Answer Happy

2. The institutions hypothesis Answer the following questions based on the paper by Acemoglu, Johnson, & Robinson (2001), and on our discussion of their paper during lecture. Acemoglu, Johnson, & Robinson (2001) use historical data to identify the effect of institutions on economic performance. Specifically, they use cross-sectional data on a set of former colonies, indexed by i. Denote per capita income in 1995 by Yi, average protection against expropriation risk in 1985-1995 as Rị, and a vector of country covariates by Xį. Suppose that the country covariates are latitude and continental dummies (Asia, Africa, and other continent). A naïve OLS regression can be written as In yi = pi + aR; +yX; + Ei (a) Why isn't there an i subscript for the constant term u? (b) Why does R¡ represent institutions? What kind of institutions? Why do we think it would have a positive causal relationship with yi? Elaborate. (c) Write down the strict exogeneity assumption that is necessary for consistent estimation of the coefficient a. (d) Propose two possible ways in which the above assumption would be violated and, in each case, explain the expected direction of bias. Using settler mortality Mị as an instrument for Rị, they use an instrumental variable strategy to overcome possible identification issues above. Nonetheless, for this to be valid, Mị must satisfy the relevance condition and the exclusion restriction. (e) In this case, is the exclusion restriction testable? Why/why not? (f) Describe two possible reasons why the exclusion restriction may not hold. Make sure you distinguish these reasons from the ones you proposed in part (d).