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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://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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Web page: http://www.lse.ac.uk/

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  1. 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.
  2. McLaren, J, 1996. "Supplier Relations and the Market Context : A Theory of Handshakes," Papers 766, Yale - Economic Growth Center.
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  15. Izquierdo, Alejandro & Morisset, Jacques & Olarreaga, Marcelo, 2003. "Information diffusion in international markets," Policy Research Working Paper Series 3032, The World Bank.
  16. Chisik, Richard, 2003. "Export industry policy and reputational comparative advantage," Journal of International Economics, Elsevier, vol. 59(2), pages 423-451, March.
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  19. Dani Rodrik, 2000. "How Far Will International Economic Integration Go?," Journal of Economic Perspectives, American Economic Association, vol. 14(1), pages 177-186, Winter.
  20. John McMillan & Christopher Woodruff, 1999. "Interfirm Relationships And Informal Credit In Vietnam," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1285-1320, November.
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