Seminar 4 (Oct. 26)

I. Culture and trust

Consider a version of the "trust game": There are two players A and B. A starts with an endowment 10. At stage 1, she transfers any amount x between 0 and 10 to B and keeps the rest for herself. This is then doubled, so B receives 2x. At stage 2, player B decides an amount y to return to player A, chosen between 0 and 2x. This transfer is again doubled, so A receives 2y. B keeps whatever was not transferred and also receives a final payment of 10.

1. Set up the game tree and show A's and B's payoffs as functions of x and y. Use backwards induction to find the subgame perfect Nash equilibrium (SPNE) of the game, and explain why this outcome is not Pareto optimal.
2. Explain why this game can illustrate situations encountered in real life, for instance in market transactions.
3. Assume now that the players A and B meet regularly, say once every day, to play the trust game. They each have a (daily) discount factor ¦Â. Could they then be able to sustain trust in the game? One definition of "trust" is that A chooses x=10 and B chooses y=10.
   Hint: The main challenge is to get B to cooperate
4. Assume instead that there are many players around where every player is matched with a randomly chosen other player every period. Discuss to what extent trust can be sustained in this environment. Discuss particularly whether a multilateral punishment strategy, as discussed by Geif (1993), can work in this setting.
5. Assume players have a visible marker of identity, such as ethnicity. Could a situation where players trust the other player if they are both from the same ethnicity, but not if the other player is from a different ethnicity be a SPNE in the repeated game? Discuss whether this can help us understand why more ethnically fragmented countries on average have less good economic performance than more homogeneous countries.
6. The Nordic countries have traditionally been among the countries with the highest trust level in the world. Explain first why this may have been a (partial) explanation for the success of the Nordic countries. Discuss next whether this is likely to be a pure blessing in a more globalized world.

II. Sugar and inequality

Consider Engerman and Sokoloff's (1997) paper:

1. Try to describe generally how differences in resource endowments affect distribution hence hence institutional development
2. In the paper "Inequality does cause underdevelopment: Insights from a new instrument" (2007), Bill Easterly use the abundance of land suitable for growing wheat relative to the abundance of land suitable for growing sugar cane as an instrument for inequality across countries
   1. Explain the rationale for such an instrument in light of Engerman and Sokoloff's work. The figure shows a version of his first stage regression: Does it correspond to what you would expect?
   2. In the first panel of his Table 4, he attempt to study the causal effect of inequality on development (measured by log per capita income). Discuss his findings.
3. In 19th century Norway, the coast of the northern part of the country was politically and economically dominated by an elite of fish buyers (v?reier) facing a nummer of poor fishermen. Further south along the coast, fisheries were less abundant and buyers were less powerful.
   1. What would be the expected outcomes regarding instituional end poilitical development in the two regions according to Engerman and Sokoloff's theory?
   2. It turns out that the first parliamentary representatives from the Labor party (then a revolutionary socialist party) came from the North. How does this fit in Engerman and Sokoloff's framework? How about the model of Acemoglu and Robinson (2001)?