SOME COUNTRIES PRODUCE SO MUCH MORE OUTPUT PER WORKER THAN OTHERS: Estimating the Effect of Social Infrastructure

Two important preliminary issues are the measurement of social infrastructure and the econometric identification of our model.
Measurement
The ideal measure of social infrastructure would quantify the wedge between the private return to productive activities and the social return to such activities. A good social infrastructure ensures that these returns are kept closely in line across the range of activities in an economy, from working in a factory to investing in physical or human capital to creating new ideas or transferring technologies from abroad, on the positive side, and from theft to corruption on the negative side.
In practice, however, there does not exist a usable quantification of wedges between private and social returns, either for single countries or for the large group of countries considered in this study. As a result, we must rely on proxies for social infrastructure and recognize the potential for measurement error.

We form our measure of social infrastructure by combining two indexes. The first is an index of government anti-diversion policies (GADP) created from data assembled by a firm that specializes in providing assessments of risk to international investors, Political Risk Services. Their International Country Risk Guide rates 130 countries according to 24 categories. We follow Knack and Keefer (1995) in using the average of 5 of these categories for the years 1986-1995. Two of the categories relate to the government’s role in protecting against private diversion: (i) law and order, and (ii) bureaucratic quality. Three categories relate to the government’s possible role as a diverter: (i) corruption, (ii) risk of expropriation, and (iii) government repudiation of contracts. Our GADP variable is an equal-weighted average of these 5 variables, each of which has higher values for governments with more effective policies for supporting production. The index is measured on a scale from zero to one.