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Trust-Based Trade

  • Luis Araujo
  • Emanuel Ornelas

Weak enforcement of international contracts can substantially reduce international trade. We develop a model where agents build reputations to overcome the difficulties that this institutional failure causes in a context of incomplete information. The model describes the interplay between institutional quality, reputations and the dynamics of international trade. We find that the conditional probability that a firm will stop exporting decreases and its foreign sales increase as the firm acquires greater export experience. The reason is that the informational costs that an exporter faces fall as the exporter becomes more confident about the reliability of its distributor. An improvement in the institutional quality of a country affects its imports through several distinct channels, as it changes the incentives of both current and potential exporters. Trade liberalization induces current exporters to increase their sales. It could induce entry as well, but this will happen only when the initial tariff is high and/or the institutional quality of the country is low.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0820.

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Date of creation: Aug 2007
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Handle: RePEc:cep:cepdps:dp0820
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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  1. Simon Johnson & John McMillan & Christopher Woodruff, 2001. "Courts and Relational Contracts," NBER Working Papers 8572, National Bureau of Economic Research, Inc.
  2. Andrew B. Bernard & J. Bradford Jensen & Stephen J. Redding & Peter K. Schott, 2007. "Firms in International Trade," Journal of Economic Perspectives, American Economic Association, vol. 21(3), pages 105-130, Summer.
  3. 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.
  4. 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.
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  8. Jonathan Eaton & Samuel Kortum & Francis Kramarz, 2004. "Dissecting Trade: Firms, Industries, and Export Destinations," NBER Working Papers 10344, National Bureau of Economic Research, Inc.
  9. Woodruff, Christopher, 1998. "Contract enforcement and trade liberalization in Mexico's footwear industry," World Development, Elsevier, vol. 26(6), pages 979-991, June.
  10. Egan, Mary Lou & Mody, Ashoka, 1992. "Buyer-seller links in export development," World Development, Elsevier, vol. 20(3), pages 321-334, March.
  11. Rauch, J E & Watson, Joel, 1999. "Starting Small in an Unfamiliar Environment," University of California at San Diego, Economics Working Paper Series qt4rp145hc, Department of Economics, UC San Diego.
  12. Chisik, Richard, 2003. "Export industry policy and reputational comparative advantage," Journal of International Economics, Elsevier, vol. 59(2), pages 423-451, March.
  13. Henry Overman & Patricia Rice & Anthony J. Venables, 2007. "Economic Linkages Across Space," CEP Discussion Papers dp0805, Centre for Economic Performance, LSE.
  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. Barry Eichengreen & Douglas A. Irwin, 1996. "The Role of History in Bilateral Trade Flows," NBER Working Papers 5565, National Bureau of Economic Research, Inc.
  16. McMillan, John & Woodruff, Christopher, 1998. "Inter-Firm Relationships and Informal Credit in Vietnam," CEPR Discussion Papers 2036, C.E.P.R. Discussion Papers.
  17. 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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  19. Alejandro Izquierdo & Jacques Morriset & Marcelo Olarreaga, 2003. "Information Diffusion in International Markets," Research Department Publications 4335, Inter-American Development Bank, Research Department.
  20. James E. Rauch & Vitor Trindade, 2003. "Information, International Substitutability, and Globalization," American Economic Review, American Economic Association, vol. 93(3), pages 775-791, June.
  21. repec:rus:hseeco:121669 is not listed on IDEAS
  22. 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.
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  24. repec:rus:hseeco:123708 is not listed on IDEAS
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