Spatial Spillovers in Trade Agreement Memberships: Does Institutional Proximity Matter?

Abstract

This paper examines spatial spillovers in the formation of preferential trade agreements (PTAs) through a new channel of institutional proximity. Our dependent variable is the status of PTAs between country attributes within a country-pair. The explanatory variable of interest is the status of PTAs in neighbouring country-pairs that share proximity in institutional development. We consider democracy and economic freedom as the main aspects of institutions, and use both as the fundamental components of institutional distance between country-pairs. Employing a spatial econometric method, we find strong evidence of the institutional interdependence of PTAs: country-pairs tend to influence each other’s decision on the formation and the chosen type of PTAs (i.e., deep or shallow), such a neighbourhood effect increases with institutional proximity and is more prominent for the decisions on the type of PTAs. The institutional spatial channel is robust to the controlling for geographical channel and possible endogeneity.

Keywords: Preferential trade agreements, institutions, democracy, economic freedom, spatial econometrics

JEL Classification: C21, C25, F13, F15, O24