Econ 302.
Econometrics
Bilkent University
Department of Economics
Lab Exercise 7
Taskin
INSTRUMENTAL VARIABLES
In growth equation, the pace of output growth is perceived as the result of economic and noneconomic factors in the country. One such exercise examines the role of “institutions” on output growth.
The paper written by Daron Acemoglu, Simon Johnson and James Robinson “The
Colonial Origins of Comparative Development: An Empirical Investigation”, published in the American Economic Review, December 2001, vol. 91, pp1369-1401, examines the role of ‘property rights’ in the output growth. The presence of secure property rights will create an advantage in creating faster capital accumulation and output growth.
However, a simple regression of GDP per capita on a measure of property rights may suffer from endogeneity problem or reverse causation of higher income also
‘causing’ better and stronger property rights in the economy. Hence simple OLS will create a biased and inconsistent estimates.
The paper makes use of the Instrumental Variable estimation technique and found one variable strongly correlated with property rights (institutions) but independent of the error in the equation because of no intertemporal correlation. (Not related in the same time period) . This variable is “settler mortality” for the countries which has colonization period in their history.
Settler mortality is seen as a predictor of good institutions, hence property rights because high death rates in the first settlers forced the colonizers to establish good institution in the countries from which they want to extract resources. The good institutions then imply good institutions now.
Daron Acemoglu’s web site provides data for 64 ex-colonies:
Variables:
Counryn: countryname
Shortnam: country abbreviaion
Lgdp: log of GDP per capita in 1995
Logmort: log of settler mortality
Latitude: absolute latitude of capital
Prot: measure of protection of property rights
Euro: proportion of population of European descent in 1975

The estimating equation is;
Logy i
= m + a
R i
+
X i
' g + e i
Where the variable of interest is the R and the coefficient is a
.
OLS estimations
1.
Conduct an OLS estimate. What are the properties of the estimate? How do you interpret the coefficients? You may also use control variables such as Latitude.
( estimate using the file colony64_2.dta in stata or XXX in eviews, conduct robust estimation, you can reproduce the 2 nd and 5 th column of Table 1)
2.
Plot Log y and R.
How to deal with the possible endogeneity problem ,
Output growth has an impact on institutional development. What variables might be an instrument for R, protection of property rights.
Theoretically it is expected that present institutions are functions of past institutions and hence,
R i
= l
R
+ b
R
C i
+
X ' i g
R
+ u
R
where C is the past institutions.
Furthermore past institutions depend on measure of early settlements S with the following function:
C i
= l
C
+ b
C
S i
+
X ' i g
C
+ u
C
,
Early settlements are functions of mortality rate of the early colonies, log of M, with the following function;
S i
= l
S
+ b
S log M i
+
X ' i g
S
+ u
S
Hence, the log of mortality rates in the early colonies can be used as an instrument for R, protection of property rights today.
3.
To see the instrument relevance let’s plot the relationship between R and log M.
4.
Estimate the relationship and see what variation of R does the log M explains.
Compute the fitted value of Rhat in this equation. (First stage of the 2SLS)
5.
Estimate the relationship between growth rate and fitted value of R, (Rhat). This is the second stage of the 2SLS
These are not reported in the article, since most researchers will conduct 2SLS by using the given software, which reports the corrected std errors, hence reliable t stats)
6.
Estimate the IV directly.
You can reproduce the same results in Table 4 in columns (1) and (2).
If you use the 2SLS command the EVIEWS should produce the same results, with some probability of minor difference resulting from difference in algorithms.

7.
Which of the three methods would you prefer and why hint: explain why standard errors will be different in a part c and d.
Overidentification tests
8.
Check for overidentification.
Stata Program commands regress logpgp95 avexpr, robust ivreg logpgp95 (avexpr=logem4), first ivreg logpgp95 (avexpr=cons00a), first ivreg logpgp95 (avexpr=cons00a logem4), first ….for overidentification test (Hausman) estimates store efficient ivreg logpgp95 (avexpr=cons00a), first estimates store consistent hausman consistent efficient ivreg logpgp95 (avexpr=cons00a) logem4 ………. for another overidentification test (with mortality as an independent variable directly in the equation rather than an instrument.)