Introduction to Modern Economic Growth these measures are purchased by businessmen contemplating investment in these countries, thus they reflect the “market assessment” of security of property rights Figure 4.1 shows that countries with more secure property rights–thus better economic institutions–have higher average incomes One should not interpret the correlation in this figure as depicting a causal relationship–that is, as establishing that secure property rights cause prosperity First, the correlation might reflect reverse causation; it may be that only countries that are sufficiently wealthy can afford to enforce property rights Second and more importantly, there might be a problem of omitted variable bias It could be something else, for example, geography or culture, that explains both why countries are poor and why they have insecure property rights Thus if omitted factors determine institutions and incomes, we would spuriously infer the existence of a causal relationship between economic institutions and incomes when in fact no such relationship exists This is the standard identification problem in economics resulting from simultaneity or omitted variable biases Finally, security of property rights–or other proxy measures of economic institutions–are themselves equilibrium outcomes, presumably resulting from the underlying political institutions and political conflict While this last point is important, a satisfactory discussion requires us to develop models of political economy of institutions, which will have to wait until Part of the book To further illustrate these potential identification problems, suppose that climate or geography matter for economic performance In fact, a simple scatterplot shows a positive association between latitude (the absolute value of distance from the equator) and income per capita consistent with the views of Montesquieu and other proponents of the geography hypothesis Interestingly, Montesquieu not only claimed that warm climate makes people lazy and thus unproductive, but also unfit to be governed by democracy He argued that despotism would be the political system in warm climates Therefore, a potential explanation for the patterns we see in Figure 4.1 is that there is an omitted factor, geography, which explains both economic institutions and economic performance Ignoring this potential third factor would lead to mistaken conclusions Even if Montesquieu’s story appears both unrealistic and condescending to our modern sensibilities, the general point should be taken seriously: the correlations 179