We propose a novel way to measure the rule of law intensity of exports at the goods level based on nearly 100 million disaggregated bilateral trade flows around the globe. We categorize goods into three groups: fragmented, primary, and other. The theoretical literature on hold-up problems connected to incomplete or incompletely enforceable contracts or property rights predicts that goods resulting from fragmented production processes should be the most rule of law intensive. However, we find that the rule of law intensity of other goods is, on average, only slightly lower than that of fragmented goods. We examine how exogenous variation in countries’ trade patterns influences the quality of institutions. Our regressions show that trade flows generated by fragmented and other processes of production improve rule of law, while trade flows generated by primary production do not.
“[…] interactions between institutions and trade are important and are likely to be quite nuanced. What kinds of effects prevail in which circumstances remains an open question.” (Levchenko 2007 , p. 814)
This chapter is based on joint work with Richard Frensch and Roman Horváth. An earlier and preliminary version was published in a working paper series (see Frensch et al. 2016).
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Institutional differences have no impact on comparative advantage when sectoral technological differences between countries are sufficiently large. Then, external liberalization provides no incentive to improve rule of law in order to keep a portion of rents in the country. For an alternative theoretical approach rooted in a Melitz-type model of firm heterogeneity and trade, see Do and Levchenko (2009).
In fact, the Heckscher-Ohlin-Ricardo trade model in Levchenko (2013) is perfectly compatible with an interpretation of incorporated hold-up problems describing capital-labor relations.
Fragmentation makes additional specialization possible, potentially promoting a shift of fragmented production processes abroad. In geographic terms, fragmentation and subsequent dislocation is especially important in East Asia and within Europe, causing systematically increasing trade in parts, components, and final capital goods across these regions (Kimura et al. 2007, 2008; Frensch et al. 2015).
An in-depth discussion of this weight can be found in Chap. 2.
Assume, for example, that both country A and country B export bananas. Suppose that country A is larger and has better rule of law than country B. Because A is larger than B, its export volume of bananas is likely to be larger than that of B. However, bananas certainly represent a larger share of B’s exports than of A’s exports. Not controlling for country size when measuring the RCA in exporting bananas might thus lead to a higher institutional intensity level for bananas simply because they are exported by a country with high institutional quality (in this case, A).
We exclude the following outlier countries from our dataset because the information from the PWT contains some statistical problems as is explained in further detail here: www.rug.nl/ggdc/docs/outliers_in_pwt80.pdf . Finally, we exclude: Bermuda, Brunei, Burundi, Congo, El Salvador, Equatorial Guinea, Gambia, Guinea Bissau, Israel, Mozambique, Saudi Arabia, Vietnam, and Zimbabwe. We also exclude some extreme outliers, Gabon (GAB) and Bahamas (BHS), as their trade data are very incomplete.
We show a list of the poor countries in Table B.2.
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I thank Nauro Campos, Jarko Fidrmuc, Michal Pilc and Eric Verhoogen and seminar participants at the VfS Wien, FIW Wien, DGO Berlin, Higher School of Economics (Moscow), IOS Regensburg, Roma Tre University and University of Perugia for helpful comments. Roman Horváth and Stephan Huber acknowledge support from the Grant Agency of the Czech Republic (grant P402/12/G097). Richard Frensch gratefully acknowledges support from the Bavarian Ministry of Science ForChange research network.
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Huber, S. (2018). Trade Patterns and Endogenous Institutions: Global Evidence. In: Product Characteristics in International Economics. Contributions to Economics. Springer, Cham. https://doi.org/10.1007/978-3-319-76093-3_4
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