Endogenous (In)Formal Institutions

Abstract:     
Albeit the relevance of democracy and strong norms of cooperation in shaping the economy is well documented, we still lack a framework identifying the origins and isolating the separate roles of these institutions. In our model, citizens and elite members either hedge against consumption risk with everyone else or invest with a member of a different group. First, each group costly instills into its members a psychological gain from cooperating --- i.e., culture. Next, the elite decides whether to allow the citizens to fix the share of investment surplus spent on public good production --- i.e., democracy---or choose herself. Finally, agents are randomly matched. The incentive to cheat when risk-sharing and the investment surplus are each shaped by an exogenous factor --- e.g., geography. In equilibrium, democratization is mainly and positively driven by the factors fostering time-inconsistency in investment, and cultural formation is strengthened by the forces aggravating consumption risk when they are not too harsh. Also, shocks that curb the investment value and so threaten democracy can push the citizens to overinvest in culture to credibly commit to cooperating in investment. Estimates based on the geography, the diffusion of monasticism, and the political institutions of 90 European regions over the 1000-1600 period are consistent with this prediction.

Number of Pages in PDF File: 43

Keywords: Geography, Culture, Democracy, Development

JEL Classification: O13, H10, Z10, O10

working papers series