Hall & Jones (1999)

Why Do Some Countries Produce So Much More Output Per Worker Than Others?
Author(s): Robert E. Hall and Charles I. Jones

Reviewed work(s):
Source: The Quarterly Journal of Economics, Vol. 114, No. 1 (Feb., 1999), pp. 83-116
Published by: Oxford University Press
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WHY DO SOME COUNTRIES PRODUCE SO MUCH MORE
OUTPUT PER WORKER THAN OTHERS?*
ROBERT E. HALL AND CHARLES I. JONES
Output per workervaries enormouslyacross countries.Why? On an account-

ing basis our analysis shows that differencesin physical capital and educational
attainment can onlypartially explain the variation in output per worker-we find
a large amount ofvariation in the level ofthe Solow residual across countries.At a
deeper level, we documentthat the differencesin capital accumulation, productiv-
ity,and thereforeoutput per worker are driven by differencesin institutionsand
governmentpolicies,whichwe call social infrastructure.We treat social infrastruc-
ture as endogenous,determinedhistoricallyby location and otherfactorscaptured
in part by language.
I. INTRODUCTION
In 1988 output per worker in the United States was more

than 35 times higherthan output per workerin Niger. In just over
ten days the average worker in the United States produced as
much as an average worker in Niger produced in an entire year.
Explaining such vast differencesin economic performanceis one
ofthe fundamentalchallenges ofeconomics.
Analysis based on an aggregate productionfunctionprovides
some insightintothese differences, an approach taken byMankiw,
Romer, and Weil [1992] and Dougherty and Jorgenson [1996],
among others. Differencesamong countries can be attributedto
differencesin human capital, physical capital, and productivity.
Building on their analysis, our results suggest that differencesin
each element ofthe productionfunctionare important.In particu-
lar, however, our results emphasize the key role played by
productivity.For example, consider the 35-fold differencein
outputper workerbetween the United States and Niger. Different
capital intensities in the two countries contributeda factorof 1.5
to the income differences,while differentlevels of educational
attainment contributed a factor of 3.1. The remaining differ-
ence- a factorof7.7 -remains as the productivityresidual.
* A previous version of this paper was circulated under the title "The
ProductivityofNations." This research was supportedby the Center forEconomic
Policy Research at Stanfordand by the National Science Foundation under grants
SBR-9410039 (Hall) and SBR-9510916 (Jones) and is part ofthe National Bureau
ofEconomic Research's programon Economic Fluctuations and Growth.We thank
Bobby Sinclair forexcellent research assistance and colleagues too numerous to
list foran outpouringofhelpfulcommentary.Data used in the paper are available
online fromhttp://www.stanford.edu/-chadj.
Instituteof
? 1999bythePresidentand FellowsofHarvardCollegeand theMassachusetts
Technology.
JournalofEconomics,
TheQuarterly February1999
83
84 QUARTERLYJOURNALOF ECONOMICS
The breakdown suggested by the aggregate productionfunc-

tion is just the firststep in understanding differencesin output
per worker.Findings in the productionfunctionframeworkraise
deeper questions such as the following:why do some countries
invest more than others in physical and human capital? And why
are some countries so much more productivethan others? These
are the questions that this paper tackles. When aggregated
throughthe productionfunction,the answers to these questions
add up to explain the differencesin output per worker across
countries.
Our hypothesis is that differencesin capital accumulation,
productivity,and thereforeoutput per worker are fundamentally
related to differencesin social infrastructureacross countries.By
social infrastructurewe mean the institutions and government
policies that determine the economic environmentwithin which
individuals accumulate skills, and firmsaccumulate capital and
produce output.A social infrastructurefavorable to high levels of
outputper workerprovides an environmentthat supportsproduc-
tive activities and encourages capital accumulation, skill acquisi-
tion, invention,and technologytransfer.Such a social infrastruc-
ture gets the prices right so that, in the language of North and
Thomas [1973], individuals capture the social returns to their
actions as private returns.
Social institutionsto protectthe output ofindividual produc-
tive units fromdiversion are an essential component of a social
infrastructurefavorable to high levels of output per worker.
Thievery,squatting, and Mafia protectionare examples of diver-
sion undertaken by private agents. Paradoxically, while the
government is potentially the most efficientprovider of social
infrastructurethat protectsagainst diversion,it is also in practice
a primaryagent ofdiversionthroughoutthe world.Expropriation,
confiscatorytaxation, and corruption are examples of public
diversion. Regulations and laws may protect against diversion,
but theyall too oftenconstitutethe chiefvehicle ofdiversionin an
economy.
Across 127 countrieswe finda powerfuland close association
between output per workerand measures ofsocial infrastructure.
Countries with long-standing policies favorable to productive
activities-rather than diversion-produce much more output per
worker. For example, our analysis suggests that the observed
differencein social infrastructurebetween Niger and the United
OUTPUT PER WORKERACROSS COUNTRIES 85
States is more than enough to explain the 35-fold differencein

output per worker.
Our research is related to many earlier contributions.The
large body of theoretical and qualitative analysis of property
rights, corruption, and economic success will be discussed in
Section III. The recent empirical growth literature associated
with Barro [1991] and others shares some commonelements with
our work,but our empirical frameworkdiffersfundamentallyin
its focus on levels instead of rates of growth. This focus is
importantforseveral reasons.
First, levels capture the differencesin long-run economic
performancethat are most directlyrelevant to welfare as mea-
sured by the consumptionofgoods and services.
Second, several recent contributionsto the growthliterature
point toward a focus on levels instead of growthrates. Easterly,
Kremer, Pritchett,and Summers [1993] document the relatively
low correlation of growth rates across decades, which suggests
that differencesin growthrates across countries may be mostly
transitory.Jones [1995] questions the empirical relevance of
endogenous growth and presents a model in which different
governmentpolicies are associated with differencesin levels, not
growth rates. Finally, a number of recent models of idea flows
across countries such as Parente and Prescott [1994], Barro and
Sala-i-Martin [1995], and Eaton and Kortum [1995] implythat all
countries will grow at a commonrate in the long run: technology
transferkeeps countries fromdriftingindefinitelyfar fromeach
other. In these models, long-run differencesin levels are the
interestingdifferencesto explain.
Some of the cross-countrygrowthliterature recognizes this
point. In particular, the growth regressions in Mankiw, Romer,
and Weil [1992] and Barro and Sala-i-Martin [1992] are explicitly
motivated by a neoclassical growth model in which long-run
growth rates are the same across countries or regions. These
studies emphasize that differencesin growthrates are transitory:
countries grow more rapidly the furtherthey are below their
steady state. Nevertheless,the focusofsuch growthregressionsis
to explain the transitory differencesin growth rates across
countries.' Our approach is different:we try to explain the
1. The trend in the growthliterature has been to use more and more of the
short-runvariation in the data. For example, several recentstudies use panel data
at five-or ten-year intervals and include countryfixed effects.The variables we
focus on change so slowly over time that their effectsmay be missed entirelyin
such studies.
variation in long-runeconomic performanceby studyingdirectly

the cross-sectionrelation in levels.2
The purpose of this paper is to call attention to the strong
relation between social infrastructureand output per worker.
Countries with corruptgovernmentofficials,severe impediments
to trade, poor contractenforcement,and governmentinterference
in productionwill be unable to achieve levels ofoutput per worker
anywhere near the norms of western Europe, northernAmerica,
and eastern Asia. Our contributionis to show,quantitatively,how
importantthese effectsare.
We can summarize our analysis of the determinants of
differencesin economicperformanceamong countriesas
Output per Worker
I
(Inputs, Productivity)
Social Infrastructure.
This frameworkserves several purposes. First, it allows us to
distinguish between the proximate causes of economic success-
capital accumulation and productivity-and the more fundamen-
tal determinant.Second, the frameworkclarifiesthe contribution
of our work. We concentrate on the relation between social
infrastructure and differencesin economic performance. The
productionfunction-productivity analysis allows us to trace this
relationthroughcapital accumulation and productivity.
We are conscious that feedback may occur fromoutput per
workerback to social infrastructure.For example, it may be that
poorcountrieslack the resourcesto build effectivesocial infrastruc-
tures. We controlforthis feedback by using the geographical and
linguistic characteristics of an economy as instrumental vari-
ables. We view these characteristicsas measures ofthe extent to
which an economy is influenced by western Europe, the first
region of the world to implement broadly a social infrastructure
favorable to production.Controllingforendogeneity,we still find
2. Chari, Kehoe, and McGrattan [1997] also analyze levels of economic

performance.In cross-countrygrowthregressions that include the initial level of
income and emphasize the transition dynamics interpretation,one can map the
into effectson the long-runlevel ofincome. However,
growthregressioncoefficients
we know of only one attempt to do this mapping, the prepublication version of
Sachs and Warner [1997].
that differencesin social infrastructureacross countries account

for much of the differencein long-run economic performance
around the world.
II. LEVELS ACCOUNTING
Our analysis begins by examining the proximate causes of

economicsuccess. We decompose differencesin output per worker
across countries into differencesin inputs and differencesin
productivity.
There are three approaches to the decomposition of output
per worker into inputs and productivity.One was developed by
Christensen, Cummings, and Jorgenson[1981] and involves the
comparison of each country to a reference point. A country's
productivityresidual is formedby weightingthe log-differences of
each factor input from the reference point by the arithmetic
average of the country's factor share and the reference factor
share. The second is similar, except that the factor shares are
assumed to be the same for all countries; this amounts to
calculating the residual froma Cobb-Douglas technology.Finally,
there is a method based directlyon Solow [1957], discussed in a
predecessorto this paper, Hall and Jones [1996], and summarized
below. Because the Solow method gives results quite similar to
those based on Christensen, Cummings, and Jorgenson or on
Cobb-Douglas with standard elasticities, we will not dwell on this
aspect of the work. We present results based on the simplest
Cobb-Douglas approach.
Assume that output Yi in countryi is produced accordingto
(1) Yi = Ku-(AiHi)l a,
where Ki denotes the stock ofphysical capital, Hi is the amount of
human capital-augmented labor used in production,and Ai is a
labor-augmentingmeasure ofproductivity.We assume that labor
Li is homogeneouswithina countryand that each unit oflabor has
been trained with Ei years of schooling (education). Human
capital-augmentedlabor is given by
(2) Hi = e((Ei)Li.
In this specificationthe function+(E) reflectsthe efficiencyof a
unit of labor with E years of schooling relative to one with no
schooling(4(O) = 0). The derivative +'(E) is the returnto school-
ing estimated in a Mincerian wage regression [Mincer 1974]: an
additional year ofschoolingraises a worker'sefficiency proportion-

ally by 4)'(E).3 Note that if +)(E) = 0 for all E this is a standard
productionfunctionwith undifferentiatedlabor.
With data on output,capital, and schooling,and knowledgeof
a and 4)( ), one can calculate the level ofproductivitydirectlyfrom
the productionfunction.It turns out to be convenientto rewrite
the productionfunctionin termsofoutputper worker,y YIL, as
(3) =(K.)o()=Yi a
where h HIL is human capital per worker.

This equation allows us to decompose differencesin output
per workeracross countriesinto differencesin the capital-output
ratio, differencesin educational attainment, and differencesin
productivity.We follow David [1977]; Mankiw, Romer, and Weil
[1992]; and Klenow and Rodriguez [1997] in writingthe decompo-
sition in terms ofthe capital-outputratio rather than the capital-
labor ratio, fortwo reasons. First, along a balanced growthpath,
the capital-outputratio is proportionalto the investmentrate, so
that this formofthe decompositionalso has a natural interpreta-
tion. Second, consider a countrythat experiences an exogenous
increase in productivity,holding its investment rate constant.
Over time,the country'scapital-labor ratio will rise as a result of
the increase in productivity.Therefore,some of the increase in
output that is fundamentallydue to the increase in productivity
would be attributedto capital accumulation in a frameworkbased
on the capital-labor ratio.
To measure productivityand decompose differencesin output
per workerinto differencesin capital intensity,human capital per
worker, and productivity,we use data on output, labor input,
average educational attainment,and physical capital forthe year
1988.
Our basic measure of economic performanceis the level of
outputper worker.National income and productaccount data and
labor forcedata are taken fromthe Penn World Tables Mark 5.6
revision of Summers and Heston [1991]. We do not have data on
hours per worker for most countries, so we use the number of
workersinstead ofhours to measure labor input. Our calculations
ofproductivityalso incorporatea correctionfornatural resources
3. Bils and Klenow [1996] suggest that this is the appropriate way to
incorporateyears ofschoolinginto an aggregate productionfunction.
used as inputs. Because ofinadequate data, our correctionis quite

coarse: we subtract value added in the mining industry (which
includes oil and gas) from GDP in computing our measure of
output. That is, we assign all of mining value added to natural
resource inputs and neglect capital and labor inputs in mining.
Without this correction,resource-richcountries such as Oman
and Saudi Arabia would be among the top countries in terms of
productivity.4Average educational attainment is measured in
1985 forthe population aged 25 and over,as reportedby Barro and
Lee [1993]. Physical capital stocks are constructed using the
perpetual inventorymethod.5Because we need data only on the
capital stock for 1988, our measure is quite insensitive to the
choice ofthe initial value. Our data set includes 127 countries.6
Regardingthe parameters ofthe productionfunction,we take
a standard neoclassical approach.7 We assume a value of a = 1/3,
which is broadly consistent with national income accounts data
fordeveloped countries.Withrespect to human capital, Psacharo-
poulos [1994] surveysevidence frommany countrieson return-to-
schooling estimates. Based on his summary of Mincerian wage
regressions,we assume that 4)(E) is piecewise linear. Specifically,
forthe firstfouryears ofeducation, we assume a rate ofreturnof
13.4 percent, correspondingto the average Psacharopoulos re-
portsforsub-Saharan Africa.For the next fouryears we assume a
value of10.1 percent,the average forthe worldas a whole. Finally,
foreducation beyond the eighth year we use the value Psacharo-
poulos reportsforthe OECD, 6.8 percent.
A. Productivity
CalculationsbyCountry
Figure I shows productivitylevels across countries plotted
against output per worker.The figureillustrates that differences
4. Apart fromthe ranking ofproductivityand output per worker,none ofour

empirical results that follow are sensitive to this correction.We compute the
mining share of GDP in current prices from United Nations [1994] for most
countries. Data for China, Israel, Czechoslovakia, Ireland, Italy, Poland, and
Romania are taken fromUnited Nations [1993].
5. We limit our sample to countrieswith investmentdata going back at least
to 1970 and use all available investmentdata. For example, suppose that 1960 is
the firstyear ofinvestmentdata forsome country.We estimate the initial value of
the 1960 capital stock forthat countryas I6o/(g + 6), where g is calculated as the
average geometric growthrate from 1960 to 1970 of the investment series. We
assume a depreciationrate of6 percent.
6. As discussed in more detail later,we had to impute the data on educational
attainmentfor27 ofthese countries.
7. This is a natural benchmark. It ignores externalities fromphysical and
human capital. We believe that there is little compelling evidence of such
externalities,much less any estimate oftheirmagnitudes. We leave a moregeneral
analysis ofsuch possibilities in our frameworkto futurework.
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NER MRT Coeff= 0.600

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1000 2000 4000 8000 16000 32000

OutputperWorker,1988 (in 1985 U.S. Dollars)
FIGURE I
Productivityand Output per Worker
in productivityare very similar to differencesin output per

worker; the correlation between the two series (in logs) is 0.89.
Apart fromPuerto Rico,8the countries with the highest levels of
productivityare Italy, France, Hong Kong, Spain, and Luxem-
bourg.Those withthe lowest levels are Zambia, Comoros,Burkina
Faso, Malawi, and China. U. S. productivityranks thirteenthout
of 127 countries.
Table I decomposes output per worker in each countryinto
the three multiplicative terms in equation (3): the contribution
8. Puerto Rico deserves special mentionas it is-by far-the most productive

countryaccordingto our calculation. Its output per workeris similar to that in the
United Kingdom but measured inputs are much lower.The result is a high level of
productivity.Baumol and Wolff[1996] comment on Puerto Rico's extraordinary
recent growthin output per worker.In addition, there is good reason to believe
that Puerto Rico's national income accounts overstate output. Many U. S. firms
have located productionfacilitiestherebecause oflow tax rates. To take maximum
advantage of those low rates and to avoid higher U. S. rates, they may report
exaggerated internal transferprices when the productsare moved withinthe firm
fromPuerto Rico back to the United States. When these exaggerated nonmarket
prices are used in the Puerto Rican output calculations, they result in an
overstatementofreal output.
TABLE I
PRODUCTIVITY CALCULATIONS: RATIOS TO U. S. VALUES
Contributionfrom
Country YIL (K! Y).1/(l

-a) HIL A
United States 1.000 1.000 1.000 1.000

Canada 0.941 1.002 0.908 1.034
Italy 0.834 1.063 0.650 1.207
West Germany 0.818 1.118 0.802 0.912
France 0.818 1.091 0.666 1.126
United Kingdom 0.727 0.891 0.808 1.011
Hong Kong 0.608 0.741 0.735 1.115
Singapore 0.606 1.031 0.545 1.078
Japan 0.587 1.119 0.797 0.658
Mexico 0.433 0.868 0.538 0.926
Argentina 0.418 0.953 0.676 0.648
U.S.S.R. 0.417 1.231 0.724 0.468
India 0.086 0.709 0.454 0.267
China 0.060 0.891 0.632 0.106
Kenya 0.056 0.747 0.457 0.165
Zaire 0.033 0.499 0.408 0.160
Average, 127 countries: 0.296 0.853 0.565 0.516
Standard deviation: 0.268 0.234 0.168 0.325
Correlationwith YIL (logs) 1.000 0.624 0.798 0.889
CorrelationwithA (logs) 0.889 0.248 0.522 1.000
The elements ofthis table are the empirical counterpartsto the componentsofequation (3), all measured
as ratios to the U. S. values. That is, the firstcolumn ofdata is the productofthe otherthree columns.
from physical capital intensity,the contribution from human

capital per worker,and the contributionfromproductivity.It is
importantto note that this productivitylevel is calculated as a
residual, just as in the growthaccountingliterature.
To make the comparisons easier, all terms are expressed as
ratios to U. S. values.9 For example, accordingto this table, output
per worker in Canada is about 94 percent of that in the United
States. Canada has about the same capital intensityas the United
States, but only 91 percent of U. S. human capital per worker.
Differencesin inputs explain lower Canadian output per worker,
so Canadian productivityis about the same as U. S. productivity.
Other OECD economies such as the United Kingdom also have
9. A complete set of results is available from the web site listed in the
acknowledgmentfootnote.
productivitylevels close to U. S. productivity.Italy and France are

slightlyhigher;Germanyis slightlylower.10
Consistent with conventional wisdom, the U.S.S.R. has ex-
tremelyhigh capital intensityand relativelyhigh human capital
but a ratherlow productivitylevel. For the developingcountriesin
the table, differencesin productivityare the most importantfactor
in explaining differencesin output per worker. For example,
Chinese output per workeris about 6 percentofthat in the United
States, and the bulk ofthis differenceis due to lower productivity:
withoutthe differencein productivity, Chinese output per worker
would be more than 50 percentofU. S. output per worker.
The bottomhalf of Table I reportsthe average and standard
deviation of the contributionof inputs and productivityto differ-
ences in output per worker.According to either statistic, differ-
ences in productivityacross countries are substantial. A simple
calculation emphasizes this point. Output per workerin the five
countriesin 1988 with the highestlevels ofoutput per workerwas
31.7 times higher than output per worker in the five lowest
countries (based on a geometricaverage). Relatively little ofthis
differencewas due to physical and human capital: differencesin
capital intensity and human capital per worker contributed
factorsof 1.8 and 2.2, respectively,to the differencein output per
worker.Productivity,however,contributeda factorof 8.3 to this
difference:with no differencesin productivity,output per worker
in the fiverichestcountrieswould have been onlyabout fourtimes
larger than in the fivepoorestcountries.In this sense, differences
in physical capital and educational attainment explain only a
modest amount of the differencein output per worker across
countries.
The reason forthe lesser importanceofcapital accumulation
is that most of the variation in capital-output ratios arises from
variation in investment rates. Average investment rates in the
five richest countries are only 2.9 times larger than average
investment rates in the five poorest countries. Moreover, this
differencegets raised to the power o/(1 - ox)which fora neoclassi-
cal productionfunctionwith a. 1/3is only ?2-so it is the square
root ofthe differencein investmentrates that matters foroutput
per worker.Similarly,average educational attainment in the five
richest countries is about 8.1 years greater than average educa-
10. Hours per worker are higher in the United States than in France and
Italy,making theirproductivitylevels more surprising.
tional attainmentin the fivepoorestcountries,and this difference

also gets reduced when convertedinto an effecton output: each
year of schooling contributesonly somethinglike 10 percent (the
Mincerian returnto schooling)to differencesin output per worker.
Given the relativelysmall variation in inputs across countriesand
the small elasticities implied by neoclassical assumptions, it is
hard to escape the conclusionthat differencesin productivity-the
residual-play a key role in generating the wide variation in
output per workeracross countries.
B. Discussion
Our earlier paper [Hall and Jones 1996] compared results
based on the Cobb-Douglas formulationwith alternative results
based on the application of Solow's method with a spatial rather
than temporal orderingofobservations." In this latter approach,
the production functionis not restricted to Cobb-Doublas, and
factor shares are allowed to differacross countries. The results
were very similar. We do not thinkthat the simple Cobb-Douglas
approach introduces any importantbiases into any ofthe results
presented in this paper.
Our calculation ofproductivityacross countriesis related to a
calculation performedby Mankiw, Romer, and Weil [1992]. Two
importantdifferencesare worth noting. First, they estimate the
elasticities of the production function econometrically. Their
identifyingassumption is that differencesin productivityacross
countries are uncorrelated with physical and human capital
accumulation. This assumption seems questionable, as countries
that provide incentives for high rates of physical and human
capital accumulation are likely to be those that use their inputs
productively,particularlyif our hypothesisthat social infrastruc-
ture influencesall three componentshas any merit.Our empirical
results also call this identifyingassumption into question since,
as shown in Table I, our measure of productivityis highly
correlated with human capital accumulation and moderately
11. More specifically,assume that the index for observations in a standard

growthaccounting frameworkwith Y = AF(KH) refersto countries rather than
time. The standard accounting formula still applies: the differencein output
between two countries is equal to a weighted average ofthe differencesin inputs
plus the differencein productivity, where the weights are the factorshares. As in
Solow [1957], the weights will generally vary across observations. The only
subtletyin this calculation is that time has a natural order,whereas countriesdo
not. In our calculations, we found that the productivityresults were robust to
differentorderings (in order of output per worker or of total factor input, for
example).
94 Q UARTERLYJOURNALOF ECONOMICS
correlated with the capital-output ratio. Second, they give little

emphasis to differencesin productivity,which are econometric
residuals in their framework;they emphasize the explanatory
power of differencesin factor inputs for differencesin output
across countries.In contrast,we emphasize our findingofsubstan-
tial differencesin productivitylevels across countries.Our produc-
tivitydifferencesare larger in part because of our more standard
treatmentofhuman capital and in part because we do not impose
orthogonality between productivity and the other factors
ofproduction.12
Finally, a question arises as to why we find a large Solow
residual in levels. What do the measured differencesin productiv-
ity across countries actually reflect?First, from an accounting
standpoint, differencesin physical capital intensity and differ-
ences in educational attainment explain only a small fractionof
the differences in outputper workeracross countries.One interpre-
tation ofthis result is that we must turn to otherdifferences,such
as the quality of human capital, on-the-jobtraining, or vintage
effects.That is, we could add to the inputs included in the
productionfunction.A second and complementaryinterpretation
of the result suggests that a theoryof productivitydifferencesis
needed. Differences in technologies may be important: for ex-
ample, Parente and Prescott [1996] constructa theoryin which
insiders may prevent new technologies frombeing adopted. In
addition,in economies with social infrastructuresnot conduciveto
efficientproduction, some resources may be used to protect
against diversion rather than to produce output: capital could
consist of security systems and fences rather than factoriesand
machinery.Accounting forthe differencesin productivityacross
countriesis a promisingarea offutureresearch.
III. DETERMINANTS OF ECONOMIC PERFORMANCE
At an accounting level, differencesin output per worker are

due to differencesin physical and human capital per worker and
12. In helping us to think about the differences,David Romer suggested that

the treatmentof human capital in MRW implies that human capital per worker
varies by a factorof more than 1200 in their sample, which may be much higher
than is reasonable. Klenow and Rodriguez [1997] explore the differencesbetween
these two approaches in more detail. Extending the MRW analysis, Islam [1995]
reportslarge differencesin productivitylevels, but his results, led by econometric
estimates, neglectdifferencesin human capital in computingthe levels.
to differencesin productivity.But why do capital and productivity

differso much across countries? The central hypothesis of this
paper is that the primary,fundamentaldeterminantofa country's
long-run economic performanceis its social infrastructure.By
social infrastructurewe mean the institutions and government
policies that providethe incentivesforindividuals and firmsin an
economy. Those incentives can encourage productive activities
such as the accumulation of skills or the development of new
goods and productiontechniques, or those incentives can encour-
age predatory behavior such as rent-seeking, corruption, and
theft.
Productive activities are vulnerable to predation. If a farm
cannot be protectedfromtheft,then thieverywill be an attractive
alternative to farming. A fraction of the labor force will be
employed as thieves, making no contributionto output. Farmers
will spend more of their time protectingtheir farmsfromthieves
and consequentlygrowfewercrops per hour ofeffort.
Social controlofdiversionhas two benefits.First, in a society
free of diversion, productive units are rewarded by the full
amount oftheir production:where there is diversion,on the other
hand, it acts like a tax on output. Second, where social controlof
diversion is effective,individual units do not need to invest
resources in avoiding diversion. In many cases, social controlis
much cheaper than private avoidance. Where there is no effective
social controlofburglary,forexample, propertyowners must hire
guards and put up fences. Social controlofburglaryinvolves two
elements. First is the teaching that stealing is wrong. Second is
the threat of punishment. The threat itself is free: the only
resources required are those needed to make the threat credible.
The value of social infrastructuregoes far beyond the notion that
collective action can take advantage of returns to scale in avoid-
ance. It is not that the city can put up fences more cheaply than
can individuals: in a cityrun well, no fencesare needed at all.
Social action-typically throughthe government-is a prime
determinant of output per worker in almost any view. The
literature in this area is far too voluminous to summarize
adequately here. Importantcontributionsare Olson [1965, 1982],
Baumol [1990], North [1990], Greif and Kandel [1995], and
Weingast [1995].
A number of authors have developed theoretical models of
equilibrium when protection against predation is incomplete.13

Workerschoose between productionand diversion.There may be
more than one equilibrium: for example, there may be a poor
equilibrium where productionpays little because diversion is so
common,and diversion has a high payoffbecause enforcementis
ineffectivewhen diversion is common. There is also a good
equilibrium with little diversion,because productionhas a high
payoffand the high probabilityof punishment deters almost all
diversion. Rapaczynski [1987] gives Ilobbes creditfororiginating
this idea. Even if there is only a single equilibrium in these
models, it may be highlysensitive to its determinantsbecause of
near-indeterminacy.
Thus, the suppression of diversion is a central element of a
favorable social infrastructure.The governmententers the pic-
ture in two ways. First, the suppression ofdiversionappears to be
most efficientif it is carried out collectively,so the governmentis
the natural instrumentofantidiversionefforts.Second, the power
to make and enforcerules makes the governmentitself a very
effectiveagent of diversion. A governmentsupports productive
activity by deterring private diversion and by refrainingfrom
divertingitself.Of course, governmentsneed revenue in order to
carry out deterrence, which requires at least a little diversion
throughtaxation.
Diversion takes the formof rent-seekingin countries of all
types, and is probably the main form of diversion in more
advanced economies [Krueger 1974]. Potentially productiveindi-
viduals spend their effortsinfluencingthe government.At high
levels, they lobby legislatures and agencies to provide benefitsto
their clients. At lower levels, they spend time and resources
seeking governmentemployment.They use litigation to extract
value fromprivate business. They take advantage of ambiguities
in propertyrights.
Successful economies limit the scope ofrent-seeking.Consti-
tutional provisions restrictinggovernmentintervention,such as
the provisions in the U. S. Constitutionprohibitinginterference
with interstate commerce,reduce opportunitiesforrent-seeking.
A good social infrastructurewill plug as many holes as it can
where otherwise people could spend time bettering themselves
economicallyby methods otherthan production.In addition to its
13. See, forexample, Murphy,Shleifer,and Vishny [1991]; Acemoglu [1995];

Schrag and Scotchmer [1993]; Ljungqist and Sargent [1995]; and Grossman and
Kim [1996].
directeffectson production,a good social infrastructuremay have

important indirect effectsby encouraging the adoption of new
ideas and new technologies as they are invented throughoutthe
world.
IV. ESTIMATINGTHE EFFECT OF SOCIAL INFRASTRUCTURE

Two important preliminaryissues are the measurement of
social infrastructureand the econometric identificationof our
model.
A. Measurement
The ideal measure ofsocial infrastructurewould quantifythe
wedge between the private returnto productiveactivities and the
social return to such activities. A good social infrastructure
ensures that these returnsare kept closelyin line across the range
ofactivities in an economy,fromworkingin a factoryto investing
in physical or human capital to creatingnew ideas or transferring
technologies fromabroad, on the positive side, and fromtheftto
corruptionon the negative side.
In practice,however,there does not exist a usable quantifica-
tion ofwedges between private and social returns,eitherforsingle
countries or for the large group of countries considered in this
study.As a result,we must relyon proxiesforsocial infrastructure
and recognizethe potential formeasurement error.
We formour measure of social infrastructureby combining
two indexes. The firstis an index of governmentantidiversion
policies (GADP) created from data assembled by a firm that
specializes in providing assessments of risk to international
investors, Political Risk Services.14Their International Country
Risk Guide rates 130 countries according to 24 categories. We
follow Knack and Keefer [1995] in using the average of five of
these categories forthe years 1986-1995. Two of the categories
relate to the government's role in protecting against private
diversion: (i) law and order,and (ii) bureaucratic quality. Three
categoriesrelate to the government'spossible role as a diverter:(i)
corruption,(ii) risk ofexpropriation,and (iii) governmentrepudia-
14. See Coplin, O'Leary, and Sealy [1996] and Knack and Keefer[1995]. Barro
[1997] considers a measure fromthe same source in regressionswiththe growthof
GDP per capita. Mauro [1995] uses a similar variable to examine the relation
between investment and growth of income per capita, on the one hand, and
measures ofcorruptionand otherfailures ofprotection,on the otherhand.
tion of contracts. Our GADP variable is an equal-weighted

average ofthese fivevariables, each ofwhich has highervalues for
governmentswith more effectivepolicies for supportingproduc-
tion. The index is measured on a scale fromzero to one.
The second element of our measure of social infrastructure
captures the extent to which a countryis open to international
trade. Policies toward internationaltrade are a sensitive index of
social infrastructure.Not onlydoes the impositionoftariffsdivert
resources to the government,but tariffs,quotas, and other trade
barriers create lucrative opportunities for private diversion. In
addition,policies favoringfreetrade yield benefitsassociated with
the trade itself. Trade with other countries yields benefitsfrom
specialization and facilitates the adoption of ideas and technolo-
gies fromthose countries. Our work does not attempt to distin-
guish between trade policies as measures of a country'sgeneral
infrastructureand the specificbenefitsthat come fromfreetrade
itself.
Sachs and Warner[1995] have compiled an index that focuses
on the openness of a countryto trade with other countries. An
importantadvantage oftheirvariable is that it considers the time
since a countryadopted a more favorable social infrastructure.
The Sachs-Warner index measures the fractionof years during
the period 1950 to 1994 that the economyhas been open and is
measured on a [0,1] scale. A countryis open ifit satisfies all ofthe
followingcriteria: (i) nontariffbarriers cover less than 40 percent
oftrade, (ii) average tariffrates are less than 40 percent,(iii) any
black market premiumwas less than 20 percentduringthe 1970s
and 1980s, (iv) the countryis not classified as socialist by Kornai
[1992], and (v) the governmentdoes not monopolizemajor exports.
In most of the results that we present, we will impose (after
testing) the restrictionthat the coefficientsforthese two proxies
forsocial infrastructureare the same. Hence, we focus primarily
on a single index ofsocial infrastructureformedas the average of
the GADP and openness measures.
B. Identification
To examine the quantitative importance of differencesin
social infrastructureas determinantsofincomes across countries,
we hypothesizethe followingstructuralmodel:
(4) log Y/L= ot+ PS + Ey
and
(5) S = y + 8 log YIL + XO +mi,
where S denotes social infrastructureand X is a collectionofother
variables.
Several features of this frameworkdeserve comment. First,
we recognizeexplicitlythat social infrastructureis an endogenous
variable. Economies are not exogenously endowed with the insti-
tutions and incentives that make up their economic environ-
ments, but rather social infrastructureis determined endoge-
nously,perhaps depending itselfon the level ofoutput per worker
in an economy. Such a concern arises not only because of the
general possibilityoffeedbackfromthe unexplained componentof
output per workerto social infrastructure,but also fromparticu-
lar features ofour measure of social infrastructure.For example,
poor countries may have limited ability to collect taxes and may
thereforebe forcedto interferewith internationaltrade. Alterna-
tively,one might be concerned that the experts at Political Risk
Services who constructedthe componentsofthe GADP index were
swayed in part by knowledge ofincome levels.
Second, our specificationforthe determinationofincomes in
equation (4) is parsimonious, reflectingour hypothesisthat social
infrastructureis the primary and fundamental determinant of
output per worker. We allow for a rich determination of social
infrastructurethroughthe variables in the X matrix. Indeed, we
will not even attemptto describe all ofthe potential determinants
of social infrastructure;we will not estimate equation (5) of the
structuralmodel. The heart ofour identifyingassumptions is the
restrictionthat the determinants of social infrastructureaffect
output per worker only through social infrastructureand not
directly.We test the exclusion below.
Our identifyingscheme includes the assumption that EX'E
0. Under this assumption, any subset ofthe determinantsofsocial
infrastructureconstitutevalid instrumentsforestimation of the
parameters in equation (4). Consequently, we do not require a
complete specificationof that equation. We will return to this
pointin greater detail shortly.
Finally, we augment our specification by recognizing, as
discussed in the previous section, that we do not observe social
infrastructuredirectly.Instead, we observe a proxy variable S
computed as the sum of GADP and the openness variable,
normalized to a [0,1] scale. This proxyforsocial infrastructureis
related to true social infrastructurethrough random measure-

ment error:
(6) S=S + v,
where v is the measurement error,taken to be uncorrelatedwithS
and X. Withoutloss of generality,we normalize qf= 1; this is an
arbitrarychoice ofunits since S is unobserved. Therefore,
S = S - v.
Using this measurement equation, we rewriteequation (4) as
(7) log Y/L =o + PS + a,

where
E--V.
-
The coefficiente will be identified by the orthogonality

conditions EX'i = 0. Therefore, both measurement error and
endogeneity concerns are addressed. The remaining issue to
discuss is how we obtain valid instruments for GADP and our
openness measure.
C. Instruments
Our choice of instruments considers several centuries of
world history.One of the key features of the sixteenth through
nineteenth centuries was the expansion of Western European
influencearound the world. The extent of this influencewas far
fromuniform,and thus provides us with identifyingvariation
which we will take to be exogenous. Our instrumentsare various
correlates ofthe extentofWesternEuropean influence.These are
characteristics of geography such as distance fromthe equator
and the extent to which the primary languages of Western
Europe-English, French, German, Portuguese, and Spanish-
are spoken as firstlanguages today.
Our instrumentsare positively correlated with social infra-
structure.Western Europe discovered the ideas ofAdam Smith,
the importance of propertyrights,and the system of checks and
balances in government,and the countries that were strongly
influenced by Western Europe were, other things equal, more
likelyto adopt favorableinfrastructure.
That the extentto whichthe languages ofWesternEurope are
spoken as a mother tongue is correlated with the extent of
Western European influence seems perfectlynatural. However,

one may wonder about the correlation of distance from the
equator with Western European influence. We suggest this is
plausible fortwo reasons. First, Western Europeans were more
likely to migrate to and settle regions of the world that were
sparsely populated at the start of the fifteenthcentury.Regions
such as the United States, Canada, Australia, New Zealand, and
Argentina appear to satisfythis criterion.Second, it appears that
Western Europeans were more likely to settle in areas that were
broadly similar in climate to WesternEurope, which again points
to regions farfromthe equator.15
The otherimportantcharacteristicofan instrumentis lack of
correlation with the disturbance e. To satisfy this criterion,we
must ask whether European influencewas somehow more inten-
sivelytargeted toward regions ofthe worldthat are more likelyto
have high output per workertoday. In fact,this does not seem to
be the case. On the one hand, Europeans did seek to conquer and
exploit areas ofthe worldthat were richin natural resources such
as gold and silver or that could provide valuable trade in
commodities such as sugar and molasses. There is no tendency
today forthese areas to have high output per worker.
On the otherhand, European influencewas much strongerin
areas of the world that were sparsely settled at the beginning of
the sixteenthcentury,such as the United States, Canada, Austra-
lia, New Zealand, and Argentina.Presumably,these regions were
sparsely settled at that time because the land was not especially
productive given the technologies of the fifteenthcentury.For
these reasons, it seems reasonable to assume that our measures of
WesternEuropean influenceare uncorrelatedwith e.
We measure distance fromthe equator as the absolute value
oflatitude in degrees divided by 90 to place it on a 0 to 1 scale.16It
is widelyknownthat economies fartherfromthe equator are more
successful in terms ofper capita income. For example, Nordhaus
15. Engerman and Sokoloff [1997] provide a detailed historical analysis

complementaryto this story. They conclude that factor endowments such as
geography,climate, and soil conditionshelp explain why the social infrastructure
that developed in the United States and Canada was more conducive to long-run
economicsuccess than the social infrastructurethat developed in Latin America.
16. The latitude of each countrywas obtained fromthe Global Demography
Project at the University of California, Santa Barbara (http://www.ciesin.org/
datasets/gpw/globldem.doc.html), discussed by Tobler et al. [1995]. These location
data correspond to the center of the county or province within a countrythat
contains the largest number of people. One implication of this choice is that the
data source places the centerofthe United States in Los Angeles, somewhat south
ofthe median latitude ofthe country.
[1994] and Theil and Chen [1995] examine closely the simple
correlationof these variables. However, the explanation forthis
correlationis farfromagreed upon. Kamarck [1976] emphasizes a
direct relationship through the prevalence of disease and the
presence of a highlyvariable rainfall and inferiorsoil quality. We
will postulate that the direct effectof such factors is small and
impose the hypothesisthat the effectis zero: hence distance from
the equator is not included in equation (4). Because of the
presence of overidentifyingrestrictionsin our framework,how-
ever, we are able to test this hypothesis,and we do not reject it,
eitherstatisticallyor economically,as discussed later in the paper.
Our data on languages come fromtwo sources: Hunter [1992]
and, to a lesser extent,Gunnemark [1991].17We use two language
variables: the fractionof a country'spopulation speaking one of
the fiveprimaryWesternEuropean languages (includingEnglish)
as a mothertongue,and the fractionspeaking English as a mother
tongue. We are, therefore,allowing English and the other lan-
guages to have separate impacts.
Finally, we also use as an instrument the variable con-
structed by Frankel and Romer [1996]: the (log) predicted trade
share of an economy,based on a gravitymodel of international
trade that only uses a country's population and geographical
features.
Our data set includes 127 countriesforwhich we were able to
constructmeasures of the physical capital stock using the Sum-
mers and Heston data set. For these 127 countries we were also
able to obtain data on the primarylanguages spoken, geographic
information,and the Frankel-Romerpredictedtrade share. How-
ever,missing data were a problemforfourvariables: 16 countries
in our sample were missing data on the openness variable, 17
were missing data on the GADP variable, 27 were missing data on
educational attainment,and 15 were missing data on the mining
share ofGDP. We imputedvalues forthese missing data using the
79 countriesforwhich we have a completeset ofdata.18
17. The sources oftendisagree on exact numbers. Hunter [1992] is much more
precise, containing detailed data on various dialects and citations to sources
(typicallysurveys).
18. For each country with missing data, we used a set of independent
variables to impute the missing data. Specifically,let C denote the set of 79
countries with complete data. Then, (i) foreach countryi not in C, let W be the
independent variables with data and V be the variables that are missing data. (ii)
Using the countries in C, regress V on W. (iii) Use the coefficientsfromthese
regressions and the data W (i) to impute the values ofV (i). The variables in V and
W were indicatorvariables fortype ofeconomic organization,the fractionofyears
32000 jW
CHE -
PRI NZL ESP

IRL JPN HK(SGP
TrO VENSAU
16000 MR
SUtRG MlXR
MLT
OMNjOR
G5N YP
BRB
URY ~~~~~KR PRT
DZA URY BRA HUN
FJI ~ ~
o 0 "NU PER ECU
- 8000 ~~SYNOM I')NUJTs K YEM
EGY NAM MAR
PRY
GAB SLV LKA
swz THA
BOL
BGD Cd&K PHL HNDIC JAM
> 4000 GeM IDN
CIV BWA
IND
PNG CMR
ChN
SDDLE ZWE LSO
2000 HTI BEN fl1
SOME1fkjB GMB
RWA GIN
ZAR it COM
1000 BUR a
0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

ObservedIndexof Social Infrastructure
FIGURE II
Social Infrastructureand Output per Worker
V. BASIC RESULTS
Figure II plots outputper workeragainst our measured index

ofsocial infrastructure.The countrieswith the highest measured
levels ofsocial infrastructureare Switzerland, the United States,
and Canada, and all three are among the countries with the
highestlevels ofoutput per worker.Three countriesthat are close
to the lowest in social infrastructure are Zaire, Haiti, and
Bangladesh, and all three have low levels ofoutput per worker.
Consideration ofthis figureleads to two importantquestions
addressed in this section. First, what is the impact on output per
worker of a change in an exogenous variable that leads to a
one-unit increase in social infrastructure?Second, what is the
range ofvariation oftrue social infrastructure?We see in Figure II
that measured social infrastructurevaries considerablyalong this
open, GADP, the fractionof population speaking English at home, the fractionof
population speaking a European language at home, and a quadratic polynomialfor
distance from the equator. In addition, total educational attainment and the
miningshare ofGDP were included in Vbut not in W; i.e., theywere not treated as
independent.
TABLE II
BASIC RESULTS FOR OUTPUT PER WORKER
log YIL = oa+ A3S+ E
OverID test Coefftest

Social p-value p-value
Specification infrastructure test result test result &j
1. Main specification 5.1432 .256 .812 .840

(.508) Accept Accept
Alternativespecificationsto checkrobustness
2. Instruments: 4.998 .208 .155 .821
Distance, Frankel-Romer (.567) Accept Accept
3. No imputed data 5.323 .243 .905 .889
79 countries (.607) Accept Accept
4. OLS 3.289 - .002 .700
(.212) Reject
The coefficienton Social infrastructurereflectsthe change in log output per worker associated with a
one-unit increase in measured social infrastructure.For example, the coefficientof 5.14 means than a
differenceof .01 in our measure of social infrastructureis associated with a 5.14 percentdifferencein output
per worker. Standard errors are computed using a bootstrap method, as described in the text. The main
specificationuses distance fromthe equator, the Frankel-Romer instrument,the fractionof the population
speaking English at birth,and the fractionofthe population speaking a Western European language at birth
as instruments.The OverID test column reportsthe result oftestingthe overidentifying restrictions,and the
Coefftestreportsthe result oftestingforthe equality ofthe coefficients on the GADP policyindex variable and
the openness variable. The standard deviation oflog Y/L is 1.078.
zero-one scale. How much ofthis is measurement error,and how

much variation is there across countriesin true social infrastruc-
ture? Combining the answers to these two general questions
allows us to quantifythe overall importanceofdifferencesin social
infrastructureacross countries in explaining differencesin long-
run economicperformance.
Table II reports the results for the estimation of the basic
relation between output per worker and social infrastructure.
Standard errors are computed using a bootstrap method that
takes into account the fact that some of the data have been
imputed.19
19. The bootstrapproceeds as followswith 10,000 replications.First,we draw

uniformly127 times fromthe set of79 observationsforwhich there are no missing
data. Second, we create missing data. For each "country,"we draw fromthe sample
joint distributionofmissing data to determinewhich variables, ifany,are missing
(any combinationof GADP and years open). Third, we impute the missing data,
using the method described in footnote18. Finally,we use instrumentalvariables
on the generated data to get a new estimate, P. The standard errorsreportedin the
table are calculated as the standard deviation ofthe 10,000 observations ofA.
The main specificationin Table II reports the results from

instrumental variables estimation of the effectof a change in
social infrastructure on the log of output per worker. Four
instruments are used: distance fromthe equator, the Frankel-
Romer predictedtrade share, and the fractionsofthe population
speaking English and a European language, respectively.The
pointestimate indicates that a differenceof.01 in social infrastruc-
ture is associated with a differencein output per worker of 5.14
percent.Witha standard errorof.508, this coefficient is estimated
with considerable precision.
The second column ofnumbers in the table reportsthe result
oftestingthe overidentifying restrictionsofthe model,such as the
orthogonalityof the error term and distance fromthe equator.
These restrictions are not rejected. Similarly, we test for the
equality ofthe coefficientson the two variables that make up our
social infrastructureindex,and this restrictionis also notrejected.
The lower rows of the table show that our main result is
robust to the use of a more limited set of instruments and to
estimation using only the 79 countries for which we have a
complete data set. In results not reported in the table, we have
dropped one instrument at a time to ensure that no single
instrument is driving the results. The smallest coefficienton
social infrastructureobtained in this robustness check was 4.93.
Our estimate of P tells us the differencein log output per
workerof a differencein some exogenous variable that leads to a
differencein social infrastructure.The point estimate indicates
that a differenceof.01 in social infrastructure,as we measure it, is
associated with a differencein output per workerof a little over 5
percent. Because we believe that social infrastructureis mea-
sured with error,we need to investigate the magnitude of the
errorsin orderto understand this number.We need to determine
how much variation there is in true, as opposed to measured,
social infrastructureacross countries.
Our discussion starts fromthe premise that true simultane-
ityresults in a positive correlationbetween the disturbance in our
structural equation and social infrastructure.Recall that our
systemis
(8) log YIL =U +

?S + E - V3,
(9) S -y?+ 6logY/L +XO + a.

The reduced-formequation forS is

- + 8a + 8E +XO + q
(10) S = I - by ? v.
Correlation of S with E arises from two sources. One is

feedback controlledby the parameter 8. Provided that the system
satisfiesthe stabilitycondition8P < 1, a positivevalue of8 implies
that E is positively correlated with S. As we noted earlier, the
natural assumption is that 8 is nonnegative,since social infrastruc-
ture requires some resources to build, and log YIL measures those
resources.
The second source ofcorrelationofS with E is correlationof q
with E.Again, it would appear plausible that countrieswith social
infrastructureabove the level of the second structural equation
would tend to be the same countries that had output per worker
above the firststructuralequation. Thus, both sources ofcorrela-
tion appear to be nonnegative.
On the otherhand, as the reduced-formequation forS shows,
measured social infrastructureis unambiguouslypositivelycorre-
lated with the measurement error v. Hence there is a negative
correlationbetween S and the part ofthe disturbance in the first
structuralequation arising frommeasurement error,- Tv.
Informationabout the net effectof the positive correlation
arising from simultaneity and the negative correlation arising
frommeasurement erroris providedbythe differencebetween the
instrumental variables estimate of e and the ordinary least
squares estimate. The last row of Table II reports the latter.
Because the OLS estimate is substantially smaller than the IV
estimate, measurement error is the more important of the two
influences.
Under the assumption that there is no true simultaneity
problem,that is, E is uncorrelated with S, we can calculate the
standard deviation of true social infrastructure,vs., from the
differencebetween the IV and OLS estimates. A standard result in
the econometrics of measurement error is that OLS is biased
toward zero by a multiplicative factor equal to the ratio of the
(
variance of the true value of the right-hand variable to the
variance ofthe measured value. Thus,
1/2
( 11) plim 130VLS)
UpS
AAIVS
That is, we can estimate the standard deviation of true social

infrastructurerelative to the standard deviation of measured
social infrastructureas the square rootofthe ratio ofthe OLS and
IV estimates. With our estimates, the ratio of the standard
deviations is 0.800.
If the correlationofS and E is positive,so true simultaneityis
a problem,additional informationis required to pin down uv.The
positive correlation fromendogeneity permits a larger negative
correlationfrommeasurement errorand thereforea larger stan-
dard deviation of that measurement error.A simple calculation
indicates that the ratio of standard deviations given in equation
(11) is the correlationbetweenmeasured and true social infrastruc-
ture, which we will denote rts. Therefore,a lower bound on the
correlation between measured and true social infrastructure
provides a lower bound on uv.It is our belief,based on comparing
the data in Figure II with our priors, that the R2 or squared
correlationbetween true and measured social infrastructureis no
smaller than 0.5. This implies a lower bound on rss of .5 = .707.
Withthese numbers in mind we will considerthe implications
of our estimate of Siv = 5.14. Measured social infrastructure
ranges froma low value of0.1127 in Zaire to a high value of1.0000
in Switzerland. Ignoringmeasurement error,the implied range of
variation in output per worker would be a factorof 95, which is
implausibly high. We can apply the ratio r?,s = us/us to get a
reasonable estimate of the range of variation of true social
infrastructure.20 The lower bound on this range implied by ras =
.707 suggests that differencesin social infrastructurecan account
for a 25.2-fold differencein output per worker across countries.
Alternatively,if there is no true endogeneityso that r?,s = .800,
differencesin social infrastructureimply a 38.4-folddifferencein
output per worker across countries. For comparison, recall that
output per workerin the richest country(the United States) and
in the poorest country(Niger) in our data set differby a factorof
35.1.
We conclude that our results indicate that differencesin
social infrastructureaccount formuch of the differencein long-
run economicperformancethroughoutthe world,as measured by
output per worker. Countries most influenced by Europeans in
past centurieshave social infrastructuresconduciveto high levels
of output per worker,as measured by our variables, and, in fact,
20. That is, we calculate exp (r,$S3kv(Smax

- Snmin)).
have high levels of output per worker. Under our identifying

assumptions, this evidence means that infrastructureis a power-
fulcausal factorpromotinghigheroutput per worker.
A. Reduced-FormResults
Table III reportsthe tworeduced-formregressionscorrespond-
ing to our main econometricspecification.These are OLS regres-
sions oflog outputper workerand social infrastructureon the four
main instruments. Interpretingthese regressions calls forcare:
our frameworkdoes not require that these reduced forms be
complete in the sense that all exogenous variables are included.
Rather, the equations are useful but potentially incomplete
reduced-formequations.
The reduced-formequations documentthe close relationship
between our instruments and actual social infrastructure.Dis-
tance fromthe equator, the Frankel-Romerpredictedtrade share,
and the fractionofthe population speaking a European language
(including English) combine to explain a substantial fractionof
the variance ofour index ofsocial infrastructure.Similarly,these
instrumentsare closelyrelated to long-runeconomicperformance
as measured by output per worker.
TABLE III
REDUCED-FORM REGRESSIONS
Dependent variables
Social Log (output

Regressors infrastructure per worker)
Distance fromthe equator, (0,1) scale 0.708 3.668

(.110) (.337)
Log ofFrankel-Romerpredictedtrade share 0.058 0.185
(.031) (.081)
Fraction ofpopulation speaking English 0.118 0.190
(.076) (.298)
Fraction ofpopulation speaking a European
language 0.130 0.995
(.050) (.181)
R2 .41 .60
N = 127. Standard errors are computed using a bootstrap method, as described in the text. A constant
term is included but not reported.
B. Results byComponent
Table IV examines in more detail the sources ofdifferencesin
output per worker across countries by considering why some
countries have higher productivityor more physical or human
capital than others.
The dependentvariables in this table use the contributionsto
output per worker (the log of the terms in equation (3)), so that
adding the coefficientsacross columns reproduces the coefficient
in the main specification of Table II. Broadly speaking, the
explanations are similar. Countries with a good social infrastruc-
ture have high capital intensities,high human capital per worker,
and high productivity.Each of these components contributesto
high output per worker.
Along with this broad similarity,some interestingdifferences
are evident in Table IV. The residual in the equation forcapital
intensity is particularly large, as measured by the estimated
standard deviation of the error. This leads to an interesting
observation. The United States is an excellent example of a
countrywith good social infrastructure,but its stock of physical
capital per unit of output is not remarkable. While the United
States ranks firstin output per worker, second in educational
attainment, and thirteenth in productivity,its capital-output
ratio ranks thirty-ninthamong the 127 countries. The United
States ranks much higherin capital per worker(seventh) because
ofits relativelyhigh productivitylevel.
TABLE IV
RESULTS FOR logKI Y, logHIL, and logA
Component = of+ IS + e
Dependent variable
1 _a log K/Y log H/L logA
Social infrastructure 1.052 1.343 2.746

(.164) (.171) (.336)
OverID test (p) .784 .034 .151
Test result Accept Reject Accept
Se .310 .243 .596
&fDepvar .320 .290 .727
Estimation is carried out as in the main specificationin Table II. Standard errorsare computed using a
bootstrapmethod,as described in the text.
TABLE V
FACTORS OF VARIATION: MAXIMUM/MINIMUM
YIL (K/Y)a'(1-0) HIL A
Observed factorofvariation 35.1 4.5 3.1 19.9

Ratio, 5 richestto 5 poorest countries 31.7 1.8 2.2 8.3
Predicted variation, onlymeasurement error 38.4 2.1 2.6 7.0
Predicted variation, assuming rS = .5 25.2 1.9 2.3 5.6
The firsttwo rows reportactual factorsofvariation in the data, firstforthe separate componentsand then
forthe geometricaverage ofthe fiverichest and fivepoorest countries(sorted accordingto YIL). The last two
rows report predicted factors of variation based on the estimated range of variation of true social
infrastructure.Specifically,these last two rows reportexp (rprv(Sa,, - S in)) firstwith r = .800 and second
withr2 = .5.
Table V summarizes the extent to which differencesin true

social infrastructurecan explain the observed variation in output
per worker and its components. The first row of the table
documentsthe observed factorofvariation between the maximum
and minimumvalues of output per worker,capital intensity,and
othervariables in our data set. The second row shows numberswe
have already reported in the interpretationof the productivity
results. Countries are sorted by output per worker,and then the
ratio of the geometric average of output per worker in the five
richest countries to the fivepoorest countries is decomposed into
the productofa capital intensityterm,a human capital term,and
productivity.The last two rows of the table use the basic coeffi-
cient estimates fromTables II and IV to decompose the predicted
factorofvariation in output into its multiplicativecomponents.
One sees fromthis table that differencesin social infrastruc-
ture are sufficientto account forthe bulk ofthe observed range of
variation in capital intensity,human capital per worker, and
productivity.21Interpretedthroughan aggregate productionfunc-
tion,these differencesare able to account formuch ofthe variation
in output per worker.
VI. ROBUSTNESS OF THE RESULTS
The central equation estimated in this paper has onlya single

fundamentaldeterminantofa country'soutput per worker,social
21. One must be carefulin interpretingthese results since social infrastruc-

ture is potentiallyendogenous. What this statement really means is that differ-
ences in exogenous variables that lead to the observed range ofvariation in social
infrastructurewould implythe factorsofvariation reportedin the table.
infrastructure.Ourmaintainedhypothesis (alreadytestedin part

usingthe testofoveridentifying restrictions)is thatthisrelation
does not omit other fundamentaldeterminantsof outputper
worker.For example,characteristics ofan economysuch as the
size ofgovernment, therateofinflation, orthe shareofhigh-tech
goodsin international tradeare all bestthoughtofin ouropinion
as outcomesratherthan determinants.Just as investmentin
skills,capital,and technologies,these variablesare determined
primarily bya country'ssocialinfrastructure.
To examinetherobustnessofourspecification, we selecteda
set ofcandidatesto be additionalfundamental determinants and
considera rangeofspecifications.These alternativespecifications
are reportedin TableVI.
The firsttwo specificationsredefinemeasuredsocial infra-
structureto be eitherthe GADP variable or the Sachs-Warner
opennessvariable,ratherthantheaverageofthetwo.The results
TABLE VI
ROBUSTNESS RESULTS
log YIL = o + IS + X Added Variable + e
OverID test
Social Additional p-value
Specification infrastructure variable test result &k
1. S=GADP 5.410 ... .006 .769

(.394) Reject
2.S= years open 4.442 ... .131 1.126
(.871) Accept
3. Distance fromequator 5.079 0.062 .129 .835
(2.61) (2.062) Accept
4. Ethnolinguisticfractionalization 5.006 -0.223 .212 .816
(N = 113) (.745) (.386) Accept
5. Religious affiliation(N = 121) 4.980 See .478 .771
(.670) Note Accept
6. Log (population) 5.173 0.047 .412 .845
(.513) (.060) Accept
7. Log (C-H density) 5.195 -0.546 .272 .850
(.539) (1.11) Accept
8. Capitalist systemindicator 6.354 -1.057 .828 .899
variable (1.14) (.432) Accept
9. Instruments:main set plus 4.929 ... .026 .812
continentdummies (.388) Reject
See notes to Table II. Instrumentsare the same as in Table II, except where noted. Additional variables
are discussed in the text. The coefficientson the religious variables in line 5, followedby standard errors,are
Catholic (0.992,.354), Muslim (0.877,.412), Protestant (0.150,.431), and Hindu (0.839,1.48).
are similar to those in our main specification.When social

infrastructure is measuredby GADP alone, the overidentifying
restrictionsare rejected;someoftheinstruments appeartobelong
in theequation.
In the thirdspecification we treatdistancefromthe equator
as an includedexogenousvariable.The result,consistentwith
previousoveridentifying tests,is littlechangein thecoefficienton
social infrastructure and a small and insignificant coefficienton
distancefromtheequator.22 This supportsourcontention thatthe
bulk of the high simple correlationbetweendistancefromthe
equator and economicperformanceoccurs because historical
circumstanceslead this variable to proxy well for social
infrastructure.
Thefourth specificationexaminestheethnolinguistic fraction-
alization(ELF) indexcomputedbyTaylorand Hudson[1972]and
used byMauro[1995].ELF measurestheprobability thatanytwo
people chosen at randomfromwithina countrywill belongto
differentethnicorlinguisticgroups.Whilethe simpleassociation
ofthisvariablewithoutputperworkeris quitestrong,thepartial
regressioncoefficient is small in magnitude(the variable is
measuredon a [0,1]scale) and statistically insignificant.
The fifthspecification adds religiousaffiliation variablesto
the specification.Specifically,these variablesmeasurethe frac-
tion(on a [0,1]scale) ofa country's populationaffiliated
withthe
Catholic,Muslim,Protestant,and Hindu religions.23 The point
estimateon social infrastructure is changedlittlewhen these
variables are includedin the specification. Both Catholic and
Muslim affiliation variables entersignificantly into the regres-
sion,whiletheProtestant and Hindu variables not.
do
The sixth specificationadds the log of populationto the
regression.A numberofrecentgrowthmodelsin the traditionof
Romer[1990] emphasizethat nonrivalry ofideas shouldlead to
increasingreturnsto scale. Our simpleattemptto measurescale
withpopulationdoes notfindevidenceofthiseffect. One explana-
22. The large standard erroron social infrastructureis somewhat misleading.

The associated p-value testing the hypothesis of a zero coefficienton social
infrastructure(computed fromthe bootstrap distributionof coefficients)is only
0.008. The large standard error-the standard deviation of the bootstrap coeffi-
cients-occurs because the distributionofcoefficients is skewed heavily toward the
right,i.e., toward positive values. In contrast, the distributionof the bootstrap
coefficients fordistance fromthe equator is skewed heavily toward the left.
23. These data were provided by Robert Barro and are discussed in Barro
[1997].
tionis thatnationalboundariesdonotlimittheareas whereideas

are applied.
The seventhspecification considersa measureofthe density
ofeconomicactivity, computedfollowing the methodsofCiccone
and Hall [1996].24The densitymeasureis constructed to have a
theoreticalcoefficient ofone: it wouldhave preciselythisvalue in
Cicconeand Hall's crosssectionofstates.Here,however, in a cross
sectionofcountries, thevariationin otherdeterminants ofoutput
per workeris so largethatit is difficult to measurethe effects of
densitywithmuchprecision.
The resultsforthe eighthspecification are unexpected.This
specificationadds an indicatorvariabletakingthevalue ofonefor
countriesthatare categorizedas capitalistormixed-capitalist by
the Freedom House [Finn 1994]. The odd result is that the
regressioncoefficient implies that capitalistcountriesproduce
substantiallyless output per workerthan otherwisesimilar
noncapitalistcountries.In part,thisreflects theparticulardefini-
tionofcapitalismemployedbythe FreedomHouse. According to
theirclassification, a numberofsub-SaharanAfricaneconomies
are classifiedas capitalist.
The finalspecification of Table VI adds a list of continent
dummiestotheinstrument set.25As withtheotherspecifications,
the coefficient on social infrastructure is unchanged by the
additionofthe continentsto the instrumentlist. However,the
overidentification testnowrejectstherestrictions, in partbecause
Africaneconomieshave loweroutputper workerthan otherwise
similareconomieson othercontinents.
VII. CONCLUSION
Countriesproducehighlevelsofoutputperworkerinthelong
run because theyachieve high rates of investmentin physical
capitaland humancapitaland becausetheyuse theseinputswith
24. The Ciccone-Hall measure forcountryi is given by
-
Di= a(Y1
Ni S(=Sj
whereNi is the population ofcountryi, Si is the set ofall provincesin countryi, n.
=
is the population ofprovinces, and a. is the area ofprovinces. We use a value ofMy
1.058, as estimated by Ciccone and Hall. This value implies that doubling density
increases Di by about 6 percent.
25. The continents are North America (including Central America), South
America,Africa,Asia (plus Oceania), and Europe.
a high level of productivity.Our empirical analysis suggests that

success on each ofthese frontsis drivenby social infrastructure.A
country'slong-runeconomicperformanceis determinedprimarily
by the institutions and governmentpolicies that make up the
economic environmentwithin which individuals and firmsmake
investments, create and transferideas, and produce goods and
services.
Our major findings can be summarized by the following
points:
1. Many of the predictionsof growththeorycan be success-
fully considered in a cross-section context by examining
the levels ofincome across countries.
2. The large variation in output per workeracross countries
is only partially explained by differencesin physical
capital and educational attainment.Paralleling the growth
accounting literature, levels accounting finds a large re-
sidual that varies considerablyacross countries.
3. Differencesin social infrastructureacross countries cause
large differencesin capital accumulation, educational at-
tainment,and productivity, and thereforelarge differences
in income across countries.
4. The extent to which differentcountries have adopted
differentsocial infrastructuresis partially related to the
extent to which they have been influenced by Western
Europe. Using distance fromthe equator and language
data, we conclude that our finding that differencesin
social infrastructurecause large differencesin income is
robustto measurement errorand endogeneityconcerns.
STANFORDUNIVERSITY,HOOVER INSTITUTION,AND NATIONALBUREAU OF ECONOMIC

RESEARCH
STANFORD UNIVERSITY AND NATIONALBUREAU OF ECONOMIC RESEARCH
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Why Do Some Countries Produce So Much More Output Per Worker Than Others?

Author(s): Robert E. Hall and Charles I. Jones

Output per workervaries enormouslyacross countries.Why? On an account-

In 1988 output per worker in the United States was more

The breakdown suggested by the aggregate productionfunc-

States is more than enough to explain the 35-fold differencein

variation in long-runeconomic performanceby studyingdirectly

2. Chari, Kehoe, and McGrattan [1997] also analyze levels of economic

that differencesin social infrastructureacross countries account

II. LEVELS ACCOUNTING

Our analysis begins by examining the proximate causes of

additional year ofschoolingraises a worker'sefficiency proportion-

where h HIL is human capital per worker.

used as inputs. Because ofinadequate data, our correctionis quite

4. Apart fromthe ranking ofproductivityand output per worker,none ofour

NER MRT Coeff= 0.600

1000 2000 4000 8000 16000 32000

in productivityare very similar to differencesin output per

8. Puerto Rico deserves special mentionas it is-by far-the most productive

Country YIL (K! Y).1/(l

United States 1.000 1.000 1.000 1.000

from physical capital intensity,the contribution from human

productivitylevels close to U. S. productivity.Italy and France are

tional attainmentin the fivepoorestcountries,and this difference

11. More specifically,assume that the index for observations in a standard

correlated with the capital-output ratio. Second, they give little

III. DETERMINANTS OF ECONOMIC PERFORMANCE

At an accounting level, differencesin output per worker are

12. In helping us to think about the differences,David Romer suggested that

to differencesin productivity.But why do capital and productivity

equilibrium when protection against predation is incomplete.13

13. See, forexample, Murphy,Shleifer,and Vishny [1991]; Acemoglu [1995];

directeffectson production,a good social infrastructuremay have

IV. ESTIMATINGTHE EFFECT OF SOCIAL INFRASTRUCTURE

tion of contracts. Our GADP variable is an equal-weighted

related to true social infrastructurethrough random measure-

(7) log Y/L =o + PS + a,

The coefficiente will be identified by the orthogonality

Western European influence seems perfectlynatural. However,

15. Engerman and Sokoloff [1997] provide a detailed historical analysis

PRI NZL ESP

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Figure II plots outputper workeragainst our measured index

OverID test Coefftest

1. Main specification 5.1432 .256 .812 .840

zero-one scale. How much ofthis is measurement error,and how

19. The bootstrapproceeds as followswith 10,000 replications.First,we draw

The main specificationin Table II reports the results from

(8) log YIL =U +

(9) S -y?+ 6logY/L +XO + a.

The reduced-formequation forS is

Correlation of S with E arises from two sources. One is

That is, we can estimate the standard deviation of true social

20. That is, we calculate exp (r,$S3kv(Smax

have high levels of output per worker. Under our identifying

Social Log (output

Distance fromthe equator, (0,1) scale 0.708 3.668

1 _a log K/Y log H/L logA

Social infrastructure 1.052 1.343 2.746

YIL (K/Y)a'(1-0) HIL A

Observed factorofvariation 35.1 4.5 3.1 19.9

Table V summarizes the extent to which differencesin true

VI. ROBUSTNESS OF THE RESULTS

The central equation estimated in this paper has onlya single

Hall & Jones (1999)

Hall & Jones (1999)