Proximity as a Substitute of Contract Enforcement in Specialized Trade

We examine how geographic proximity can substitute for contract-enforcement institutions in enabling international exports of specialized goods. When ex-porters must meet buyers’ specific product requirements, successful trade de-pends on either strong contract enforcement or close buyer-seller relationships that enable monitoring and trust. We argue that geographic proximity facilitates such relationships by reducing the costs of frequent business travel. Our theoretical framework predicts that institutional quality should primarily affect specialized trade over longer distances, as proximity-based relationship-building becomes prohibitively expensive. Using bilateral, product-specific export data in a gravity model, we find strong empirical support for this prediction. Consistent with our theory, we also show that business travel expenses and passenger flights decline more sharply with distance when destination countries have weak contract enforcement institutions.