Evaluating Ingenious Instruments for Fundamental Determinants of Long-Run Economic Growth and Development

Empirical studies of the determinants of cross-country differences in long-run development are characterized by the ingenious nature of the instruments used. However, scepticism remains about their ability to provide a valid basis for causal inference. This paper examines whether explicit consideration of the statistical adequacy of the underlying reduced form, which provides an embedding framework for the structural equations, can usefully complement economic theory as a basis for assessing instrument choice in the fundamental determinants literature. Diagnostic testing of the reduced forms in influential studies reveals evidence of model misspecification, with parameter non-constancy and spatial dependence of the residuals being almost ubiquitous. This feature, surprisingly not previously identified, potentially undermines the inferences drawn about the structural parameters, such as the quantitative and statistical significance of different fundamental determinants.