do a geographical regression discontinuity
approach to see whether nighttime light jumps at the border. Note that this can be done as African
borders were quite random. Both of these approaches show that current institutions are not able to
predict outcomes across countries once the old institutions, culture, and ethnicity are controlled for. Ok,
so what about the other way, does old institutions predict differences across groups even within current
countries? Yes. They formalize this by also testing one particular aspect of institutions, state capacity.
They should note, however, that the causal claims for this latter question are not as strong since old
ethnic groups were not formed randomly.
For full points they should discuss the articles in relation to each other.
Question 3: Credit (15 points).
10 points for reaching the main equation and saying that default rates are not high for poor people so it
cannot drive it.
Main equation:
The expected profit of the lender is p(1  i) L  (1  r ) L
Under perfect competition there are no profits, hence: p(1  i ) L  (1  r ) L =0
Solving for the interest rate gives:
i
1 r
1
p
Implication: Even under perfect competition informal sector interest rates are very sensitive to the
default risk.
5 points for correctly discussing the twist.
So, it is not actual default, but the cost of avoiding default seems to be the most important issue. The
problem is that low default rates require hard and therefore costly work.
Moreover, many expenses that the lender must incur do not go away for small loans. Basic information
must be collected even for small loans. As a result, the smaller the loan, the larger the monitoring and
screening costs will be as a fraction of the loan size. (This last point is not necessary).
Question 4: Inequality (25 points).
Here, the students should refer to the various approaches discussed by Galor (2012). However, some
insights may also be taken from Ray.
A) Inequality may lead to lower growth
They should discuss the Political Economy approach:
Alesina and Rodrik (1994) and Persson and Tabellini (1994):
- Redistribution policies (taxes) chosen by the median voter
- In an unequal society the median voter is poorer than the mean
- Taxes imposed on the margin are distortionary and slows growth
and the Credit Market Imperfections approach:
In the presence of credit market imperfections inequality leads to under-investment in education
B) Inequality may be beneficial for growth
The Classical approach.
Assumes marginal savings rate increases with wealth.
Inequality channels resources towards individuals whose marg. propensity to save is higher, giving:
- higher aggregate savings
- more capital accumulation
- economic growth
Show in a figure that with an increasing marginal savings rate full equality leads to lower savings than
inequality.
For full points: In the Galor and Zeira model inequality may hurt growth in a rich economy, but inequality
may enhance growth in a poor economy. The reason is that in a very poor economy, there will be few
people who afford education. Redistribution is harmful for growth if it means that these people cannot
afford education anymore, and the extra income for the poor is not enough for them to afford education.
(Alternatively they can mention this under C)
C) Inequality may be beneficial for growth in early stages of development, but may be harmful for
growth at later stages of development
The unified theory of inequality and growth (Galor and Moav 2004):
The effect of inequality on growth depends on the relative return to physical and human capital. During
early industrialization physical capital was the prime engine for growth. Inequality channels resources to
towards people with a high marg. propensity to save and invest in physical capital. At later stages of
development, human capital became more important, and the relative return to physical capital
decreased. Equality alleviates adverse effects of credit constraints on human capital formation. As there
are diminishing returns to human capital, investments spread among individuals are growth-enhancing.
A discussion of Ray’s S-shaped savings function is also relevant, but not necessary for full points.