Institutional Quality and Comparative Advantage: an Empirical Assesment

Institutional Quality and Comparative Advantage: an Empirical Assesment

Marcella Nicolini

University of Milan

Long Abstract

Institutional quality is a fundamental factor in promoting economic development. Institutions have evolved through centuries, in order to give solutions to the growing needs of economic activity: the demand for impersonal contract enforcement, merchant law courts... Without institutions there can not be economic development. Capital market entails security of property rights, and can not evolve without legal enforcement of property rights and contracts (North1991). But this evolution of institutions is not necessary, and we are facing nowadays countries where early forms of organizations still exist. It is thus evident how relevant is the role of good quality institutions in promoting the economic performance, and thus the growth of countries.

A seminal work in this sense is the paper by Acemoglu, Johnson and Robinson (2001) on colonialism and development. In countries where Europeans could not easily settle, the countries with higher mortality rates, colonizers imposed extractive institutions, that concentrate power in the hands of the colonizing élite and create a risk of expropriation for the majority of population, instead of granting protection for property rights. The colonial extracting institutions still persist up to the present, and in these countries we find now a stronger negative impact of low institutional quality on income per capita.

Several empirical works have inspected the relationship between income levels and institutional quality: Rodrik, Subramanian and Trebbi (2002) have shown that institutions are the main factor to explain income levels, much more relevant than trade or geography. Other paper have emphasized how corruption impedes investment and, in this way, growth (Mauro 1995).

Institutional quality is relevant also in a open economy context. The literature on capital flows has shown the leading role that a good institutional environment has in promoting and attracting foreing direct investments, thus fostering economic growth and economic development of the host country (see for example Benassy-Quere, Coupet, Mayer, 2005 or Alfaro, Kalemli-Ozcan, Volosovych 2005 for recent empirical papers that investigate this relationship).

Only recently, few papers have shown that a relationship intercurs between institutional quality, and comparative advantage. Contract enforcement is a way to give comparative advantage in the production of contract-intensive goods. This means that improving the institutional environment can induce a comparative advantage in some sectors, thus fostering export performance in more complex goods.

These kind of models merge two different streams of literature. We have literature on comparative advantage, and literature on contract enforcement, which is based on the Grossman-Hart-Moore model of contract enforcement. The Grossman-Hart-Moore model has given inspiration to a number of paper in international trade literature.

Since now, they have been focusing on the limits on the firm, and the choice between outsourcing and internalization. We have works like Grossman Helpman (2002) that focuses on the choice between integration and outsourcing, or Grossman Helpman (2002bis) that focuses on the choice between in-house or subcontracting, either at home or abroad. They develop further this kind of argument, and model (Grossman Helpman 2003) the choice between outsourcing and foreign direct investment.

The aim of the present work is to focus on the literature that considers the relationship between institutions and comparative advantage. I will compare the results of four paper that present different models, and different implications.

I use a Romalis equation to show that countries capture larger shares of trade in sectors that intensively use their abundant factor. Following Levchenko (2003), I enrich this specification, adding a third factor of production, institutional quality.

This is my baseline equation:

rel_shareic=α+β1inst_depi*instc+β2skint3i*skillc+β3capint3i*capitalc+γc+δi+εic

where i indexes industries and c countries. The dependent variable is country c’s share in US imports in sector i divided by the average share of industry i in US imports, in order to make coefficients comparable across countries, and to account for country size and closeness of trade relationship. Data on US import for 1998, classified by 4-digit SIC industry and country of origin, come from the NBER website (177 countries 389 industries).

inst_depi is a measure of intermediate input use, computed from the US Input-Output Table for 1992. I use several measures of concentration in intermediate input use: entropy, Herfindahl index, Gini coefficient, share of top 20 intermediate inputs and the number of intermediates employed in the production. These measures are strongly and significantly correlated with each other. instcis an index of institutional quality, taken from the Governance Matters IV Database. As a robustness check, I use discrete measures of contract enforcement taken from WDI. These are the number of days and procedures required to enforce a contract, and the years to resolve insolvancy.

capint3i is a measure of capital intensity, and is equal to one minus the share of total compensation in value added, while skint3i is a measure of capital intensity, and is equal to the ratio of non production workers to total employment, multiplied by the total share of labout in value added. These data come from the US Manufacturing database manteined by NBER and US Census Bureau’s Center for Economic Studies for 1996, the most recent year available. skillcand capitalc are country level measures of capital and skill abundance, and are adopted from Hall and Jones (1999).

I show the consistency of my results with those of Levchenko, and perform a number of robustness test, both using new measures for concentration of intermediate inputs use, and for intitutional quality of a country. I also rise an econometric issue on the consistency and bias of my estimates using ols tecnique on trade data that contain a disproportionate number of zero flows observations. I then perform my estimates using alternative tecniques, like probit and tobit estimation.

Costinot model predicts that absolute productivity is an independent source of comparative advantage in more complex sectors. I modify my equation in order to test this prediction, adding a measure of absolute productivity.

Finally, I consider the model by Acemoglu, Antras and Helpman, which predicts that the institutional source of comparative advantage is stronger in presence of complementarities between different tasks. I test this hypothesis including in my equation a measure of technological complementarity.

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