Institutions, Market Concentrations, and Trade

Abstract

There are twofold purposes of this study: first, to propose a trade general equilibrium model in which the institution is modeled within the framework of international market concentration, and second, to empirically test our theoretical findings on the optimizing integration strategies by firms given the institution of a country. The study delves into the scope to which the institutional quality of a country affects the bilateral industry-level trade flows of manufacturing goods and services. Based on the interactive general equilibrium trade model of country-specific and industry-specific institutionally intensive variables, including the traditional control variables in bilateral trade, we analyze the six-digit NAICS classified industry-level bilateral trade flows from 220 countries and 389 industries for the year 1997. Corresponding to the Dixit-Stiglitz differentiated product solution, the theoretical portion of the study confirms that the new differentiated product solution is also a functional form of the institutions. The causal relationship is established by addressing the econometric challenges and endogeneity problems first with the Ordinary Least Squares (OLS) method of estimation and then with the Tobit model and Poisson Pseudo Maximum Likelihood (PPML) method of estimation with several robustness checks. Results indicate that countries with stronger institutions shift industries from highly concentrated markets with lower trade shares to lower concentrated markets with higher trade shares. Moreover, the institutions of the exporting countries are causal factors that manipulate the market structures for bilateral trade. This outcome is robust across industries that are non-agricultural manufacturing rather than agricultural-manufacturing within the manufacturing sector and across all the quartiles of the volumes of bilateral trade flows. The results are also robust across model selection and other robustness checks within the model specification, including established control variables standard in prior studies on the influence of institutions on trade patterns.