International Trade and Institutional Change

This article analyzes the impact of international trade on the quality of institutions, such as contract enforcement or property rights. It presents a model in which imperfect institutions create rents for some parties within the economy and 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: both trade partners are forced to improve institutions after opening. On the other hand, domestic institutions will not improve in either country when one of the countries has a strong enough technological comparative advantage in the institutionally intensive good. While time series results are not statistically significant, a related cross-sectional prediction of the model is consistent with the data. Countries whose exogenous geographical characteristics predispose them to exporting in institutionally intensive sectors exhibit significantly higher institutional quality.