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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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File URL: http://cep.lse.ac.uk/pubs/download/dp0820.pdf
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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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  5. Watson, Joel, 1999. "Starting Small and Commitment," University of California at San Diego, Economics Working Paper Series qt37p340fc, Department of Economics, UC San Diego.
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  19. repec:rus:hseeco:121669 is not listed on IDEAS
  20. Anderson James E & Young Leslie, 2006. "Trade and Contract Enforcement," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 5(1), pages 1-36, November.
  21. repec:rus:hseeco:123708 is not listed on IDEAS
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