Institutional Quality and Comparative Advantage: an Empirical Assessment

Several papers have recently underlined the relationship between institutional quality and international trade. Institutions are in charge of the enforcement of contracts: good institutions are those which punish the part that breaks the contract, and implement this activity with a high probability of success. Goods can be more or less complex, according to the number of intermediate inputs needed for the implementation. Complex goods require a large number of contracts to be produced, and therefore rely more on the level of contract enforcement of their country. This implies that good contract enforcement, and thus high institutional quality, is a source of comparative advantage in the production of more complex goods. Several theoretical models decline this idea. This paper tests empirically the di¤erent predictions of these models following Romalis (2004) speci…cation. I …nd strong support to the predictions of the di¤erent models. New measures of complexity of goods and of institutional quality are employed as robustness check. Attention is drawn to the question of the correct econometric treatment of zero ‡ows of trade. JEL classi…cation: D23; D51;F11;L14;O11 Keywords: International trade; Comparative advantage; Relationshipspeci…c investments; Contract enforcement. I am grateful to Anna Falzoni, Paolo Epifani and Giovanni Bruno for providing helpful comments and suggestions. yDepartment of Economics, Business and Statistics, University of Milan and ISLA, Bocconi University, Via Sarfatti, 25, I-20136 Milano; e-mail: [email protected]