Institutions and the Changing Composition of International Trade in the Post-Socialist Transition

This paper examines the importance of market institutions in the transition from communism to a market economy. Blanchard and Kremer’s (1997) developed a partial equilibrium model explaining how, in the presence of imperfect information and incomplete contracts, liberalization causes the “disorganization” of traditional producer-supplier relationships in post-socialist economies and contributes to a decline in economic output. Schuler (2002) places this into an open economy, general equilibrium framework to show how disorganization also induces a change in the commodity composition of trade as economic resources shift into sectors of the economy where producers and suppliers can rely on self-enforcing contracts and out of the production of more complex goods. In this paper I test the expanded disorganization hypothesis using international trade data for 1991–96. I regress changes in trade flows on an indicator of the unmet need for contract enforcement and a matrix of product and country controls. Net exports of complex goods decline as the unmet need for enforcement rises. The estimated coefficient is statistically significant after controlling for various product and country characteristics. This result is robust to changes in the specification of the model and to the use of alternative indicators of the demand for enforcement. These results give statistical support to claims that weak institutions contributed to the output decline that accompanied liberalization in post-socialist countries in the 1990s. Paper presented at the annual conference of the International Society of New Institutional Economics, Budapest, September 11–13, 2003.