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Trust-Based Trade

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  • Luis Araujo

    (Michigan State University and Fucape)

  • Emanuel Ornelas

    (University of Georgia and IBMEC Business School - Rio de Janeiro)

Abstract

There is substantially more trade within national borders than across borders. An important explanation for this fact is the weak enforcement of international contracts. We develop a model in which agents build reputations to overcome this institutional failure. The model describes the interplay between institutional quality, reputations and the dynamics of international trade. It also rationalizes several empirical regularities. We find that history matters for trade volumes, but that its effects vary with the institutional setting of the country. The same is true for the efficacy of trade liberalization programs. Moreover, while stricter enforcement of contracts enhances trade in the short run, it makes it harder for individual traders to develop good reputations. We show that this indirect negative effect may produce an "institutional trap": for sufficiently low initial levels of contract enforcement, a small tightening in enforcement reduces future trade flows. We find also that search frictions aggravate the problems created by weak enforceability of contracts, even if they impose no direct cost on agents, but that trade liberalization can mitigate these negative effects.

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Bibliographic Info

Paper provided by Economics Research Group, IBMEC Business School - Rio de Janeiro in its series IBMEC RJ Economics Discussion Papers with number 2005-08.

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Date of creation: 30 Nov 2005
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Handle: RePEc:ibr:dpaper:2005-08

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Postal: Av. Pres. Wilson 118, 11 andar, Rio de Janeiro, RJ, Brazil, 20030-020
Web page: http://professores.ibmecrj.br/erg/
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Keywords: International trade; Export dynamics; Contract enforcement; Reputation;

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References

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  1. McLaren, J, 1996. "Supplier Relations and the Market Context : A Theory of Handshakes," Papers 766, Yale - Economic Growth Center.
  2. Rauch, James E. & Watson, Joel, 2003. "Starting small in an unfamiliar environment," International Journal of Industrial Organization, Elsevier, vol. 21(7), pages 1021-1042, September.
  3. Bernard, Andrew & Jensen, J Bradford & Redding, Stephen J & Schott, Peter, 2007. "Firms in International Trade," CEPR Discussion Papers 6277, C.E.P.R. Discussion Papers.
  4. James E. Anderson & Douglas Marcouiller, S.J., 1999. "Insecurity and the Pattern of Trade: An Empirical Investigation," Boston College Working Papers in Economics 418, Boston College Department of Economics, revised 03 Aug 2000.
  5. Jonathan Eaton & Samuel Kortum & Francis Kramarz, 2004. "Dissecting trade: firms, industries, and export destinations," Staff Report 332, Federal Reserve Bank of Minneapolis.
  6. Richard Chisik, 2010. "Export Industry Policy and Reputational Comparative Advantage," Working Papers 017, Ryerson University, Department of Economics.
  7. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," NBER Working Papers 5131, National Bureau of Economic Research, Inc.
  8. Alejandro Izquierdo & Jacques Morriset & Marcelo Olarreaga, 2003. "Information Diffusion in International Markets," IDB Publications 6509, Inter-American Development Bank.
  9. Barry Eichengreen & Douglas A. Irwin, 1998. "The Role of History in Bilateral Trade Flows," NBER Chapters, in: The Regionalization of the World Economy, pages 33-62 National Bureau of Economic Research, Inc.
  10. Henry Overman & Patricia Rice & Anthony Venables, 2010. "Economic Linkages across Space," Regional Studies, Taylor & Francis Journals, vol. 44(1), pages 17-33.
  11. Alejandro Cuñat & Marc J. Melitz, 2007. "Volatility, Labor Market Flexibility, and the Pattern of Comparative Advantage," NBER Working Papers 13062, National Bureau of Economic Research, Inc.
  12. Simon Johnson & John McMillan & Christopher Woodruff, 2001. "Courts and Relational Contracts," NBER Working Papers 8572, National Bureau of Economic Research, Inc.
  13. Anderson James E & Young Leslie, 2006. "Trade and Contract Enforcement," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 5(1), pages 1-36, November.
  14. Dani Rodrik, 2000. "How Far Will International Economic Integration Go?," Journal of Economic Perspectives, American Economic Association, vol. 14(1), pages 177-186, Winter.
  15. John McMillan & Christopher Woodruff, 1999. "Interfirm Relationships And Informal Credit In Vietnam," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1285-1320, November.
  16. Egan, Mary Lou & Mody, Ashoka, 1992. "Buyer-seller links in export development," World Development, Elsevier, vol. 20(3), pages 321-334, March.
  17. Greif, Avner, 1993. "Contract Enforceability and Economic Institutions in Early Trade: the Maghribi Traders' Coalition," American Economic Review, American Economic Association, vol. 83(3), pages 525-48, June.
  18. Watson, Joel, 1999. "Starting Small and Commitment," University of California at San Diego, Economics Working Paper Series qt37p340fc, Department of Economics, UC San Diego.
  19. Woodruff, Christopher, 1998. "Contract enforcement and trade liberalization in Mexico's footwear industry," World Development, Elsevier, vol. 26(6), pages 979-991, June.
  20. James E. Rauch, 2001. "Business and Social Networks in International Trade," Journal of Economic Literature, American Economic Association, vol. 39(4), pages 1177-1203, December.
  21. repec:rus:hseeco:121669 is not listed on IDEAS
  22. repec:rus:hseeco:123708 is not listed on IDEAS
  23. James E. Rauch & Vitor Trindade, 2003. "Information, International Substitutability, and Globalization," American Economic Review, American Economic Association, vol. 93(3), pages 775-791, June.
  24. Ghosh, Parikshit & Ray, Debraj, 1996. "Cooperation in Community Interaction without Information Flows," Review of Economic Studies, Wiley Blackwell, vol. 63(3), pages 491-519, July.
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