Why Some Countries Trade More Than Others: The Effect of the Governance Environment on Trade Flows

Manuscript Type: Empirical Research Question/Issue: We study why some countries trade more than others by examining the effect of governance environment on trade flows between countries. We argue that countries with highly rule-based governance environments are relatively easy to trade with their transparent regulations and fair rules. In contrast, countries with highly relation-based governance environments are more difficult and/or more costly to trade with and therefore tend to have smaller trade flows. Research Findings/Results: Examining trade patterns among 44 countries representing 89 per cent of world trade, we find that overall, rule-based countries trade more than relation-based countries. Countries with a large gap in governance environments tend to trade less. A positive effect on trade flows exist between two highly rule-based countries, but not between two highly relation-based countries. Any trade relationship involving a relation-based country negatively affects trade flows. Theoretical Implications: This study refines and extends institutional theory and contributes to both governance and trade literatures by distinguishing two governance environments and how they affect trade flows between countries. Practical Implications: In addition to trade policies, governments must pay attention to the governance environment to evaluate their own and their trading partners' trading environment. When selecting trading partners, a firm needs to consider the prospective trading partner's characteristics (such as reputation, resources, and so forth), the trade policies of the partner's country, and the governance environment of that country.