The Institutional Determinants of Bilateral Trade Patterns
Summary (2 min read)
- Recent research in international economics points at the likely relevance of barriers to trade other than tariffs and quotas.
- The impact of institutions on transaction costs has received a lot of attention in the literature on economic growth and development (e.g., Hall and Jones 1999 , Olson 1996 , Knack and Keefer 1995) .
- The authors therefore investigate the hypothesis that institutions matter for international trade 1 .
- Interpreting trade between two countries as the economic analogue of the mutual gravitational force between two bodies, with their respective GDPs reflecting mass, the authors see the intuitive rationale for a gravity model of bilateral trade 2 .
- Indicators from 17 different sources, constructed by 15 organisations have been combined, including the sources used by Anderson and Marcouiller (World Economic Forum's Global Competitiveness Report) and Koukhartchouk and Maurel (Heritage Foundation, Economic Freedom Index) .
II. DATA DESCRIPTION AND MODEL SETUP
- In the empirical analysis that follows, the authors make use of both country-specific and bilateral data from various sources.
- Since these variables are more or less standard in the literature, the authors do not extensively discuss them here.
- It reflects whether citizens and business can prevent arbitrariness in the behaviour of government and enforce good governance when needed.
- It presents the sample means and standard deviations for each of these indicators, together with some tentative illustration of the corresponding cross-country differences in institutional quality.
- The independent variables are, respectively: national income (Y), income per capita (y), the distance between i and j (D ij ), dummies reflecting whether i and j share: a land border (Adj), their primary language (Lang), membership in a regional Preferential Trade Agreement (PTA), their main religion , and whether they were part of a common colonial empire (Col).
III. BASIC RESULTS
- Before investigating the effects of institutions, the authors first discuss a set of specifications of the gravity equation that take into account standard variables often applied in the literature.
- Distance negatively affects the intensity of trade.
- The result supports the importance of trade costs for explaining the patterns of trade.
- Standard gravity models also control for other country-specific and bilateral characteristics that may affect trade.
- Following the introduction of country-specific dummies, the coefficients on the bilateral dummy variables rise, and they become statistically more significant.
IV. THE ROLE OF INSTITUTIONS
- In this section the authors extend the analysis in the previous section and focus on the explanatory role of institutional quality and institutional homogeneity for the intensity of bilateral trade.
- This reduces transaction costs directly, by increasing the security of property, as well as indirectly, by increasing the level of trust in the process of economic transactions.
- If traders in both countries experience similar levels of institutional effectiveness, they are better equipped to use each other's institutions, to operate in each other's institutional environment.
- This price markup depends on two factors.
- Anderson and Marcouiller refer to the instrumental roles that can be played in this matter by language commonality and contiguity.
4.1 The effects of institutional quality
- 8. This confirms the finding by Tamirisa and Wei (2002) that corruption is an important informal barrier to trade.
- A possible solution for the missing theoretical explanation why rich countries trade more has been found.
4.2 The effects of institutional homogeneity
- Alternatively, differences in institutional quality only start to have independent negative effects on trade, when the difference becomes really large.
- Then, unfamiliarity adds an extra dimension to the transaction costs of bilateral trade.
- Adjustment costs, and additional lack of trust and confidence in the security of transactions begin to accumulate when differences in the institutional environment between exporters and importers increase.
- Recent research draws attention to the importance of informal barriers to international trade, caused by intangible factors.
- An important implication emerges from their separate focus on country-specific quality of institutions and bilateral homogeneity of governance.
- This reflects the adjustment costs and extra uncertainty involved when traders do not share a sufficiently effective institutional framework.
- Institutional dissimilarity affects trade between countries with the best institutional quality and those that have the lowest effectiveness.
- Potential trade between these countries is diverted to partners closer in terms of institutional effectiveness.
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