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Trust-based trade

Author

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  • Araujo, Luis
  • Ornelas, Emanuel

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.

Suggested Citation

  • Araujo, Luis & Ornelas, Emanuel, 2007. "Trust-based trade," LSE Research Online Documents on Economics 19693, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:19693
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    More about this item

    Keywords

    International trade; Export dynamics; Contract enforcement;

    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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