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Do Good Institutions Make Citizens Happy, or Do Happy Citizens Build Better Institutions?

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Abstract

Recent empirical investigations show that ‘good institutions’, in the form of democracy and economic freedom, are related to elevated scores of subjective well-being across countries. Most of these studies automatically assume that causality runs from formal institutions to happiness. None the less, an inverse relationship is also feasible and only a few authors have specifically analyzed this possibility. Furthermore, not much is known about the individual aspects of institutions that are valued by citizens, and how these preferences might change with the level of economic development. This paper contributes to closing these gaps, conducting ordinary least squares- and instrumental variable analysis as an empirical strategy. Results show that citizens in developing countries value the procedural aspects of democracy, access to sound money, and free trade, while citizens in developed countries only seem to value a comparatively well-functioning legal system and higher security of property rights. Findings indicate the existence of a causal channel from economic freedom to well-being, but can’t exclude a long run effect of intrinsic happiness on economic freedom through social capital.

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Notes

  1. Reviews by Frey and Stutzer (2002), Di Tella and MacCulloch (2006), Dolan et al. (2008), Frey (2008) all provide good overviews of the topic.

  2. When discussing this point, most authors refer to the very limited availability of cross country panel data, which undoubtedly complicates such an investigation. Many argue that a causality running from life satisfaction to institutions is neither probable nor logical.

  3. Radcliff (2001) and Tsai (2009) agree that the current studies of cross-national design can’t resolve such questions.

  4. As the name says, informal institutions are non-formalized rules and restrictions (North 1981), which can substitute or complement formalized institutions to a certain degree (Williamson and Mathers 2011).

  5. Using detailed micro-data and controlling for a large variety of individual and cantonal differences, the authors interpret the resulting variations in life satisfaction as procedural utility, derived from the process of democratic decision making.

  6. Recent contradicting evidence comes from Heukamp and Ariño (2011), who find that political and economic institutions are irrelevant for life satisfaction in their model, once the birth rate, life expectancy, corruption, and a Muslim culture are controlled for. Still, results might crucially depend on the model employed, which probably explains the deviating conclusions.

  7. This is likely to be due to some unobserved individual personality factors, and it suggests that some of the positive association is the consequence of reverse causality.

  8. Using the German Socioeconomic Household Panel, citizens who lose their volunteering opportunities as a consequence of the sociopolitical changes of 1989/1990 are compared to citizens that experienced no such change.

  9. Guven (2012) follows Putnam (1995) and defines social trust as membership in organizations and varying forms of trust.

  10. The use of country averages also makes the investigation of causality a less problematic affair, as compared to the use of micro data.

  11. The EF Index has been extensively used by economic research in recent years, and numerous authors have demonstrated it to be an adequate measure of how well national institutions are aligned with economic performance. See Berggren (2003), de Haan et al. (2006) for overviews.

  12. The areas have been shown to be useful tools in growth regressions by Ayal and Karras (1998), Heckleman and Stroup (2000), Carlsson and Lundström (2002), Dawson (2003), Berggren and Jordahl (2005), Justensen (2008).

  13. Reproducing studies by Rodrik and Wacziarg (2005), Epstein et al. (2006), Cheibub et al. (2010) further show that the choice of democracy measure in different empirical studies does matter, and that it has important implications for the results obtained.

  14. Purchasing power parity (PPP) standards are used for two reasons: First, since high inflation also seems to reduce life satisfaction, as highlighted by Dolan et al. (2008), using PPP will account for relatively recent changes in income that are due to inflation, without having to introduce another flow variable. Second, what most likely matters to citizens’ life satisfaction is the quantity of goods, their individual income will buy them, as compared to what they earn in nominal terms.

  15. In particular, data is taken from the third wave, which was conducted for 54 different countries from 1995 to 1998, from the fourth wave, which was conducted for 70 different countries between 1999 and 2000, and from the fifth wave, which was conducted for 57 different countries between 2005 and 2008.

  16. One could argue that pooling the dataset artificially increases observations and gives some countries greater weight than others. However, results are consistent when estimating with the three individual cross-sections.

  17. Different studies by Bjørnskov et al. (2008, 2010) show these dummies to be highly significant in similar models, making them an adequate tool to control for unexplained cultural differences and joint macro trends in SWB levels.

  18. In contrast with the previous table, dummy variables are introduced starting with model 1.

  19. Ovaska and Takashima (2006), Bjørnskov et al. (2007) also find that the size of government has a significant impact on life satisfaction. Both measure government size differently and observe different time periods, which might explain the contradicting outcomes.

  20. Legal structure and security of property rights has also been shown by Ayal and Karras (1998), Heckleman and Stroup (2000), Carlsson and Lundström (2002), Dawson (2003), Berggren and Jordahl (2005), and Justensen (2008), Rode and Coll (2012) to be the most important institutional element for economic growth.

  21. In a statistical sense, one could say that there is just not enough variation in the data to determine whether democracy provides citizens with procedural utility.

  22. Aggregate scores of personality tests are good predictors of life satisfaction across countries, as is demonstrated by Steel and Ones (2002), Lynn and Steel (2006). These measures also correlate well with institutions, which exclude them as suitable instruments.

  23. I am grateful to Christian Bjørnskov for having suggested this line of reasoning to me.

  24. The Hausman test finds the estimators to be consistent and Sargan’s test of over identified restrictions shows the instruments are valid and therefore exogenous.

  25. A value of 10 is usually assumed as acceptable for the incremental F-statistic in 2SLS analysis.

  26. Sargan’s test of over-identification can only be employed when using more than one instrument.

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Authors and Affiliations

  1. Departamento de Economía, Universidad de Cantabria, Av. de los Castros s/n, 39005, Santander, Spain

    Martin Rode

  2. Department of Economics, Gus A. Stavros Center, Florida State University, 250 S Woodward Ave, Tallahassee, FL, 32306, USA

    Martin Rode

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Correspondence to Martin Rode.

Appendix

Appendix

See Tables 6 and 7.

Table 6 Country samples
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Table 7 Life satisfaction and economic institutions (first stage regressions)
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Rode, M. Do Good Institutions Make Citizens Happy, or Do Happy Citizens Build Better Institutions?. J Happiness Stud 14, 1479–1505 (2013). https://doi.org/10.1007/s10902-012-9391-x

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