Contractual frictions and margins of trade

A recent body of work has shown that quality of national institutions that enforce written contracts plays an important role in shaping a country’s comparative advantage. The current paper contributes to this literature by providing a comprehensive analysis of the mechanisms through which institutional frictions affect the pattern of aggregate trade flow by distinguishing its effect on the intensive and extensive margins. We find that better contracting institutions not only increase the probability of exporting (the extensive margin) but also enhance the export sales after entry (the intensive margin), particularly in industries where relationship-specific investments are most important. With around two-third to three-fourth share (depending on the definition used), the contribution of institutions along the intensive margin dominates that along the extensive margin. The benefits of improved institutions, particularly via the intensive margin, favor the less developed countries over the more developed ones. In addition, better contracting institutions increase the probability of survival of export products in more contract-intensive industries in particular. These findings are robust to measuring the intensive and extensive margins using a more granular export data based on firm-level aggregates, as well as the variety and destination based definitions.