Contractual frictions and margins of trade

Théophile T Azomahou,Hibret Maemir,Hassen A Wako

doi:10.1016/j.jce.2021.04.003

Théophile T Azomahou, Hibret Maemir + Show 1 more

Open Access

https://doi.org/10.1016/j.jce.2021.04.003

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Abstract

A recent body of work has shown that quality of national institutions that enforce written contracts plays an important role in shaping a country’s comparative advantage. The current paper contributes to this literature by providing a comprehensive analysis of the mechanisms through which institutional frictions affect the pattern of aggregate trade flow by distinguishing its effect on the intensive and extensive margins. We find that better contracting institutions not only increase the probability of exporting (the extensive margin) but also enhance the export sales after entry (the intensive margin), particularly in industries where relationship-specific investments are most important. With around two-third to three-fourth share (depending on the definition used), the contribution of institutions along the intensive margin dominates that along the extensive margin. The benefits of improved institutions, particularly via the intensive margin, favor the less developed countries over the more developed ones. In addition, better contracting institutions increase the probability of survival of export products in more contract-intensive industries in particular. These findings are robust to measuring the intensive and extensive margins using a more granular export data based on firm-level aggregates, as well as the variety and destination based definitions.

Highlights

Understanding the sources of comparative advantage lies at the heart of the international trade literature
Several studies have shown that countries with poor contracting institutions export relatively more in industries that are less susceptible to holdup problems, as measured by input concentration (Levchenko 2007) or contractual input intensity (Nunn 2007)
The effects of contracting institutions on trade patterns are extensively studied, little is known about the exact mechanisms through which this effect operates

Summary

Introduction

Understanding the sources of comparative advantage lies at the heart of the international trade literature. While traditional theories have emphasized the role of technology and factor endowments, a growing body of work has focused on differences in institutional quality as a source of comparative advantage (Levchenko 2007, Nunn 2007). Several studies have shown that countries with poor contracting institutions export relatively more in industries that are less susceptible to holdup problems, as measured by input concentration (Levchenko 2007) or contractual input intensity (Nunn 2007). We decompose the effects of institutional quality on aggregate exports into the two standard margins of trade, namely the entry into exporting (extensive margin) and the volume of export after entry (intensive margin)

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