Trade Openness and Political Distortions

Abstract

In this paper we explore the relationship between international trade openness and two major political distortions, political polarization and political instability. We consider both the extensive and intensive margins of trade as measured by the number of trade partners and trade volume, respectively. As political distortions and trade characteristics of the country are endogenously related, we instrument political instability by the age difference between the youngest and the oldest effective political leaders of a country and the average neighbors’ neighbors political instability. We find that political instability reduces trade openness both at the extensive and intensive margin while political polarization negatively affects the extensive margin of trade. We propose a simple model that provides intuition on our findings.