Trade, Inequality, and the Political Economy of Institutions

48 Pages Posted: 31 Jan 2006

See all articles by Andrei A. Levchenko

Andrei A. Levchenko

University of Michigan - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Quy-Toan Do

World Bank - Development Research Group (DECRG)

Multiple version iconThere are 3 versions of this paper

Date Written: January 26, 2006

Abstract

We analyze the relationship between international trade and the quality of economic institutions, such as contract enforcement, rule of law, or property rights. The literature on institutions has argued, both empirically and theoretically, that larger firms care less about good institutions and that higher inequality leads to worse institutions. Recent literature on international trade enables us to analyze economies with heterogeneous firms, and argues that trade opening leads to a reallocation of production in which largest firms grow larger, while small firms become smaller or disappear. Combining these two strands of literature, we build a model that has two key features. First, preferences over institutional quality differ across firms and depend on firm size. Second, institutional quality is endogenously determined in a political economy framework. We show that trade opening can worsen institutions when it increases the political power of a small elite of large exporters, that prefer to maintain bad institutions. The detrimental effect of trade on institutions is most likely to occur when a small country captures a sufficiently large share of world exports in sectors characterized by economic profits.

Keywords: International Trade, Heterogeneous Firms, Political Economy, Institutions

JEL Classification: F12, P48

Suggested Citation

Levchenko, Andrei A. and Do, Quy Toan, Trade, Inequality, and the Political Economy of Institutions (January 26, 2006). Available at SSRN: https://ssrn.com/abstract=879746 or http://dx.doi.org/10.2139/ssrn.879746

Andrei A. Levchenko (Contact Author)

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Quy Toan Do

World Bank - Development Research Group (DECRG) ( email )

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Washington, DC 20433
United States

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