Why some countries trade more, some trade less, some trade almost nothing: The effect of the governance environment on trade flows

Abstract

We examine the effect of a country's governance environment on its propensity to trade. Using an updated framework of governance environment, we classify countries based on the dominant mode of governance into three types: (1) rule-based (strong public rule of law), (2) relation-based (weak rule of law and strong informal network based on private relations), and (3) family-based (absence of both public rules and private network). We then examine how different governance types affect trade patterns among 44 countries representing 89% of world trade. We find that overall, rule-based countries trade more than relation-based or family-based countries. A large positive effect on trade flows exists between two highly rule-based countries and between two relation-based countries. Any trade relationship involving a family-based country negatively affects trade flows, even between two family-based countries. Our study contributes to the trade literature by examining the effects of different types of governance environment on trade flows and more successfully explaining why some countries still trade almost nothing even after scholars and policy makers have convincingly proven that freer trade leads to higher welfare for a country.