Trust and parameter heterogeneity in the neoclassical growth model

Previous research has shown that trust alters input efficiencies across countries, which is suggestive of parameter heterogeneity. In this paper, trust's role in parameter heterogeneity is further explored within the context of the neoclassical growth model. This heterogeneity creates a nonlinear regression specification, which is estimated using a Metropolis within Gibbs algorithm. Results show that country-level trust differences cause human capital's exponent to vary by 43% and physical capital's exponent to vary by 29% across countries. This trust-induced parameter heterogeneity has important implications for various aspects of the development process. Under higher trust levels, the responsiveness of output per worker to changes in savings is increased by as much as 52%. In addition, this parameter heterogeneity also serves to mitigate untenably high implied rates of rate return differences between the US and other countries.