International Trade and Institutional Change ∗

This paper analyzes the impact of international trade on the quality of institutions, such as contract enforcement, property rights, or investor protection. It presents a model in which institutional differences play two roles: they create rents for some parties within the economy, and they are a source of comparative advantage in trade. Institutional quality is determined as an equilibrium of a political economy game. When countries share the same technology, there is a “race to the top” in institutional quality: irrespective of country characteristics, both trade partners are forced to improve institutions after opening. On the other hand, domestic institutions will not improve in either trading partner when one of the countries has a strong enough technological comparative advantage in the good that relies on institutions. We test these predictions in a sample of 141 countries, using an extension of the geography-based methodology of Frankel and Romer (1999). Countries whose exogenous geographical characteristics predispose them to exporting in institutionally intensive sectors exhibit significantly higher institutional quality. JEL Classifications: F15, P45, P48.