Embedded Culture as a Source of Comparative Advantage

The Cultural Economics Revolution

In the second half of the 20th century, economics operated under two fundamental assumptions: that humans were perfectly rational (the rationality assumption) and that their behavior was universally consistent across cultures and contexts (the universality assumption). These hypotheses were challenged by two streams of literature: behavioral economics and cultural economics.

The behavioral revolution made economics more human but not less universal. It maintained the premise that deviations from rationality due to cognitive biases and behavioral patterns were consistent across cultures and contexts. In contrast, cultural economics argues that individuals’ beliefs (priors) and preferences (values) are fundamentally shaped by their personal and communal history, leading to persistent differences in economic behavior across societies.

Embedded cultural versus Functional Culture

Over the past three decades, cultural explanations have gained increasing acceptance in economics, finance, entrepreneurship and accounting, with over 9,000 papers incorporating “culture” in their abstracts in the SSRN database. However, the dominant approach treats culture functionally – as an optimal response to collective action problems and organizational challenges – rather than as a deeply embedded phenomenon that shapes economic behavior in ways that cannot be fully explained by rational planning and optimization.

Our paper examines how the sociological concept of embedded culture has influenced economics and argues for its broader recognition.  Embeddedness entails the idea that economic actions and choices as inherently situated within a society cultural and social normative framework. We propose that embedded culture represents an important initial endowment that individuals or nations share – one that can only be modified slowly over time and that fundamentally shapes economic outcomes.

The explanatory power of this approach is illustrated by cases like Southern Italy, where historically determined low self-efficacy beliefs profoundly impact the success of both democratic and capitalist institutions, despite having formal institutions identical to Northern Italy. This persistence occurs through intergenerational transmission and socialization, becoming embedded in local culture and social norms.

Such cultural persistence helps explain why cross-country differences in economic performance prove so enduring – culture, as a slowly changing, historically rooted set of beliefs and values, provides societies with unique characteristics that influence their economic performance in ways difficult for others to replicate quickly. Economic rationality and behavioral traits affect agents decisions differently depending on where they take place of from where the decision maker comes from. Culture segments geographically the decisions making process of both rational and behavioral agents.

The implications of embedded culture extend to corporate settings. While the traditional literature views corporate culture as an additional management tool for maximizing the firm objectives, we demonstrate how societal culture fundamentally shapes corporate behavior. The bidirectional relationship between Japanese society and Toyota illustrates this dynamic: while Toyota’s principle of continuous improvement (kaizen) has significantly influenced Japanese society, kaizen itself is rooted in the Japanese concept of hansei (reflection).

Culture as a Source of Comparative Advantage

The persistent nature of cultural traits can create lasting comparative advantages or disadvantages for individuals, nations, and corporations. For instance, recent research shows that students from countries with higher levels of long-term orientation perform better in school across various host nations, even after controlling for numerous factors. At the national level, the historically determined civic capital of Italian regions continues to influence their financial development and economic performance today. Sometimes, cultural traits that were initially dysfunctional can become advantageous when conditions change – as illustrated by the Jewish communities’ emphasis on literacy, which transitioned from being economically burdensome in agricultural societies to providing a significant advantage in urbanized economies.

In corporate settings, this cultural advantage manifests through multiple channels. Companies headquartered in high-trust regions benefit from greater decentralization, can economize in monitoring costs, enjoy a wider span of control and thus achieve a larger size. Firms’ ability to implement certain management practices often depends on the cultural background of their workforce – as demonstrated by the complementarity between Toyota’s kaizen principle and the Japanese cultural concept of hansei. These cultural advantages prove difficult to replicate, as they are embedded in deeper societal values and norms rather than being merely functional organizational choices.

Future Research Directions

The embedded culture perspective opens new avenues for research, particularly in understanding:

• How functional and embedded aspects of culture interact
• The role of education in cultural transmission
• How policy choices generate cultural externalities
• The cultural spillovers from corporate decisions

These areas represent promising frontiers for future research in economics and finance.