Firms, Contract Enforcement, and the Institutional Sources of Trade Openness

• In Event: Production Networks and Market Protection

Abstract

Why are democracies more open to trade than non-democracies? Existing explanations, which focus on the political power of voters, are at odds with many empirical regularities. In contrast to dominant theories, which emphasize the role of institutions in aggregating preferences, we point to the role of institutions in shaping the domestic preference landscape. We offer a theory of trade openness that combines two features. First, key beneficiaries and supporters of free trade are firms that export, import, and participate in global production networks. Second, concerns about contract enforcement impede trade between firms and therefore the emergence of firms that benefit from trade openness. Because democratic institutions are associated with better contract enforcement, they are also associated with the emergence of more firms that benefit from trade openness. We show that democracies boast more exporting firms; trade more products, especially contract-intensive products; and that the trade profile of democracies is skewed toward contract-intensive products, which involve more firms in the production process, spreading the benefits of open markets across the economy. We offer a new institutional theory of trade openness and, by emphasizing the role of contract enforcement, identify important parallels in the literatures over international trade and investment.

Authors

• Yoo Sun Jung, University College Dublin

• Timm Betz, Technical University of Munich