Trade and Institutional Distance

Abstract

This paper examines institutional determinants of bilateral trade in a thorough fashion, paying special attention to the issues of selecting institutional measures (using a composite measure institutional dataset 1990 – 2010), institutional endogeneity and state of the art gravity trade. In terms of the institutional focus, we emphasize that institutional distance can be an even more relevant determinant of trade than institutional quality on its own. We derive a theoretical gravity equation and test it empirically on a world panel of bilateral country trade flows for two decades. We find that not all types of institutions matter for bilateral trade to the same extent. The significant marginal effects discovered can be seen as the push factor of origin’s legal institutions and the pull factor of destination’s political and economic institutions. More importantly, we highlight the importance of the effect of institutional distance on trade, showing that economic distance affects trade significantly and negatively, as expected through trade costs, while political institutional distance increases trade, pointing to alternative ways of trade enhancement.