40 Pages Posted: 20 Nov 2012 Last revised: 20 Nov 2015
Date Written: November 19, 2015
Institutions have gathered considerable interest as to their effects on international trade and growth. We model how weak institutions can reduce the returns to high quality products, thereby creating inefficiency, and we explore whether the ability to export to markets with strong institutions can alleviate this inefficiency. We find that access to developed markets can exacerbate the problems caused by weak institutions and harm home welfare further, because the exporting decisions are based on home prices that do not accurately capture the value of high quality to the home market. Among other results, first, there is always an export price at which the country is better off if exporting were prevented. Second, any harm is increasing in the amount exported. Third, if some high quality remains on the home market, then home welfare can always be increased by restricting exports. Fourth, the opening of trade can reduce producer surplus and so in the long run lead to a reduction in the production of the export good. Fifth, welfare can decrease even if production of the exported good increases.
Keywords: adverse selection, moral hazard, asymmetric information, quality, trade, development
JEL Classification: D82, F12, L15, O24
Suggested Citation: Suggested Citation