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Dynamic effects of institutions on firm-level exports

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Abstract

The gap between theoretically predicted trade patterns and actual trade suggests that our understanding of what shapes trade patterns is incomplete. Institutional barriers may be one factor behind this gap, and recent research suggests that institutions are a greater obstacle to trade than tariffs. Using detailed firm-level data, we analyze how institutional quality in recipient countries affects exports by Swedish firms. Our results suggest that weak institutions in recipient countries make exports to these countries less likely and that exports to countries with weak institutions are characterized by relatively short duration and small volume. Analyzing long-term trade flows, we identified a learning process where exporters become less dependent on institutional quality in the target economy over time. More specifically, in addition to previous research that emphasize learning related to knowledge about the contracting partner and rule of law, we extend this notion and show that there is also a learning process where firms acquire knowledge about the general business climate. When learning about the contractual partner and business institutions in recipients countries takes place, exports increase relatively quickly during the first 2 years of exports and thereafter levels out. Hence, firms that are initially sensitive to weak institutions, start small, and learn how to handle foreign institutions are likely to be most successful in maintaining long-term relationships with foreign markets.

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Notes

  1. See, for example, North (1991) and Massini et al. (2010).

  2. The theoretical models used in these papers relate to the model of Araujo and Ornelas (2007) on trust, export dynamics and institutions.

  3. There is no widely accepted definition of institutions, and different definitions have emerged. We support a commonly used definition formulated by North (1991), who states, “Institutions are the humanly devised constraints that structure political, economic and social interaction”.

  4. See Williamson (1985, 1996).

  5. For a more detailed discussion, see Williamson (2000).

  6. Ornelas and Turner (2008) show that the hold-up problem is worsened when the contracting partner is located abroad.

  7. In the case of differentiated goods, with one producer per product and single product firms, the extensive margin measured as new export firms or new products coincide. The majority of trade, however, occurs within the intensive margin of trade.

  8. Bernard and Jensen (2004) is an example in which skill intensity has been used to explain selection with respect to internationalization. The idea is that highly productive and skill-intensive firms are more internationalized than other firms. Similarly, exporters have overcome the internationalization barrier and are therefore more likely to engage in international offshoring.

  9. This selection equation is similar to the export equation in Roberts and Tybout (1997) and Bernard and Jensen (2004).

  10. We also had eight different measures of political freedom and democracy; however, the contribution from these variables was marginal. In addition, it is difficult to determine the (decisive) role of politically related variables in the export decisions of firms. Therefore, these variables were dropped from the analysis. For an example of estimations, including the institutional variables capturing political freedom, see Table 6 in the appendix.

  11. For an introduction to factor analysis, see Abdi (2003).

  12. More information on CEPII’s distance measure is found in Mayer and Zignago (2006).

  13. Repeating this estimation using the Heckman estimator yields similar results, see Table 11 in the appendix.

  14. Following Bernard and Jensen (2004), the share of workers with tertiary education is used for the exclusion restrictions.

  15. A Vuong test comparing the ZINB model to a negative binomial model shows support for the ZINB model. Moreover, likelihood-ratio tests comparing the ZINB model with the zero-inflated Poisson model strongly favor the ZINB model.

  16. The phrase “money does not smell” was said by Roman Emperor Vespasian to his son Titus when he ordered a new tax on public bathrooms. This can be interpreted as meaning that if you see an opportunity, you should take it.

  17. In addition, creating summary indices is one way to address multicollinearity among various measurements of institutional quality.

  18. Our industry dummies absorb the direct effect of the industry- specific intensity in buyer–seller interaction.

  19. The durations include new trade flows that end after 1 year, 2–3 years and 4–7 years. Long-lived, (right-hand) truncated flows are represented by export flows with a duration of at least 6–8 years and continuous exporters, that is, firms that export to a country throughout the period of observation.

  20. To reduce clutter, control variables are not displayed in Table 4.

  21. Because the selection of trade partners occurs at the beginning of each spell, we confine the analysis to the volume of exports.

  22. The assumed decreasing sensitivity to institutions over time is not directly spelled out by Araujo et al. (2012) and Aeberhaedt et al. (2011) but is viewed here as a consequence of learning.

  23. Uncertainty about business institutions may also contribute to uncertainty and low initial volumes.

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Acknowledgments

Financial support from Torsten Söderbergs Research Foundation and The Confederation of Swedish Enterprise is gratefully acknowledged.

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Authors and Affiliations

  1. Ratio Institute, Sveavägen 59, Box 3203, 103 64, Stockholm, Sweden

    Bengt Söderlund & Patrik Gustavsson Tingvall

  2. Stockholm School of Economics, Stockholm, Sweden

    Bengt Söderlund

  3. The Confederation of Swedish Enterprise, Stockholm, Sweden

    Bengt Söderlund

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  1. Bengt Söderlund
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Correspondence to Patrik Gustavsson Tingvall.

Appendix

Appendix

See Tables 6, 7, 8, 9, 10, 11 and 12.

Table 6 Political variables
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Table 7 Factor analysis
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Table 8 Description
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Table 9 Correlation institutional variables
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Table 10 Correlation control variables
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Table 11 Business and law variables
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Table 12 Average export volume, by duration of export flows and level of institutional quality
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Söderlund, B., Tingvall, P.G. Dynamic effects of institutions on firm-level exports. Rev World Econ 150, 277–308 (2014). https://doi.org/10.1007/s10290-013-0181-2

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