Contractual frictions and the patterns of trade: The role of generalized trust

Abstract

Extant studies on the relationship between ‘domestic institutions, comparative advantage, and international specialization’ have primarily focused on formal institutions. This paper contributes to this literature by focusing on domestic informal contracting institutions vis-á-vis generalized trust as a source of comparative advantage. Employing a bilateral industry trade data, the paper finds robust evidence that countries with high generalized trust level export relatively more in industries that are prone to contractual frictions. Results on export margins further suggest that countries with a high generalized trust level enter more markets, ship more products to each destination, and have higher export per product and export intensities in those industries. On the one hand, the results reemphasize the importance of trust for improved economic performance. On the other hand, the results explain why a country endowed with weak formal domestic contracting institutions may still have a comparative cost advantage in contract intensive industries due to having strong domestic informal institutions such as generalized trust.