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Institutional Quality, Trade, and the Changing Distribution of World Income

  • Brigitte Desroches
  • Michael Francis

Conventional wisdom holds that institutional changes and trade liberalization are two main sources of growth in per capita income around the world. However, recent research (e.g., Rigobon and Rodrik 2004) suggests that the Frankel and Romer (1999) trade and growth finding is not robust to the inclusion of institutional quality. In this paper, the authors argue that this "trade and growth puzzle" can be explained once institutional quality is acknowledged as a determinant of the willingness to save and invest, and hence acknowledged as a determinant of long-run comparative advantage. The paper consists of two parts. First, the authors develop a theoretical model which predicts that institutions determine a country's underlying comparative advantage: countries that have good institutions will tend to export relatively more capital-intensive (or sophisticated) goods compared with countries that have poor institutions; trade can magnify the effect of institutional quality on income, leading to greater income divergence than if countries remain in autarky. Second, using a panel of over eighty countries and twenty years of data, the authors find empirical support for their hypotheses.

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Paper provided by Bank of Canada in its series Working Papers with number 06-19.

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Length: 47 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:bca:bocawp:06-19
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  1. Dani Rodrik & Arvind Subramanian & Francesco Trebbi, 2002. "Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development," NBER Working Papers 9305, National Bureau of Economic Research, Inc.
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  4. Lee, Ha Yan & Ricci, Luca Antonio & Rigobon, Roberto, 2004. "Once again, is openness good for growth?," Journal of Development Economics, Elsevier, vol. 75(2), pages 451-472, December.
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  7. Manning, R, 1981. "Specialization and Dynamics in a Trade Model," The Economic Record, The Economic Society of Australia, vol. 57(158), pages 251-60, September.
  8. Baldwin, Richard E, 1992. "Measurable Dynamic Gains from Trade," Journal of Political Economy, University of Chicago Press, vol. 100(1), pages 162-74, February.
  9. Carl-Johan Dalgaard & Henrik Hansen & Finn Tarp, 2001. "On the Empirics of Foreign Aid and Growth," EPRU Working Paper Series 03-13, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics, revised Sep 2003.
  10. Dollar, David & Kraay, Aart, 2001. "Trade, growth, and poverty," Policy Research Working Paper Series 2615, The World Bank.
  11. Pol Antràs, 2003. "Firms, Contracts, and Trade Structure," NBER Working Papers 9740, National Bureau of Economic Research, Inc.
  12. Rigobon, Roberto & Rodrik, Dani, 2004. "Rule of Law, Democracy, Openness and Income: Estimating the Interrelationships," CEPR Discussion Papers 4653, C.E.P.R. Discussion Papers.
  13. Marianne Baxter, 1991. "Fiscal policy, specialization, and trade in the two-sector model: the return of Ricardo?," Discussion Paper / Institute for Empirical Macroeconomics 56, Federal Reserve Bank of Minneapolis.
  14. Dutt, Amitava Krishna & Mukhopadhyay, Kajal, 2005. "Globalization and the inequality among nations: A VAR approach," Economics Letters, Elsevier, vol. 88(3), pages 295-299, September.
  15. Steve Bond, 2002. "Dynamic panel data models: a guide to microdata methods and practice," CeMMAP working papers CWP09/02, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  16. Michael Francis, 2005. "Trade and the enforcement of environmental property rights," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 14(3), pages 281-298.
  17. Eric Friedman & Simon Johnson & Peter Boone & Alasdair Breach, 1999. "Corporate Governance in the Asian Financial Crisis," Departmental Working Papers 199920, Rutgers University, Department of Economics.
  18. Dornbusch, Rudiger & Fischer, Stanley & Samuelson, Paul A, 1980. "Heckscher- Ohlin Trade Theory with a Continuum of Goods," The Quarterly Journal of Economics, MIT Press, vol. 95(2), pages 203-24, September.
  19. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
  20. Brecher, Richard A & Chen, Zhiqi & Choudhri, Ehsan U, 2002. "Absolute and Comparative Advantage, Reconsidered: The Pattern of International Trade with Optimal Saving," Review of International Economics, Wiley Blackwell, vol. 10(4), pages 645-56, November.
  21. Holger Strulik & Ines Lindner, 1999. "Why not Africa? -- Growth and Welfare Effects of Secure Property Rights," Quantitative Macroeconomics Working Papers 19909, Hamburg University, Department of Economics.
  22. Davis, Donald R, 1998. "Does European Unemployment Prop Up American Wages? National Labor Markets and Global Trade," American Economic Review, American Economic Association, vol. 88(3), pages 478-94, June.
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  24. Bhagwati, Jagdish N, 1972. "The Heckscher-Ohlin Theorem in the Multi-Commodity Case," Journal of Political Economy, University of Chicago Press, vol. 80(5), pages 1052-55, Sept.-Oct.
  25. David H. Romer & Jeffrey A. Frankel, 1999. "Does Trade Cause Growth?," American Economic Review, American Economic Association, vol. 89(3), pages 379-399, June.
  26. Michael Francis & François Painchaud & Sylvie Morin, 2005. "Understanding China's Long-Run Growth Process and Its Implications for Canada," Bank of Canada Review, Bank of Canada, vol. 2005(Spring), pages 5-17.
  27. C. H. Kwan, 2002. "The Rise of China and Asia's Flying-Geese Pattern of Economic Development: An Empirical Analysis Based on US Import Statistics," Discussion papers 02009, Research Institute of Economy, Trade and Industry (RIETI).
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