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Trust-based trade

Author Info

  • Luis Araujo
  • Emanuel Ornelas

Abstract

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://eprints.lse.ac.uk/19693/
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 19693.

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Length: 38 pages
Date of creation: Aug 2007
Date of revision:
Handle: RePEc:ehl:lserod:19693
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Keywords: International trade; Export dynamics; Contract enforcement;

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Find related papers by JEL classification:
  • F10 - International Economics - - Trade - - - General
  • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
  • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations

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  1. Andrew B. Bernard & J. Bradford Jensen & Stephen J. Redding & Peter K. Schott, 2007. "Firms in International Trade," NBER Working Papers 13054, National Bureau of Economic Research, Inc.
  2. Jonathan Eaton & Samuel Kortum & Francis Kramarz, 2004. "Dissecting trade: firms, industries, and export destinations," Staff Report 332, Federal Reserve Bank of Minneapolis.
  3. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," Boston University - Institute for Economic Development 59, Boston University, Institute for Economic Development.
  4. 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.
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  7. Parikshit Ghosh & Debraj Ray, 1995. "Cooperation in Community Interaction Without Information Flows," Boston University - Institute for Economic Development 64, Boston University, Institute for Economic Development.
  8. John McMillan & Christopher Woodruff, 1998. "Interfirm Relationships and Informal Credit in Vietnam," William Davidson Institute Working Papers Series 132, William Davidson Institute at the University of Michigan.
  9. Barry Eichengreen & Douglas A. Irwin, 1996. "The Role of History in Bilateral Trade Flows," NBER Working Papers 5565, National Bureau of Economic Research, Inc.
  10. Alejandro Izquierdo & Jacques Morriset & Marcelo Olarreaga, 2003. "Information Diffusion in International Markets," Research Department Publications 4335, Inter-American Development Bank, Research Department.
  11. McLaren, John, 1999. "Supplier relations and the market context: A theory of handshakes," Journal of International Economics, Elsevier, vol. 48(1), pages 121-138, June.
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  13. Alejandro Cunat & Marc J. Melitz, 2007. "Volatility, labor market flexibility, and the pattern of comparative advantage," LSE Research Online Documents on Economics 19714, London School of Economics and Political Science, LSE Library.
  14. Egan, Mary Lou & Mody, Ashoka, 1992. "Buyer-seller links in export development," World Development, Elsevier, vol. 20(3), pages 321-334, March.
  15. repec:rus:hseeco:123708 is not listed on IDEAS
  16. Henry Overman & Patricia Rice & Anthony J. Venables, 2007. "Economic Linkages Across Space," CEP Discussion Papers dp0805, Centre for Economic Performance, LSE.
  17. 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.
  18. Joel Watson, 1999. "Starting Small and Commitment," Cowles Foundation Discussion Papers 1217, Cowles Foundation for Research in Economics, Yale University.
  19. Simon Johnson & John McMillan, 2002. "Courts and Relational Contracts," Journal of Law, Economics and Organization, Oxford University Press, vol. 18(1), pages 221-277, April.
  20. Richard Chisik, 2010. "Export Industry Policy and Reputational Comparative Advantage," Working Papers 017, Ryerson University, Department of Economics.
  21. Woodruff, Christopher, 1998. "Contract enforcement and trade liberalization in Mexico's footwear industry," World Development, Elsevier, vol. 26(6), pages 979-991, June.
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  24. Dani Rodrik, 2000. "How Far Will International Economic Integration Go?," Journal of Economic Perspectives, American Economic Association, vol. 14(1), pages 177-186, Winter.
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