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The Institutional Determinants of Bilateral Trade Patterns

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Author Info
Henri L.F. De Groot ()
Gert-Jan Linders ()
Piet Rietveld ()
Uma Subramanian

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Abstract

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

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Paper provided by European Regional Science Association in its series ERSA conference papers with number ersa03p421.

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Date of creation: Aug 2003
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Handle: RePEc:wiw:wiwrsa:ersa03p421

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  1. Matilde Bombardini & Giovanni Gallipoli & Germán Pupato, 2009. "Skill Dispersion and Trade Flows," NBER Working Papers 15097, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Bjørnskov, Christian, 2005. "Political Ideology and Economic Freedom," Working Papers 05-8, University of Aarhus, Aarhus School of Business, Department of Economics. [Downloadable!]
  3. Arjan M. Lejour & Ruud de Mooij, 2004. "Turkish Delight – Does Turkey’s accession to the EU bring economic benefits?," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  4. Simon Guttmann & Anthony Richards, 2004. "Trade Openness: An Australian Perspective," RBA Research Discussion Papers rdp2004-11, Reserve Bank of Australia. [Downloadable!]
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  5. Gert-Jan M. Linders & Arjen Slangen & Henri L.F. de Groot & Sjoerd Beugelsdijk, 2005. "Cultural and Institutional Determinants of Bilateral Trade Flows," Tinbergen Institute Discussion Papers 05-074/3, Tinbergen Institute. [Downloadable!]
  6. Anthony Briant & Pierre-Philippe Combes & Miren Lafourcade, 2009. "Product complexity, quality of institutions and the pro-trade effect of immigrants," PSE Working Papers 2009-06, PSE (Ecole normale supérieure). [Downloadable!]
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  7. Arjan Lejour & J.W. de Paiva Verheijden, 2004. "Services trade within Canada and the European Union. What do they have in common?," CPB Discussion Papers 42, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]
  8. Arjan Lejour & Andrea Mervar & Gerard Verweij, 2007. "The economic effects of Croatia's accession to the EU," CPB Documents 154, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]
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  9. Das, Gouranga Gopal & Andriamananjara, Soamiely, 2004. "Hub-and-Spokes Free-Trade-Agreements in the Presence of Technology Spillovers: An Application to the Western Hemisphere," Working Papers 15870, United States International Trade Commission, Office of Economics. [Downloadable!]
  10. A.M. Lejour & R.A. de Mooij & C.H. Capel, 2004. "Assessing the economic implications of Turkish accession to the EU," CPB Documents 56, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]
  11. Luigi Guiso & Paola Sapienza & Luigi Zingales, 2007. "Cultural Biases in Economic Exchange?," Economics Working Papers ECO2007/42, European University Institute. [Downloadable!]
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  12. Frank A.G. den Butter & Christiaan Pattipeilohy, 2007. "Productivity Gains from Offshoring: an Empirical Analysis for the Netherlands," Tinbergen Institute Discussion Papers 07-089/3, Tinbergen Institute. [Downloadable!]
  13. Aditya Bhattacharjea, 2004. "IMPERIAL LEGACY The Persistence of Colonial Trade Patterns," Working papers 126, Centre for Development Economics, Delhi School of Economics. [Downloadable!]
  14. Nathan Nunn, 2005. "Relationship Specificity, Incomplete Contracts and the Pattern of Trade," International Trade 0512018, EconWPA. [Downloadable!]
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  15. Henri L.F. de Groot & Gert-Jan Linders & Piet Rietveld, 2003. "Why do OECD-Countries trade more?," Tinbergen Institute Discussion Papers 03-092/3, Tinbergen Institute. [Downloadable!]
  16. Arjan Lejour & Vladimir Solanic & Paul Tang, 2006. "EU accession and income growth: an empirical approach," CPB Discussion Papers 72, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]
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  17. Gert-Jan M. Linders & Henri L.F. de Groot & Piet Rietveld, 2005. "Institutional Determinants of Bilateral Trade: An Analysis according to Product Type," Tinbergen Institute Discussion Papers 05-023/3, Tinbergen Institute. [Downloadable!]
  18. Mina Yakop & Peter A.G. van Bergeijk, 2009. "The weight of economic and commercial diplomacy," Working Papers - General Series 478, Institute of Social Studies. [Downloadable!]
  19. Subramanian, Uma & Anderson, William P. & Lee, Kihoon, 2005. "Measuring the impact of the investment climate on total factor productivity : the cases of China and Brazil," Policy Research Working Paper Series 3792, The World Bank. [Downloadable!]
  20. Gert-Jan Linders, 2004. "The Effect of Domestic Institutions on International Trade Flows: A sectoral analysis," ERSA conference papers ersa04p357, European Regional Science Association. [Downloadable!]
  21. Amin, Mohammad & Mattoo, Aaditya, 2006. "Do institutions matter more for services ?," Policy Research Working Paper Series 4032, The World Bank. [Downloadable!]
  22. Henk Kox & Arjan Lejour & Raymond Montizaan, 2004. "The free movement of services within the EU," CPB Documents 69, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]
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