A re-examination of the relation between democracy and international trade

Abstract

Scholars and policy makers believe that democracy will bring prosperity through integration into the global economy via increased international trade. Existing research is plagued by methodological problems that obscure the empirics and avoid the theoretical problem of why democracies may or may not trade more. In this paper, I seek to correct these shortcomings. I test two theories as to why democracies might trade more. First, political freedom may be correlated with economic freedom, thus prompting higher levels of economic activity, thereby driving states to trade more. Second, democracy implies higher quality governance either through institutions or policy making procedures. To test the impact of democracy on trade and the potential transmission mechanisms, I utilize a bilateral gravity trade model covering approximately 150 countries from 1950 to 1999, with fixed effects for time, importers, and exporters. I find the theory that democracy, and many of its components, promotes international trade unconvincing. The coefficients are the theoretically correct sign; however, many are statistically or economically insignificant and fragile to changes in modeling or data. Economic freedom does not have the expected impact on international trade levels, but quality of governance variables have broad economic and statistical significance.

Keywords:

• bilateral trade
• developing countries
• governance
• gravity model
• liberalization
• trade policy

Notes

1. For a recent investigation of mercantilism, see for example Congleton and Lee (2009).

2. In this plot on the Political Freedom axis, 1 is free and 7 is not free. On the Economic Freedom axis 100 is considered free and 0 is considered not free. Therefore, points in the upper left hand corner are both politically and economically free while those in the lower right hand corner are not free.

3. To download the data, paper drafts, and supporting output for STATA go to http://faculty.haas.berkley.edu/arose

4. The gravity model has been used by a wide variety of authors to study a wide variety of trade issues (Feenstra, Markusen, and Rose 2000; Rose and Spiegel 2003; Anderson and van Wincoop 2003, 2004; Feenstra 2002; Glick and Rose 2001; Rose 2003, 2004b; Frankel and Romer 1999).

5. Please note that in my data set, due to direction of trade data, not all countries from the Rose data set have been included. For instance Bhutan, Namibia, and Swaziland were not included as there were not four trade numbers from which to arrive at an average of two import data statistics.

6. The natural log of small numbers is negative therefore many observations of real imports are negative observations. 12.8% of all observations of the natural log of real imports were zero or below.

7. The models, variables, dataset, and descriptions are almost completely from Rose (2003) except as noted previously.

8. Table 1 does not present the results of all baseline regressions as all basic gravity model variables such as distance and GDP returned nearly identical coefficients across regressions. The focus of this study is on the democratic, autocratic, and polity variables rather than the impact of distance.

9. It is worth noting and emphasizing that due to econometric issues not every variable will appear in each variation of the model, especially between the perturbations with and without country effects. This is in keeping with the gravity model literature and observation of plausibility. It is worth emphasizing that there is a significant degree of similarity between the regressions with or without fixed country effects.

10. It is worth noting that the gravity model in the absence of fixed country effects returned some rather large returns to certain variables. In fact many users of the gravity model now include fixed country effects to moderate implausibly large returns on variables. The Polity Exporter variable comes back close to zero, indicating the coefficient without fixed country effects should be taken with a grain of salt.