How much do cultural biases affect economic exchange? We answer this question by using data on bilateral trust between European countries. We document that this trust is affected not only by the characteristics of the country being trusted, but also by cultural aspects of the match between trusting country and trusted country, such as their history of conflicts and their religious, genetic, and somatic similarities. We then find that lower bilateral trust leads to less trade between two countries, less portfolio investment, and less direct investment, even after controlling for the characteristics of the two countries. This effect is stronger for goods that are more trust intensive. Our results suggest that perceptions rooted in culture are important (and generally omitted) determinants of economic exchange.

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Cultural Biases in Economic Exchange

This book explores whether the world economy is breaking up into regional trading and currency blocs centred on the European Community, Japan and the United States. Frankel uses trade, investment and financial data to assess this issue. He concludes with an analysis of how trends in regional economic integration can be used as building blocks for a stronger multilateral system.

Regional Trading Blocs in the world economic system, reseñado por Antonio Ortiz-Mena L.N.

When relationship-specific investments are necessary for production, under-investment occurs if contracts cannot be enforced. The efficiency loss from under-investment will differ across industries depending on the importance of relationship-specific investments in the production process. As a consequence, a country’s contracting environment may be an important determinant of comparative advantage. To test for this, I construct measures of the efficiency of contract enforcement across countries and the importance of relationship-specific investments across industries. I find that countries with better contract enforcement specialize in industries that rely heavily on relationshipspecific investments. This is true even after controlling for traditional determinants of comparative advantage such as endowments of capital and skilled labor.

/pdf/relationship-specificity-incomplete-contracts-and-the-4s0nvmi9e3.pdf

Relationship-Specificity, Incomplete Contracts, and the Pattern of Trade

Corruption and imperfect contract enforcement dramatically reduce international trade. This paper estimates the reduction using a structural model of import demand in which insecurity acts as a hidden tax on trade. We find that inadequate institutions constrain trade as much as tariffs do. We also find that omission of indices of institutional quality biases the estimates of typical gravity models, obscuring a negative relationship between per capita income and the share of total expenditure devoted to traded goods. Finally, we argue that cross-country variation in the effectiveness of institutions and the consequent variation in the prices of traded goods offer a simple explanation for the stylized fact that high-income, capital-abundant countries trade disproportionately with each other.

/pdf/insecurity-and-the-pattern-of-trade-an-empirical-2fqly7ytaw.pdf

Insecurity and the Pattern of Trade: An Empirical Investigation

Conventional studies of bilateral trade patterns specify a log-normal gravity equation for empirical estimation. However, the log-normal gravity equation suffers from three problems: the bias created by the logarithmic transformation, the failure of the homoscedasticity assumption, and the way zero values are treated. These problems normally result in biased and inefficient estimates. Recently, the Poisson specification of the trade gravity model has received attention as an alternative to the log-normality assumption (Santos Silva and Tenreyro, 2006). However, the standard Poisson model is vulnerable for problems of overdispersion and excess zero flows. To overcome these problems, this paper considers modified Poisson fixed-effects estimations (negative binomial, zero-inflated). Extending the empirical model put forward by Santos Silva and Tenreyro (2006), we show how these techniques may provide viable alternatives to both the log-normal and standard Poisson specification of the gravity model of trade.

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On the Specification of the Gravity Model of Trade: Zeros, Excess Zeros and Zero-inflated Estimation

The intensity of international transactions remains lower than could be potentially justified on the basis of transportation costs alone. This has become known as the ‘mystery of the missing trade’. Transaction costs may be responsible for ‘under-trading’ across national borders. More specifically, the relatively low intensity of foreign trade may reflect the importance of institutions for cross-border transactions. This paper studies the effect of institutions on trade flows, using a gravity model approach.

According to the gravity model, trade between any two countries is a function of each country's gross domestic product, the distance between them, and possibly other variables that reflect the costs of trade between them. We start from a standard gravity equation that incorporates variables for geographical proximity, common language, trade policy and common history. These factors reflect costs of trade across geographical and cultural distances.

The quality of governance and the extent of familiarity with the resulting framework of rules and norms also affect the costs of doing business between any pair of countries. The effects of institutional quality and similarity on transaction costs may be substantial in international markets. Because of the greater extent of competition and higher uncertainty in international markets, the impact of quality and similarity of institutions on cross-border trade may be relatively pronounced.

Therefore, this paper extends the gravity equation to include proxies for institutional quality and institutional homogeneity between trade partners. We use indicators on political stability, regulatory quality, corruption and other proxies that reflect the quality of governance, available from the comparative data set constructed by Kaufmann and others (World Bank, 2002). Variables that capture similarity in the quality of institutions are then constructed from these indicators.

We test whether institutional homogeneity and institutional quality have an independent impact on trade volume between pairs of countries. The results indicate that, for example, having a similar law or regulatory framework promotes bilateral trade. Furthermore, a better quality of formal institutions on average coincides with higher trade.

JEL codes: F14

Keywords: bilateral trade flows, gravity model, institutions

/pdf/the-institutional-determinants-of-bilateral-trade-patterns-3dg1zi8hev.pdf

The Institutional Determinants of Bilateral Trade Patterns

Past research into the determinants of international trade highlighted the importance of the basic spatial gravity model augmented by additional variables representing sources of friction. Studies modeled many sources of friction using various proxies, including indices based on expert judgment in some cases. This paper focuses on logistics friction and draws on a data set recently compiled by the World Bank with specific quantitative metrics of logistics performance in terms of time, cost, and variability in time. It finds that the new variables that relate directly to logistics performance have a statistically significant relationship with the level of bilateral trade. It also finds that a single logistics index can capture virtually all of the explanatory power of multiple logistics indicators. The findings should spur public and private agencies that have direct or indirect power over logistics performance to focus attention on reducing sources of friction so as to improve their country's ability to compete in today's global economy. Moreover, since the logistics metrics are directly related to operational performance, countries can use these metrics to target actions to improve logistics and monitor their progress.

/pdf/global-logistics-indicators-supply-chain-metrics-and-14n05wttet.pdf

Global logistics indicators, supply chain metrics, and bilateral trade patterns

This paper examines opportunities for Sub-Saharan African countries to effectively participate in globalization, particularly given the increasing interest of China and India in Sub-Saharan Africa. How can Sub-Saharan Africa fully engage and gain benefits from global network trade? Over the past 15 years Asia has become Africa's fastest growing export market. Asian countries are much more open to trade than Europe or America. There seems to be no evidence to suggest that this trend will not continue in the near future. The authors acknowledge the numerous caveats in Asia's growing interest in the African continent, not least the resource curse of exports that are heavily concentrated on oil, minerals, and raw materials, as well as the fierce competition from Asia's cheap manufactured exports. However, they believe that there is strong evidence to suggest a clear potential for South-South cooperation in trade and investment. Drawing on evidence from their extensive research into international value chains, the authors identify five critical factors for effective participation in global network trade: price, speed-to-market, labor productivity, flexibility, and product quality. Underlying competitive performance of these critical factors are a country's policies and institutions. Effective policies, efficient institutions, and the necessary infrastructure will ensure the best outcome for trading countries. To improve the depth and sustainability of these five critical factors, it is important that developing countries create a supportive policy and institutional framework from the outset.

/pdf/can-sub-saharan-africa-leap-into-global-network-trade-174ty8hoxy.pdf

Can Sub-Saharan Africa leap into global network trade ?

This paper studies the effect of institutions on trade flows, using a gravity model approach. We start from a standard gravity equation that incorporates geographical proximity, language, trade policy and common history. These factors reflect the costs of trade across geographical and cultural distance. The quality of governance and the extent of familiarity with the resulting framework of rules and norms may also affect the costs of doing business between any pair of countries. This paper extends the gravity equation to include proxies for institutional quality and institutional homogeneity between trade partners. For this, we use indicators on political stability, regulatory quality, and other proxies that reflect the quality of governance. We test whether institutional homogeneity and institutional quality have an independent impact on the trade volume between pairs of countries. We find that having a similar law or regulatory framework promotes bilateral trade by 12-18%. Furthermore, a better quality of formal institutions tends to coincide with more trade. An increase in regulatory quality of one standard deviation from the mean leads to an estimated increase of 20-24% in bilateral trade. Lower corruption similarly accounts for 17-27% extra trade.

/pdf/the-institutional-determinants-of-bilateral-trade-patterns-1zl6y808ji.pdf

This paper examines opportunities for Sub-Saharan African countries to effectively participate in globalization, particularly given the increasing interest of China and India in Sub-Saharan Africa. How can Sub-Saharan Africa fully engage and gain benefits from global network trade? Over the past 15 years Asia has become Africa's fastest growing export market. Asian countries are much more open to trade than Europe or America. There seems to be no evidence to suggest that this trend will not continue in the near future. The authors acknowledge the numerous caveats in Asia's growing interest in the African continent, not least the"resource curse"of exports that are heavily concentrated on oil, minerals, and raw materials, as well as the fierce competition from Asia's cheap manufactured exports. However, they believe that there is strong evidence to suggest a clear potential for South-South cooperation in trade and investment. Drawing on evidence from their extensive research into international value chains, the authors identify five critical factors for effective participation in global network trade: price, speed-to-market, labor productivity, flexibility, and product quality. Underlying competitive performance of these critical factors are a country's policies and institutions. Effective policies, efficient institutions, and the necessary infrastructure will ensure the best outcome for trading countries. To improve the depth and sustainability of these five critical factors, it is important that developing countries create a supportive policy and institutional framework from the outset.

Uma Subramanian

Papers

The Institutional Determinants of Bilateral Trade Patterns

Global logistics indicators, supply chain metrics, and bilateral trade patterns

Can Sub-Saharan Africa leap into global network trade ?

The Institutional Determinants of Bilateral Trade Patterns

Can Sub-Saharan Africa leap into global network trade ?