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Trade, inequality, and the political economy of institutions

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  • Do, Quy-Toan
  • Levchenko, Andrei A.

Abstract

The authors analyze the relationship between international trade and the quality of economic institutions such as contract enforcement, rule of law, or property rights. The literature on institutions has argued, both empirically and theoretically, that larger firms care less about good institutions and that higher inequality leads to worse institutions. Recent literature on international trade enables the authors to analyze economies with heterogeneous firms, and argue that trade opening leads to a reallocation of production in which large firms grow larger, while small firms become smaller or disappear. Combining these two strands of literature, the authors build a model that has two key features. First, preferences over institutional quality differ across firms and depend on firm size. Second, institutional quality is endogenously determined in a political economy framework. They show that trade opening can worsen institutions when it increases the political power of a small elite of large exporters that prefer to maintain bad institutions. The detrimental effect of trade on institutions is most likely to occur when a small country captures a sufficiently large share of world exports in sectors characterized by economic profits.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3836.

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Date of creation: 01 Feb 2006
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Handle: RePEc:wbk:wbrwps:3836

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Keywords: Economic Theory&Research; Free Trade; Trade Law; Trade Policy; Trade and Services;

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References

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Citations

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Cited by:
  1. Alexeev, Michael & Jang, Yong Joon, 2010. "Trade liberalization, heterogeneous firms and the soft budget constraint," Journal of Comparative Economics, Elsevier, vol. 38(4), pages 449-460, December.
  2. Egger, Hartmut & Egger, Peter & Markusen, James R., 2009. "International Welfare and Employment Linkages Arising from Minimum Wages," CEPR Discussion Papers 7387, C.E.P.R. Discussion Papers.
  3. Marianna Belloc & Samuel Bowles, 2010. "International Trade, Factor Mobility and the Persistence of Cultural-Institutional Diversity," Levine's Working Paper Archive 661465000000000051, David K. Levine.
  4. Eckel, Carsten & Egger, Hartmut, 2009. "Wage bargaining and multinational firms," Journal of International Economics, Elsevier, vol. 77(2), pages 206-214, April.
  5. Tobias Seidel, 2010. "Foreign Market Entry under Incomplete Contracts," CESifo Working Paper Series 3248, CESifo Group Munich.
  6. Caleb Stroup & Benjamin Zissimos, 2011. "Pampered Bureaucracy, Political Stability, and Trade Integration," Vanderbilt University Department of Economics Working Papers 1105, Vanderbilt University Department of Economics.
  7. Francois, Joseph & Rojas-Romagosa, Hugo, 2010. "Household Inequality, Social Welfare, and Trade," CEPR Discussion Papers 7998, C.E.P.R. Discussion Papers.
  8. Olsson, Ola, 2009. "On the democratic legacy of colonialism," Journal of Comparative Economics, Elsevier, vol. 37(4), pages 534-551, December.
  9. Marcus Dejardin, 2011. "Entrepreneurship and Rent-Seeking Behavior," Working Papers 1112, University of Namur, Department of Economics.
  10. Marc J. Melitz & Stephen J. Redding, 2012. "Heterogeneous Firms and Trade," CEP Discussion Papers dp1183, Centre for Economic Performance, LSE.
  11. Luis Araujo & Giordano Mion & Emanuel Ornelas, 2012. "Institutions and export dynamics," Working Paper Research 220, National Bank of Belgium.
  12. Cervellati, Matteo & Naghavi, Alireza & Toubal, Farid, 2013. "Trade Liberalization, Democratization and Technology Adoption," IZA Discussion Papers 7132, Institute for the Study of Labor (IZA).
  13. Rubén Segura-Cayuela, 2006. "Inefficient policies, inefficient institutions and trade," Banco de España Working Papers 0633, Banco de España.
  14. Marianna Belloc & Samuel Bowles, 2009. "International Trade, Factor Mobility and the Persistence of Cultural-Institutional Diversity," Working Papers 126, University of Rome La Sapienza, Department of Public Economics.

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