Is culture a determinant of financial development?

Abstract

This article investigates the missing link in the literature – whether informal institutions, or what is known as culture, can affect the level of financial development for a country? Our hypothesis stresses that the cultural dimensions of a country can have an impact on its financial set-up. We consider multiple dimensions of culture, identified in the literature by Tabellini (2008), to test our hypothesis. As culture evolves in the form of greater trust, control and other traits, individuals' attitudes towards financial market change, and they engage in greater financial transactions. This, in turn, leads to better financial development. Using quantile estimation technique for a cross section of 90 countries, we find that culture significantly influences the level of financial development. To ensure the robustness of our findings we use Hofstede's cultural dimension – ‘Uncertainty Avoidance Index’ (UAI) – as an alternative measure for culture. Our results hold for multiple measures of financial development.

Keywords:

• informal institutions
• financial development
• culture
• social capital

JEL Classification:

• O10
• O16

Notes

¹ There are many explanations as to what generates investor protection which, in turn, aids the formation of efficient financial infrastructure. La Porta et al. (1998) and Beck et al. (2002) claimed that legal origin is key to investor protection and, thus, to financial development. Rajan and Zingales (1998) argued that the relative merits of domestic financial intermediation are a function of the contractibility of the environment and the relative value of price signals. They also claimed that special interest groups have strong incentives to block the development of a transparent and competitive financial sector of a closed economy. According to Acemoglu et al. (2001), colonial origins determined earlier institutional structure and are the sole factors that matter for an efficient financial system. Stulz and Williamson (2003) noted that countries’ principal religion predicts the cross-country differences in creditor rights.

² Appendix 1 talks in detail about the construction of the ‘culture’ variable.

³ As explained later, Tabellini (2008) identified four traits of culture – TRUST, RESPECT, CONTROL AND OBEDIENCE. If the individuals feel they have the ‘Control’ in determining their actions they will be more likely to innovate, invest in the future and work more diligently (Coyne and Williamson, forthcoming; Tabellini, forthcoming).

⁴ The World Values Survey (WVS) has been implemented in five waves so far: (i) 1981–1984, (ii) 1990–1993, (iii) 1995–1997, (iv) 1999–2002 and (v) 2005–2008. The fifth wave of this value survey covers countries that together account for about 85% of the world's population.

⁵ In recent decades, investigating empirical links of culture with other variables has been made possible by the important variables identified by Tabellini (2008).

⁶ The UAI was calculated from three questions from the survey questionnaire: (1) the feeling that company rules should not be broken, not even when the employee thinks it would be in the company's best interests to do so; (2) the respondent's intention to stay with the company for more than 5 years; and (3) the respondent's feelings of stress at work.