Marianna Belloc, Samuel Bowles

Paper #: 13-01-003

We address two seemingly unrelated empirical anomalies: the remarkable historical persistence of cultural and institutional differences affecting production and distribution even among nations and regions engaged in extensive trading, and the shortcomings of the standard model that predicts international specialization and trade on the basis of differences in factor endowments or technologies. We model the endogenous evolution of both culture (the distribution of preferences affecting individual behavior) and institutions (the distribution of contracts among employers and employees), showing that in otherwise identical economies, different cultural-institutional conventions can persist over long periods. Transitions between cultural-institutional conventions occur as a result of decentralized and un-coordinated contractual or behavioral innovations by firms or workers. In a two-good/two-factor/two-country trade model, we then show that: (i) because goods differ in the kinds of contracts and preferences that are appropriate for their production, cultural-institutional differences support differing competitive prices in autarchy, and so provide the basis for specialization and comparative advantage; (ii) the resulting gains from trade raise the cost of deviations from the prevailing culture and institutions and, as a result, trade will impede transitions to the superior convention; and (iii) by contrast, by reducing the cost of innovating, international mobility of factors of production facilitates convergence to superior cultural-institutional conventions. Our model thus provides a possible unified resolution of the anomalies concerning patterns of specialization and trade, and cultural-institutional persistence.