Contract Enforcement, Comparative Advantage and Long-Run Growth
Gianmarco I.P. Ottaviano
Bocconi University - Department of Economics and Paolo Baffi Centre on Central Banking and Financial Regulation
CEPR Discussion Paper No. DP6419
The effects of the quality of institutions on economic development and comparative advantage have been so far investigated separately. This paper proposes a theoretical framework in which trade patterns and growth rates are jointly determined by international differences in contract enforcement that affect firms' organizational decisions. In a two-country dynamic Ricardian model with endogenous innovation and hold-up problems, the value chain consists of two activities, innovation and production. Entry in the market happens through R&D and entrants face two decisions. The 'location decision' determines where to place R&D laboratories and production plants. Through the 'ownership decision' firms choose whether to perform innovation and production within the same vertically integrated structure or not. In this framework, the quality of contract enforcement drives the ownership decision, which affects R&D returns, research intensity and growth. Balance of payments adjustments cause movements in relative wages, which affect the location decision and, therefore, the pattern of sectoral specialization and international trade.
Number of Pages in PDF File: 23
Keywords: economic growth, incomplete contracts, innovation, theory of the firm
JEL Classification: D23, F10, L23, O30, O40
Date posted: May 30, 2008
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