The Institutional Determinants of Bilateral Trade Patterns

Abstract

Summary: This paper studies the effect of institutions on trade flows, using a gravity model approach. Standard gravity equations incorporate factors such as geographical proximity, language, trade policy and common history as explanatory factors for variation in bilateral trade that reflect the costs of trade across geographical and cultural distance. We extend this type of analysis by focusing on the relevance of the quality of governance and the extent of familiarity with the resulting framework of rules and norms in explaining variation in bilateral trade patterns. More specifically, we test whether institutional homogeneity and institutional quality have an independent impact on the trade volume between pairs of countries. We find that having a similar institutional framework promotes bilateral trade by 13%, on average. Furthermore, a better quality of formal institutions tends to coincide with more trade. Depending on being either importer or exporter, an increase in overall institutional quality of one standard deviation from the mean leads to an estimated increase of 30–44% in bilateral trade.