The effect of trade and political institutions on economic institutions

ABSTRACT

This study examines the relationship between trade and the quality of economic institutions under different political institutions. It uses panel data of 138 countries from 1984 to 2010 and employs instrumental variables and identification through heteroscedasticity to mitigate the problem of endogeneity. The findings suggest that the effect of trade on economic institutions reduces significantly in the presence of extractive political institutions. The findings indicate that ‘trade’ is not a sufficient tool for improving economic institutions; rather, trade policies need to be embedded in distinct political institutions to trigger the substantive improvement of economic institutions.

KEYWORDS:

• Trade
• political institutions
• economic institutions
• institutional change

JEL Classifications:

• P14
• P16
• F14
• F13

Acknowledgement

I gratefully acknowledge the helpful comments of Sonja Opper and Frederik N.G. Andersson. I also like to thank the anonymous referees for their constructive input.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1. ‘Trade flow’ is defined as the sum of exports and imports as a share of GDP.

2. Data on trade with partners come from the data set by Head, Mayer, and Ries (2010), which is only available up to the year 2006 and restricts the analysis when using instrumental variables. This data set also provides information on the GDP and population for the domestic country and its trading partner, the distance between each pair of countries, and whether they have a common language. Data on the country's other geographical features, such as its area, a dummy indicating whether it is landlocked, and its longitude and latitude, come from Mayer and Zignago (2011).

3. Countries with a GDP per capita of $5000 (in current prices) or more in the year 2000 are placed in one group and the rest are placed in the other group.

4. For the development split, variance in IP index for developed countries is 6.08 and for developing countries it is 4.04. Similarly, for the Euro-colony split, countries that were colonized have a variance of 5.60 on IP index, whereas countries that were not colonized have a variance of 6.87. The difference in variance between the groups in both of the splits is statistically significant.

5. Several measures to capture changes in economic institutions are highlighted in the literature. These include the measure of Political Freedom and Civil Liberties from Freedom House (see, for example, La Porta et al. 1999; Nicolini and Paccagnini 2011; Scully 1988). Other measures include Expropriation Risk, Rule of Law, and Repudiation of Contracts by Government, which are available from ICRG (see, for example, Acemoglu, Johnson, and Robinson 2001; Bhattacharyya 2012; Knack and Keefer 1995), and the Executive Constraint Index from the Polity IV data set (see, for example, Acemoglu, Johnson, and Robinson 2001; Bhattacharyya 2012). These measures either partially reflect the variation in economic institutions and overlap with political institutions or cover a limited time period, and are therefore not appropriate for the analysis.

6. The log of trade-to-GDP ratio is taken.

7. The sub-samples are created based on the quartile values of trade-to-GDP ratio.

8. The mean value of the trade-to-GDP ratio in the sample is 78.41, and the corresponding value in log is 4.36.

9. The PR index “measures the degree of freedom in the electoral process, political pluralism and participation, and functioning of government. Numerically, Freedom House rates political rights on a scale of 1–7, with 1 representing the most free and 7 representing the least free” (Freedom in the World 2010: Survey Methodology). A score of 1 represents a country having free and fair elections, political competition, and autonomy for all citizens, whereas a PR index value of 7 represents a country in which political rights are essentially missing because of extremely oppressive regimes, civil war, extreme violence, or warlord rule.