Trade, Inequality, and the Political Economy of Institutions

48 Pages Posted: 20 Apr 2016

See all articles by Quy-Toan Do

Quy-Toan Do

World Bank - Development Research Group (DECRG)

Andrei A. Levchenko

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

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Date Written: February 1, 2006

Abstract

The authors 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 enablesthe authors to analyze economies with heterogeneous firms, and argue that trade opening leads to a reallocation of production in which large firms grow larger, while small firms become smaller or disappear. Combining these two strands of literature, the authors 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. They 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: Economic Theory & Research, Free Trade, Trade Law, Trade Policy, Trade and Services

Suggested Citation

Do, Quy Toan and Levchenko, Andrei A., Trade, Inequality, and the Political Economy of Institutions (February 1, 2006). World Bank Policy Research Working Paper No. 3836. Available at SSRN: https://ssrn.com/abstract=922962

Quy Toan Do (Contact Author)

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

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Andrei A. Levchenko

University of Michigan - Department of Economics ( email )

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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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