Contract institution and differentiated exports

Abstract

Institution is an important determinant of economic growth and development. Contract institution represents a major institution governing economic transactions between private agents. This paper examines how quality of contract institution in source and destination countries influences exports of homogeneous and heterogeneous goods. Using a large sample of cross-country bilateral disaggregate export data, we show that competitive advantages of firms in exports of both homogeneous goods (such as agricultural commodities and minerals) and heterogeneous goods (such as manufactured goods) are eroded by weak contract institution in their source countries. We also find that weak contract institution in the destination countries exerts significant negative impacts on heterogeneous but not homogeneous exports. To explain for the differential source and destination countries’ contract institutional constraints on differentiated exports, we extend the conventional institutional cost theory by taking the differences in relationship specificity of heterogeneous and homogeneous goods into account. Our analysis has policy implications on institutional reform and provides practical location and production strategies for exporting firms.