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Trade Liberalization and Institutional Reform

Author

Listed:
  • Minyuan Zhao

    (Stephen M. Ross School of Business, University of Michigan, 701 Tappan St., Ann Arbor, MI 48109, USA.)

  • Kathy Fogel

    (Walton College of Business University of Arkansas, WCOB 302, Fayetteville, AR 72701, USA.)

  • Randall Morck

    (University of Alberta Business School and NBER, Edmonton, Alberta, Canada, T6G 2R6.)

  • Bernard Yeung

    (NUS Business School National University of Singapore and Stern School of Business, New York University, Biz 2 Building Level 6, 1 Business Link, Singapore, 117592, Republic of Singapore.)

Abstract

Opening up to global trade and investment is often thought to trigger institutional improvement by raising the expected benefits of institutional reform and reducing incumbents' incentives and ability to preserve the status quo. However, recent experience is not entirely consistent with this conventional wisdom. We suggest an explanation based on variation across countries in firms' reliance on ambient institutions. Large, well-established firms depend less on an economy's institutions than do small and incipient firms. Multinational firms likewise can use their global organizations to sidestep weak local institutions. Firm heterogeneity of this sort can thus contribute to markedly different institutional responses to liberalization-institutional development is better in locations where firms and potential entrants benefit more from such development. Our framework also suggests that institutional development might occur in stages. In an economy whose basic institutions are sound, individuals rationally invest in entrepreneurial capability and firms rationally invest less in institution substitutes. Economies with firms that rely more on ambient institutions or with more potential entrants who would rely on those institutions are more likely to experience further institutional improvement following accession to the global economy. Economies with fewer firms or potential entrants dependent on sound institutions, in acceding to the global economy, may exhibit scant institutional improvement, and perhaps even institutional deterioration. Political rent-seeking is not necessary for the latter outcome, but expands the range of conditions under which it ensues. (c) 2010 The Earth Institute at Columbia University and the Massachusetts Institute of Technology.

Suggested Citation

  • Minyuan Zhao & Kathy Fogel & Randall Morck & Bernard Yeung, 2010. "Trade Liberalization and Institutional Reform," Asian Economic Papers, MIT Press, vol. 9(2), pages 44-71, Summer.
  • Handle: RePEc:tpr:asiaec:v:9:y:2010:i:2:p:44-71
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