Essays on institutions and international trade

The Thesis analyses the impact that humanly devised institutions, defined as “formal and informal constraints on political, economic, and social interactions”, have on international trade and the patterns comparative advantage. The key assumption of the Thesis is that although institutions impact on the whole economy they may influence some sectors more than others. Industry‘s dependence on institutions is a technological feature of production. Hence, for example, industries that require a large number of intermediate inputs for production will be more dependent on the quality of contract enforcement regulation for their growth. The Thesis analyses 4 different sub-components of institutional quality: contract enforcement, financial development, property rights and labour market institutions. The Thesis’ hypotheses regarding each of these sub-components are as follows: 1. Countries with more efficient contract enforcement regulations will specialize (have a comparative advantage) in more complex sectors that depend on contracts with suppliers/producers for their growth.2. Countries with more secure property rights will specialize in sectors that are more dependent on intangible assets for production.3. Countries with higher financial development will have a comparative advantage in sectors that are more dependent on external finance for their growth.4. Countries with more flexible labour markets will specialize in more volatile industries. In order to test these assumptions we construct three econometric models (Chapters 4-6). In Chapter 4 we assess how contract enforcement regulations, financial development, property rights and labour market institutions impact on trade volumes using a well-known gravity model. In Chapter 5 we test whether these sub-components have an impact on growth of value-added at industry level. Finally, in chapter 6 the impact on firms’ productivity is tested. The results show that contract enforcement regulations and financial development affect countries’ comparative advantage by affecting countries trade flows, value-added and productivity in a way consistent with the hypothesis. The results regarding the other two institutional sub-components are mixed but we do find some evidence the countries with more secure property rights export more and have higher value-added growth in sectors that are more dependent on intangible assets. These results are robust to different specifications. Using a novel set of instrumental variables we show that causality runs from institutions to trade, value-added and productivity rather than the reverse. We supplement the empirical evidence with a case-study of Lesotho’s textiles and garment industry and also find some evidence that this export-oriented industry emerged in Lesotho at least partly due to this country’s good institutions that are better than its African competitors. From a policy perspective our results imply that institutional and regulatory reform - especially in enforcement of contracts and financial sector regulations - may enhance the capacity of poor countries to move up to specialization into higher-valued products and to reap benefits from international integration.