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Trust-Based Trade

  • Luis Araujo

    (Michigan State University and Fucape)

  • Emanuel Ornelas

    (University of Georgia and IBMEC Business School - Rio de Janeiro)

There is substantially more trade within national borders than across borders. An important explanation for this fact is the weak enforcement of international contracts. We develop a model in which agents build reputations to overcome this institutional failure. The model describes the interplay between institutional quality, reputations and the dynamics of international trade. It also rationalizes several empirical regularities. We find that history matters for trade volumes, but that its effects vary with the institutional setting of the country. The same is true for the efficacy of trade liberalization programs. Moreover, while stricter enforcement of contracts enhances trade in the short run, it makes it harder for individual traders to develop good reputations. We show that this indirect negative effect may produce an "institutional trap": for sufficiently low initial levels of contract enforcement, a small tightening in enforcement reduces future trade flows. We find also that search frictions aggravate the problems created by weak enforceability of contracts, even if they impose no direct cost on agents, but that trade liberalization can mitigate these negative effects.

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File URL: http://professores.ibmecrj.br/erg/dp/papers/dp200508.pdf
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Paper provided by Economics Research Group, IBMEC Business School - Rio de Janeiro in its series IBMEC RJ Economics Discussion Papers with number 2005-08.

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Date of creation: 30 Nov 2005
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Handle: RePEc:ibr:dpaper:2005-08
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  1. Jonathan Eaton & Samuel Kortum & Francis Kramarz, 2004. "Dissecting trade: firms, industries, and export destinations," Staff Report 332, Federal Reserve Bank of Minneapolis.
  2. Andrew B. Bernard & J. Bradford Jensen & Stephen Redding & Peter K. Schott, 2007. "Firms in International Trade," CEP Discussion Papers dp0795, Centre for Economic Performance, LSE.
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  10. Joel Watson, 1999. "Starting Small and Commitment," Cowles Foundation Discussion Papers 1217, Cowles Foundation for Research in Economics, Yale University.
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  13. 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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  17. James E. Rauch & Vitor Trindade, 2003. "Information, International Substitutability, and Globalization," American Economic Review, American Economic Association, vol. 93(3), pages 775-791, June.
  18. 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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  24. 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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