Economic growth and economic development 194

Introduction to Modern Economic Growth

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Latitude

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Figure 4.2. Relationship between latitude (distance of capital from
the equator) and income per capita in 1995.
depicted in Figure 4.1, and for that matter that shown in Figure 4.2, do not necessarily reflect causal relationships . As we pointed out in the context of the effect
of religion or social capital on economic performance, these types of scatterplots,
correlations, or their multidimensional version in ordinary least squares regressions,
cannot establish causality.
How can we overcome the challenge of establishing a causal relationship between
(economic) institutions and economic outcomes? The answer to this question is to
specify econometric approaches based on convincing identifying restrictions. This
can be done by using estimating structural econometric models or by using more
reduced-form approaches, based on instrumental-variables strategies. At the moment we do not know enough about the evolution of economic institutions and their
impact on economic outcomes to be able to specify and estimate fully-structural
econometric models. Thus as a first step, we can look at more reduced-form evidence
that might still be informative about the causal relationship between institutions

and economic growth. One way of doing so is to learn from history, in particular
180

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