Trade, Insecurty, and Home Bas: An Emprcal Investgaton James E. Anderson Boston College and NBER Douglas Marcouller Boston College Revson of NBER Workng Paper #7000 Revson date: 9 July 1999 Abstract: Corrupton and mperfect contract enforcement dramatcally reduce nternatonal trade. Ths paper estmates the reducton usng a structural model of mport demand n whch nsecurty acts as a hdden tax. We fnd that nadequate nsttutons constran trade as much as tarffs do. We also fnd that omttng ndexes of nsttutonal qualty bases other parameter estmates, obscurng a negatve relatonshp between per capta ncome and the share of total expendture devoted to traded goods. Fnally, we argue that cross-country varaton n the effectveness of nsttutons and consequent varaton n traded goods prces offer a smple explanaton of the observed global pattern of trade, n whch hgh-ncome, captal-abundant countres trade dsproportonately wth each other. Davd Tarr and Francs Ng of the World Bank provded tarff data. We also thank our colleagues at Boston College and partcpants n semnars sponsored by Harvard Unversty, the Unversty of Connectcut, the NBER, CEPR, LACEA, and the Mdwest Internatonal Economcs Group for many helpful comments. Yury Tchamourlysk gave able research assstance. Correspondence to Economcs Department, Boston College, Chestnut Hll, MA 02467 USA or to <douglas.marcouller@bc.edu>. JEL Codes: F1, D23, O17.
Recent work re-emphaszes an old puzzle: dstance and border effects account for far too much of the varaton n trade volume across country pars (Frankel, Sten and We 1998; Hellwell 1998; McCallum 1995). Dstance s more mportant than can plausbly be explaned by transportaton costs (Grossman 1998; but also see Hummels 1999). Borders matter more than can be explaned by tarffs, quotas, and formal mpedments to trade. Hdden transactons costs may explan these results. Ths paper examnes nsecurty as one possble source of hdden costs. Anecdotal evdence of the mportance of nsecurty abounds. A survey undertaken by the World Bank between August 1996 and January 1997 summarzes such stores well. Table 1 shows the rankng n order of mportance of the obstacles for dong busness, based on responses by 3685 frms located n 69 countres. It s not surprsng that frms should complan about taxes; t s remarkable, however, that corrupton should rank as the second most mportant obstacle to busness worldwde, wth crme and theft not far behnd. Complants about trade regulatons, currency and prce controls, and labor and envronmental regulatons appear relatvely nsgnfcant. Ths paper fts a structural model of nsecure trade to mport data from 1996. Our results show not only that nsecurty matters, but how much t matters and to whom t matters. The structural model also offers some nsght nto why nsecurty matters. We model two types of nsecurty, one arsng from predaton, the other arsng from mperfect contract enforcement. Each s shown to mply a prce markup analogous to a hdden tax on trade. Predaton tself can take ether of two forms. When predaton takes the form of theft, the prce markup s determned by the probablty that a partcular shpment wll be hjacked. When predaton takes the form of the extorton of brbes by corrupt offcals, the markup s equal to the proporton of the value of each shpment whch shppers expect to lose. These markups are equvalent when rsks can be dversfed through nsurance or though makng a large number of small shpments subject to ndependent rsks. Imperfect contract enforcement leads to a slghtly dfferent
Trade, Insecurty, and Home Bas p. 2 markup. When entry nto the nternatonal market nvolves sunk costs, mperfect contract enforcement exposes shppers to the holdup problem even when the nvestment s not partner-specfc. In ths case, the exogenous probablty of enforcement determnes the sze of the prce markup. These prce markups, n turn, translate nto reduced demand for mported goods. Table 1. Rankngs of Obstacles for Dong Busness Worldwde Sample Tax Regulatons or Hgh Taxes 1 Corrupton 2 Fnancng 3 Inadequate Infrastructure 4 Crme and Theft 5 Inflaton 6 Uncertanty of Cost of Regulatons 7 Polcy Instablty 8 Labor Regulatons 9 Regulatons on Foregn Trade 10 Safety or Envronmental Regulatons 11 Start-up Regulatons 12 Foregn Currency Regulatons 13 Prce Controls 14 Terrorsm 15 Source: Brunett, Ksunko, and Weder, 1997, p. 70. Fttng the structural model to the data, makng use of data on nsttutonal qualty compled by the World Economc Forum, we show that trade expands dramatcally when t s supported by strong nsttutons specfcally, by a legal system capable of enforcng commercal contracts and by transparent and mpartal formulaton and mplementaton of government economc polcy. We estmate, for example, that f the ndexes of nsttutonal qualty assocated wth the Latn Amercan countres n our sample were to mprove to the levels assocated wth the European Unon, Latn Amercan trade would expand by 32%, other thngs equal. Ths expanson s equvalent to what would be expected from the reducton of Latn Amercan tarffs to US levels. The magntude of ths effect suggests that attenton to the costs of nsecurty may
Trade, Insecurty, and Home Bas p. 3 help n solvng Trefler s (1995) mystery of the mssng trade n emboded factor servces. Emprcal models whch gnore the securty of exchange suffer from an mportant omtted varables bas. Our model reveals that the share of expendture devoted to traded goods falls as ncome per capta rses, holdng constant other varables ncludng total ncome. Ths effect, whch s consstent wth anecdotal evdence that the share of ncome devoted to consumpton of nontraded servces rses as ncome per capta rses, does not emerge when nsttutonal varables are excluded from the regresson, as n most of the exstng gravty lterature. In the exstng lterature, the postve mpact of strong nsttutons s msattrbuted to hgh ncome per capta, the ncluded varable wth whch nsttutonal qualty s correlated. The sort of home bas reported here, that the share of expendture devoted to nontraded goods rses as ncome per capta rses, stands n contrast to recent emprcal work whch has faled to reject homothetc preferences (Davs and Wensten 1998; Davs, Wensten, Bradford and Shmpo 1997). Our work leads us to echo Trefler (1995, p.1043), the bas s mportant and must be confronted theoretcally and emprcally. The stylzed fact that hgh-ncome captal-abundant countres trade dsproportonately wth each other rather than wth low-ncome labor-abundant countres has been used to motvate models based on product dfferentaton rather than factor endowments, but nsecurty provdes a smple alternatve explanaton: that the prce effect of good nsttutonal support for trade among hgh-ncome countres leads them to trade dsproportonately wth one another. Ths argument does not mply, counterfactually, that low-ncome countres should also trade dsproportonately wth one another. Ths paper begns by modelng the translaton of nsecurty nto a prce markup. The second secton tes the prce markup nto mport demand. The thrd secton descrbes the data whch are used to estmate the model n the fourth secton. The ffth secton reports several checks on the robustness of our results.
Trade, Insecurty, and Home Bas p. 4 1. Modelng the Securty of Trade Two types of nsecurty can generate prce markups equvalent to a hdden tax on nternatonal trade. A model of predaton vews shpments as subject to attack by hjackers or corrupt offcals. A model of contractual nsecurty captures the mpact of the holdup problem on shppers when fxed costs are assocated wth entry nto the nternatonal market and contract enforcement s random. These are complementary rather than competng models. Each leads to a smple prce markup whch s a reduced form functon of exogenous varables. Together they motvate the demand system estmated later n ths paper. Predaton Anderson and Marcouller (1998) present a complete general equlbrum model of predaton, n whch utlty-maxmzng agents ratonally allocate ther labor across productve and predatory actvtes, endogenously determnng the probablty of successful shpment. Here we present a slghtly smplfed verson of the model. Theves or corrupt offcals attack shpments. Any shpment whch s defended by less than the customary measures s dentfable as easy prey, attacked wth certanty, and completely lost. Under these crcumstances, all shppers wll take the normal defensve measures and theves wll attack randomly. The probablty that a normally defended shpment from country wll successfully evade capture s gven by the asymmetrc contest success functon: 1 (1.1) π = 1 +θ L B, D L a functon of total labor devoted to bandtry L B, total labor devoted to defense L D, and an exogenous technologcal parameter θ. 1 The ablty to dversfy rsk makes ( 1 π) equvalent, from the shppers pont of vew, to a proportonal 1 The same functon has been used n the context of non-anonymous predaton by Grossman and Km (1995).
Trade, Insecurty, and Home Bas p. 5 nsecurty tax on the value of every shpment. Ths tax s bounded on the unt nterval, ncreasng n bandt labor and decreasng n defensve labor. In ths paper we treat defensve arrangements L D as gven. 2 assume the world s total supply of bandt labor to be exogenously set: L B = L B determnes π.. The endogenous allocaton of bandts across countres then We also Bandts freely allocate themselves across countres n a compettve ( ( )) equlbrum so as to maxmze expected loot 1 π L B,L D,θ v, where v s the volume of trade flowng through the border of country. The reasonable assumpton that uncoordnated bandts take trade volumes as gven greatly smplfes ths problem. Solvng the frst order condtons gves the allocaton of bandt labor to each country: (1.2) L B = π ( 1 π )v L B. π ( 1 π )v A bt of algebra produces the reduced form soluton for π : ( ) 1/ 2 (1.3) π = L 1/2 w D L D /v v θl B v + w L ( D /v ) where w s country s share of total world trade. Let S ( L D /v ) 1/ 2 denote the strength of a country s nsttutons for the defense of trade. Then: (1.4) π = S w S / θlb v + w S 2. If the probablty of successfully crossng nto country j s ndependent of the probablty of successfully leavng, the proporton of all shpments from producers n j whch successfully reach ther consumers n s gven by: 2 Ths s, of course, a major smplfcaton. See Anderson and Marcouller (1998).
Trade, Insecurty, and Home Bas p. 6 (1.5) π j = π π j = S S j D, where D w S / θlb v + w S 2. The probablty of loss on ths trade route, ( 1 π j ), determnes the transactons cost and the correspondng prce markup assocated wth nsecurty. Equaton 1.5 can be extended to nclude other nfluences on π j. When the two countres share a common border (represented by a dummy b j ) or a common language (dummy l j ), π and π j may not be ndependent. The rsk of theft mght rse as the dstance traveled rses, perhaps due to loss of nformaton about ways to avod hazards. 3 Addng these varables and changng to the consderably smpler relatve securty form π j / π kj (the probablty of successful shpment between and j relatve to the probablty of successful shpment between k and j) produces the equaton: (1.6) π j π kj = S S k 1+ b j 1+ b kj β 1 1 + lj 1 + l kj β 2 dj d kj β3. The prce markup on mports by country from country j relatve to the markup on mports by k from j wll reflect ths relatve probablty of successful shpment, as descrbed n Secton 2 below. Contractual Insecurty Insecurty n the form of mperfect contract enforcement generates a prce markup when fxed costs are assocated wth entry nto the nternatonal market. Followng Anderson and Young (1999), we model a market n whch for nsttutonal reasons there s some exogenous probablty ( 1 θ) that a gven contract may fal to be enforced. When contracts are not enforced, the contractng partes engage n ex post barganng, n whch the sunk costs of trade (all handlng charges up to the pont of sale) are gnored. Foreseeng ths possblty, hgh cost traders are dscouraged from enterng the market. The 2 2 3 Ths s the only pont at whch we menton nformaton costs, but we do not wsh to deny ther mportance. For a provocatve model of nformaton costs and trade, see Casella and Rauch (1998).
Trade, Insecurty, and Home Bas p. 7 effect on trade can be modeled as a prce markup equvalent to a tarff. The sketch of the model we present here s necessarly cursory, servng only to gve the elements whch yeld a plausble reduced form whch we take to our emprcal work. See Anderson and Young (1999) for detals. Sunk costs are assocated wth entry nto nternatonal trade. 4 Internatonal exchange occurs ether accordng to the terms of a contract negotated pror to ncurrng the sunk costs or n a non-contracted market nto whch those whose contracts are not enforced necessarly fall. We allow traders wthout enforced contracts to match only once per tradng perod. 5 In the noncontracted market, exchange occurs at the barganed prce p * = argmax(p c) ω (b p) 1 ω = ω b + (1 ω)c p where b and c are the exogenously determned outsde optons (home prces) for the buyer and seller and ω (0,1) s the barganng strength of the seller. In these crcumstances, t s only by accdent that the numbers of buyers and sellers would be equal. Any unmatched trader wll return home to exchange at hs outsde opton prce. We focus n ths development on the excess demand case, n whch some potental mporters are unable to fnd exporters wth whom to strke a deal. The actual volume exchanged s that on the short sde of the market, read off the supply curve, s[p s (p *,θ,b)], where p s s the equlbrum value of the certanty equvalent prce to supplers, whch can be shown to be a reduced form functon of the barganed prce, the probablty of enforcement and the outsde opton of the buyers. To obtan the tarff equvalent of the mperfect enforcement we frst defne the hypothetcal buyers prce whch would clear the market at the actual trade volume: 4 In the usual holdup model, these costs are relatonshp-specfc: the exporter desgns a product for a partcular mporter. The outsde opton of the exporter s whatever resale value ths desgn has for others. Smlarly the outsde opton of the mporter s whatever prce must be pad for an equvalent desgn elsewhere. Here, we need not assume that the sunk costs are relatonshp specfc because we assume that search s so expensve that traders match only once. 5 If rematchng were possble, the trader who s faced wth returnng home to hs outsde opton could offer a better deal than the barganed prce to someone about to accept the bargan. That s, the outsde opton would be endogenous.
Trade, Insecurty, and Home Bas p. 8 p t (p *,θ,b) = {p d[p] = s[p s (p *,θ,b)]. Then the ad valorem tarff equvalent s (1.7) T(p *,θ,b) = p t (p *, θ,b) p s (p *,θ, b) 1 The ad valorem tarff equvalent s decreasng n θ (see Anderson and Young, 1999), hence better enforcement ncreases trade. In our applcaton, the assumed exogenous θ vares across countres so that country j s exports face dfferent markups n each country. The p* and b arguments of T( ) are handled as follows. The barganed prce p* s a weghted average of the sellers and buyers reservaton prces. The seller s reservaton prce s set at unty by conventon and s nvarant across buyers. The buyers reservaton prce b s modeled as a reduced form functon of exogenous endowment varables. Fnally, the weghts n the barganed prce are assumed to be equal for all country pars, because n the absence of a barganng theory whch can dscrmnate among countres, t seems best to assume that 1-ω s the same across buyers. Under these assumptons, the securty data we use as proxes for θ accurately pck up the effect of dfferng securty arrangements on prce markups. 2. Import Demand n an Insecure World The strength of a naton s nsttutons affects the prces t must pay for traded goods, as shown n the prevous secton. Import demand depends n turn on these prces and on the dvson of expendture between traded and nontraded goods. We assume two-stage budgetng. Agents frst determne the proporton of total expendture to allocate to traded goods. In a second stage they allocate traded goods expendture across ndvdual mports, whch are dfferentated by place of orgn. 6 The frst-stage preferences are not restrcted. Preferences across 6 Hellwell 1998, p. 10, notes other papers usng ths Armngton assumpton.
Trade, Insecurty, and Home Bas p. 9 traded goods are CES and dentcal across countres. Producton s specalzed so that each country produces a nontraded good and a unque traded good. Under these assumptons, the mpact of prces on the demand n country for mports from country j s gven by: (2.1) m j =α j p σ σ j P 1 x where x s country s total expendture on traded goods, p j s the prce of j s good n wth producer prces p jj normalzed to one, P = j 1 σ α j p j 1/(1 σ ) CES prce ndex for traded goods n, σ s the elastcty of substtuton among s the traded goods, and α j s that parametrc expendture share on j s product whch s common to all mporters. The country s total expendture on traded goods, x, s some fracton φ of the country s total ncome. The traded goods expendture share (φ) s modeled as a reduced form functon of the country s ncome, populaton and traded goods prce ndex. A varety of statc structural models yeld such a functon. 7 Anderson (1979) ratonalzed ths reduced form wth a model of perfect competton and constant returns to scale. Bergstrand (1985, 1989) developed the reduced form from a model wth monopolstc competton and economes of scale. The equlbrum prce of the nontraded good s a reduced form functon n the same varables and s subsumed n the traded goods expendture share functon. Income and populaton pck up the effect of factor endowments, possble nonhomothetc preferences, and possble scale economes, whle the traded goods prce ndex pcks up substtuton between traded and nontraded goods. Substtutng nto 2.1: (2.2) m j =α j p σ σ j P 1 φ( y,n, P )y where n s populaton and y s natonal ncome. 7 Our emprcal work explans trade n a sngle year, so statc models are approprate. In realty, balanced trade s rare and the traded goods expendture share reflects an ntertemporal margn of decson-makng. We gnore ths margn because t s remote from the concerns of our model and seems unlkely to add to ts explanatory power. Temporary trade
Trade, Insecurty, and Home Bas p. 10 Insecurty enters the model through ts effect on prces. The prce of j s product n wll exceed the producer s prce for three reasons: a tarff f applcable, a transport cost dependent on dstance, and an nsurance markup ( ) and whch captures both the proporton of shpments lost to predators 1 π j the tarff-equvalent markup attrbutable to nsecure enforcement of contracts p t (β,b, p*) p s (β, b,p*) 1. In both models of nternatonal nsecurty, p j decreases and m j ncreases as the effectveness of nsttutons for the defense of exchange mproves. Three addtonal smplfcatons have proven enormously helpful n movng toward an estmable model. Frst, we use loglnear approxmatons of the basc functons. We approxmate the prce markup as a log-lnear functon of dstance, securty, and the tarff factor, f applcable. (If nstead transportaton and nsurance markups are modeled addtvely, the model becomes deeply nonlnear.) We also model the reduced form φ functon as loglnear. Second, we focus on m j / m kj, country s mports from country j relatve to country k s mports from country j, nstead of lookng at m j drectly. Ths makes the model nvarant to multplcatve rescalng of the WEF data, and t allows us to cancel some of the nonlnear terms of the π j functon. Moreover, castng the model n terms of relatve mports by two dfferent countres from a sngle exporter elmnates the need to estmate the α j parameter. Emprcal models followng Anderson s (1979) ratonale for the gravty equaton are usually msspecfed. The gravty model s derved from the mport demand system by mposng the addng up constrant that shpments to the entre world be equal to ncome, solvng that constrant for the expendture share for each exporter and fnally substtutng the exporter-specfc expendture share nto the mport demand equaton. Anderson shows that the correct specfcaton of the gravty equaton ncludes a hghly nonlnear exporter-specfc prce ndex on the rght hand sde. Nonlnear structural estmaton mght be possble, but falng control measures taken for balance of payments reasons wll show up n the traded goods prce ndex.
Trade, Insecurty, and Home Bas p. 11 ths, an exporter-specfc ntercept s ndcated. Most gravty models and our own model f Equaton 1.5 s used n non-rato form call for the use of exporterspecfc varables whch cannot be dentfed smultaneously wth an exporterspecfc ntercept. Focusng on mports by and k from the same exporter j elmnates ths problem. gves us: (2.3) Imposng loglnearty on the prce markup and focusng on relatve prces ln p j p kj = δ ln d j 1 d kj +δ ln S 2 S k +δ ln 1 + b j 3 1+ b kj +δ ln 1+ l j 4 1 + l kj + ln 1 + (1 a )t j 1+ (1 a kj )t k. In Equaton 2.3, a j s a dummy varable whch takes the value one f the two countres are assocated n a free trade agreement, and t s the mporter s average ad valorem tarff. The unknown elastcty of the prce wth respect to dstance and securty s represented by the δ coeffcents. The tarff term lacks a δ because an ad valorem tarff rases the prce by precsely the amount of the tarff. Through ts effect on relatve prces, a rse n the contract model s relatve probablty of enforcement, β /β k, would have an effect smlar to that of a rse n the predaton model s relatve defensve capacty, S / S k. Usng Equaton 2.3 and mposng log-lnearty on the traded goods expendture share φ( y,n, P ), Equaton 2.2 mples: (2.4) ln m j = ( 1 +γ m 1 )ln y kj y k +γ ln n 2 n k σδ ln d j 1 d kj σδ ln S 2 S k σδ ln 1 + b j 3 1 + b kj σδ 4 ln 1 + l j 1+ l kj σln 1 + (1 a )t j 1 +(1 a kj )t k + σ 1 +γ ( 3)ln P P k where P / P k s the relatve overall mporter-specfc traded goods prce ndex. Our thrd smplfcaton s to approxmate the relatve traded goods prce ndex by a verson of the Törnqvst ndex: (2.5) ln P = w P k j ln p j p j kj
Trade, Insecurty, and Home Bas p. 12 where w j s the average across mporters of the share of j s product n mport expendtures. Most prevous work wth gravty models has gnored the prce ndex term, whch certanly results n msspecfcaton. Our approxmaton s an mperfect but sensble and operatonal measure. All the major elements of our model are now n place. We have modeled a world n whch traded goods are dfferentated by place of orgn. Dfferences across mporters n demand for a sngle good have two sources: (a) dfferences n the prce markups assocated wth nsecurty, dstance, and tarffs, and (b) dfferences n the dvson of expendture between traded and nontraded goods. 3. Data The securty of transactons depends upon the nsttutons whch structure nteracton among prvate frms and between prvate frms and the state. We rely on data provded by the World Economc Forum (WEF) to measure the qualty of both sets of nsttutons. The measures are drawn from the WEF 1997 Executve Survey, whch was completed by more than 3000 partcpants dstrbuted across 58 countres (World Economc Forum 1997, p.85). Partcpants n the WEF survey were asked to assgn a score rangng from one (strongly dsagree) to seven (strongly agree) to each of the followng statements: Government economc polces are mpartal and transparent (Q 2.07); The legal system n your country s effectve n enforcng commercal contracts (Q 8.06). We rescale the mean response for each country to run from zero to one and use the rescaled means as measures of nsttutonal qualty, understandng Queston 2.07 to gauge prmarly the qualty of nteracton of the prvate sector wth the state and Queston 8.06 to gauge nsttutonal support for exchange wthn the prvate sector. Admttedly, these are nosy sgnals of nsttutonal strength. Expectatons dffer across countres, so that what counts as effectve enforcement or mpartal polcy n the Ukrane may dffer from what would be smlarly classfed n Sngapore. The respondents to the survey form a selected group
Trade, Insecurty, and Home Bas p. 13 even f they were randomly selected wthn a country, they would stll represent only those who had chosen not to relocate or to shut down. Moreover, the Forum provdes only the mean response for each country; we lack nformaton about wthn-country varaton n responses. As a check on the robustness of our results, we also use a complementary composte securty ndex formed by extractng the frst prncpal factor from answers to the followng questons: Government economc polces are mpartal and transparent (2.07); Government regulatons are precse and fully enforced (2.08); Tax evason s mnmal (2.11); Irregular addtonal payments are not common n busness and offcal transactons (8.03); The legal system s effectve n enforcng contracts (8.06); Agreements and contracts wth the government are not often modfed due to budget cutbacks, changes n government or changes n government prortes (8.07); Prvate busnesses can readly fle lawsuts at ndependent and mpartal courts f there s a breach of trust on the part of the government (8.08); New governments n your country honor the commtments and oblgatons of prevous regmes (8.09); Ctzens of your country are wllng to adjudcate dsputes rather than dependng on physcal force or llegal means (8.10); Your country's polce are effectve n safeguardng personal securty so that ths s not an mportant consderaton n busness actvty (8.15); Organzed crme does not mpose sgnfcant costs on busness n your country (8.16). Unformly postve factor loadngs of roughly smlar magntude gve us confdence that these questons, as a group, relably dentfy an underlyng composte securty factor, although ths factor s less precsely defned than our two preferred ndcators. It has been suggested that n emprcal work these ndexes of nsttutonal
Trade, Insecurty, and Home Bas p. 14 qualty may act smply as proxes for more tradtonal measures of barrers to trade. However, tarff barrers and trade preferences enter our model explctly. Moreover, the correlaton coeffcent between the nontarff barrer coverage rato and our ndex of transparency s only -.32, the correlaton wth our ndex of enforceablty s -.14, and the correlaton wth our composte securty ndex s -.15. 8 The sgns are those whch one mght expect from a poltcal economy perspectve, but the magntudes of the correlatons are small. Our data on 1996 blateral mport expendtures are taken from the IMF s Drecton of Trade Statstcs. Most of the DOTS mport data are reported c..f., although some appear only f.o.b. To avod as much as possble ad hoc adjustments to the data, we generally use the reported c..f. fgures, adjustng the few f.o.b. fgures upward by a factor based on the rato between the country s total reported c..f. mports from the rest of the world and the world s reported exports to that country. Snce the f.o.b. fgures would be theoretcally more approprate, we also report n an appendx the results of estmatng our model over nterpolated f.o.b. mport flows, applyng the same factors of adjustment to deflate the c..f. mport values to approxmate f.o.b. equvalents. Data on 1996 populaton and GDP n current dollars are taken from the World Bank s World Development Indcators (WDI). We calculate dstance from captal cty to captal cty on the bass of geographcal coordnates lsted n Ftzpatrck and Modln (1986); of course, the dstance from Washngton to Ottawa only roughly captures the average dstance traversed by shpments from the Unted States to Canada. Davd Tarr and Francs Ng of the World Bank gracously provded us wth unweghted average external tarff data; these data are far more complete than the data on mport dutes as a percentage of mport expendtures reported n the WDI. 9 We composed dummy varables to capture sharng a common border, a common language, or common membershp n ASEAN, the EU, Mercosur, or NAFTA. 8 The nontarff barrer coverage ratos are taken from the WEF s Global Compettveness Report 1997, p.223. They are avalable for only 37 of our 48 countres. 9 Even so, not every country has data avalable for 1996. We have used 1996 data where avalable, but n other years have used tarff data from 1997, 1995, or 1994. Whle parspecfc blateral tarffs would be preferred, complng the more than 2000 tarffs whch would be requred surpasses our ablty at ths tme.
Trade, Insecurty, and Home Bas p. 15 Table 2. Importers n the Data Set IMPORTER Obs. IMPORTER Obs. IMPORTER Obs. Argentna 46 Hungary 47 Russa 47 Australa 47 Iceland 42 Sngapore 44 Austra 46 Inda 47 Slovak Republc 47 Belgum-Luxembourg 47 Indonesa 46 South Afrca 47 Brazl 47 Ireland 47 Span 47 Canada 47 Italy 47 Sweden 47 Chle 36 Japan 47 Swtzerland 46 Chna 47 Jordan 42 Thaland 43 Chna: Hong Kong 47 Korea 33 Turkey 47 Colomba 46 Malaysa 46 Ukrane 41 Czech Republc 47 Mexco 38 Unted Kngdom 47 Denmark 47 Netherlands 47 Unted States 47 Egypt 47 New Zealand 47 Venezuela 45 Fnland 47 Norway 46 Zmbabwe 42 France 47 Peru 45 Germany 47 Poland 47 Greece 46 Portugal 47 Total 2182 We have complete data on these varables for a total of 2182 mport flows dstrbuted across 48 mportng countres. For an addtonal 24 blateral pars, no mports were reported. 10 Table 2 shows the mportng countres n our data set and the number of postve mport flows whch we observe for each. 4. Estmaton and Results The analytcal model leads to a smple result relatve mport demand s a functon of relatve ncome, populaton, dstance, tarffs, and varables assocated wth nsttutonal qualty. Estmaton of the model n log-lnear form supports three contentons: By lowerng transactons costs, nsttutonal support for secure exchange sgnfcantly rases nternatonal trade volume; 10 Actually, n these cases the country par appears n the DOTS data matrx but the trade volume s gven as. Apparently ths represents trade volume less than one sgnfcant dgt of the unts used for reportng (see notes to the yearbook). We nterpret these as reports of zero
Trade, Insecurty, and Home Bas p. 16 Excludng nsttutonal varables obscures a negatve relaton between ncome per capta and the share of ncome spent on traded goods; The nsttutonal dfferences whch we model can generate a dsproportonately hgh volume of trade among hgh-ncome countres, a pattern whch happens to accord well wth trade patterns n the real world (Deardorff 1998, p.16). Equatons 2.4 and 2.5 gve us the followng equaton n terms of the underlyng parameters of the theoretcal model: (4.1) ln m j = ( 1 +γ m 1 )ln y kj y k +γ ln n 2 n k σδ ln d j 1 d kj + γ 1 ( 3 )δ 2 ρ 1 ln s 1 s 1k + ( γ 3 1)δ 2 ρ 2 ln s 2 s 2k σδ ln 1 + b j 3 1 + b kj σδ ln 1+ l j 4 1 + l kj + ( γ 3 1)ln 1+ (1 a )t j 1 + (1 a kj )t k + σ 1 +γ ( 3)δ 1 w j ln d j d j kj + ( σ 1+ γ 3 )δ 3 w j ln 1 + b j 1+ b j kj + σ 1+ γ ( 3)δ 4 w j ln 1 + l j 1+ l j kj. Equaton 4.1 ncludes two dmensons of nsttutonal qualty, under the assumpton that the defensve capacty varable of the predaton model, S, s determned by the nteracton of nsttutons protectng commercal contracts and nsttutons ensurng publc mpartalty: S = s 1 S k s 1k ρ 1 s 2 s 2 k ρ2. The ndcators of nsttutonal qualty do not vary across exporters for a sngle mporter; the weghted average nsttutonal terms n the traded goods prce ndex collapse nto the unweghted terms. Therefore, the coeffcent on each nsttutonal ndex ncludes ts effect on the prce of j s good n, δ 2 ρ, the drect effect of ths prce on mports of ths good, σ, and the ndrect effect of ths prce on the traded goods expendture share through the traded goods prce ndex, (σ 1 + γ 3 ). Smlarly, the weghted average tarff markup s nearly dentcal trade. There are a few other cases n whch the country par smply does not appear n the
Trade, Insecurty, and Home Bas p. 17 to the unweghted tarff markup, snce few of the two thousand observatons nvolve free trade, and these two terms have also been collapsed nto a sngle term. The weghts of the Tornqvst ndex, w j, represent the rato of expendture on traded good j to total expendture on all traded goods ncludng the traded good produced at home. It can be shown that: w j = p j m j p j m j j, j (1 w ). We use ths to construct a set of weghts w j whch sum to one and whch are constant across consumers for a gven producer. Interpretaton s eased by estmatng the model n terms of GDP and GDP per capta rather than GDP and populaton. Ths fnal adaptaton leaves us wth the followng equaton as the foundaton for emprcal analyss: (4.2) ln m j =β m 0 +β 1 ln y kj y k +β ln y /n 2 y k /n k +β ln d j 3 d kj +β ln s 1 4 s 1k +β ln s 2 5 s 2k +β 6 ln 1+ b j 1+ b kj +β ln 1 + l j 7 1 + l kj +β ln 1 +(1 a )t j 8 1+ (1 a kj )t k +β 9 +β 10 w j ln 1+ b j 1 + b j kj +β 11 j w j ln 1+ l j 1 + l kj +υ + ε k kj The error ncludes two elements. The frst captures any dsturbance whch systematcally affects all of country s mports relatve to those of the base j w j ln d j d kj country k, υ k, recognzng the panel character of our data. The second element s specfc to mports by from j relatve to mports by k from j, ε kj. The base country k s held constant. In most cases, we estmate the regresson by OLS usng Stata s Whte correcton for possble heteroscedastcty wth clusterng by mporter. Table 3. Ratos wth USA as Base Country Rato: USA as Base Number Observatons Mean Standard Devaton DOTS data. We treat these as mssng observatons.
Trade, Insecurty, and Home Bas p. 18 Import Rato cf 2135 0.281 0.977 GDP Rato 2135 0.079 0.173 GDP Per Capta Rato 2135 0.520 0.441 Dstance Rato 2135 1.204 1.848 Transparency Rato 2135 1.085 0.370 Enforceablty Rato 2135 0.833 0.226 Composte Securty Rato 2135 0.012 0.981 Common Border Rato 2135 1.026 0.238 Common Language Rato 2135 0.948 0.263 Tarff Rato 2135 1.035 0.068 Table 3 reports summary statstcs for the mport, GDP, GDP per capta, dstance, transparency, enforceablty, composte securty, 11 adjacency, language, and tarff ratos, as defned above, usng the USA as a convenent base country k. Robustness of the results wth respect to the choce of the base s explored below. Table 4 reports the results of estmatng Equaton 4.2 under varous restrctons. Results n the frst four columns reflect OLS estmaton wth robust standard errors, estmated usng the Whte correcton clustered by mporter. We use the c..f. mport data here; results usng constructed f.o.b. data are shown n the Appendx. We also estmate a tobt model n whch the twenty-four unreported mport flows are taken to be zero. 12 The ffth column presents the tobt results. 13 Our frst pont s shown n the thrd and fourth columns of Table 4: the nsttutonal qualty varables have postve and sgnfcant coeffcents. A few examples shed lght on the magntude of the effects mpled by the pont estmates of the parameters. The enforceablty of commercal contracts s rated roughly 10% hgher n Belgum than n Brazl. Interpretng the estmated coeffcent on enforceablty as a reduced form elastcty, ths dfference mples roughly 4% hgher mports nto Belgum than nto Brazl, other thngs equal. The mean enforceablty ratng among the twelve countres at the low end 11 To avod problems wth the logs of negatve numbers, we frst form the rato of country s score on each survey queston to country k s score, then take the logs of the ratos, then fnd the frst prncpal factor of the logs and score that varable. 12 Wth an elastcty of substtuton among traded goods whch exceeds one, hgh transactons costs can elmnate trade n some blateral parngs.
Trade, Insecurty, and Home Bas p. 19 of the dstrbuton s 0.52 (relatve, as always, to the ratng of the USA). The mean enforceablty ratng among the twelve countres n the hghest quartle of the dstrbuton s 1.08. A country whch saw the measure of the enforceablty of ts commercal contracts rse from 0.52 to 1.08 would see ts mport volume rse by 33%, other thngs equal. 14 Table 4. Relatve Import Demand, USA as the Base Varable OLS 1 OLS 2 OLS 3 OLS 4 Tobt Log GDP Rato 0.837 0.855 0.860 0.866 0.907 (0.045) (0.042) (0.037) (0.038) (0.025) Log GDP Per Capta Rato 0.141 0.018-0.206-0.191-0.244 (0.058) (0.094) (0.105) (0.122) (0.059) Log Dstance Rato -1.134-1.109-1.097-1.095-1.134 (0.054) (0.058) (0.056) (0.056) (0.042) Log Transparency Rato.. 0.530. 0.620.. (0.169). (0.104) Log Enforceablty Rato.. 0.385. 0.307.. (0.199). (0.133) Relatve Composte Securty... 0.285.... (0.073). Log Border Rato 0.908 0.794 0.753 0.747 0.668 (0.140) (0.155) (0.160) (0.163) (0.193) Log Language Rato 0.314 0.327 0.331 0.336 0.349 (0.081) (0.080) (0.082) (0.082) (0.112) Log Tarff Rato. -2.973-4.753-4.814-4.773. (1.992) (2.146) (2.343) (0.926) Weghted Log Dstance Rato 0.420 0.424 0.382 0.451 0.300 (0.164) (0.160) (0.137) (0.130) (0.095) Weghted Log Border Rato -1.807-1.654-1.092-1.391-0.934 (1.474) (1.378) (1.332) (1.364) (0.941) Weghted Log Language Rato 1.390 1.438-0.001-0.119 0.809 (1.639) (1.486) (1.448) (1.363) (0.801) Constant 0.055 0.076-0.169-0.184-0.142 (0.158) (0.146) (0.135) (0.147) (0.104) Number Observatons 2135 2135 2135 2135 2159 R-squared.69.69.70.70 Log Lkelhood -3859 Robust standard error wth clusterng by mporter gven n parentheses. Imports are cf, as reported by DOTS. For results usng nterpolated fob fgures, see Appendx. The elastcty of mport demand wth respect to the transparency and 13 In ths case, the log of the mport rato, ln(0), was assgned a value 0.1 below the log of the lowest postve mport rato n the data set. 14 Calculated as exp[.385*(ln(1.08)-ln(0.52))]-1.
Trade, Insecurty, and Home Bas p. 20 mpartalty of economc polcy s even hgher, as well as estmated more precsely. Other thngs equal, mports nto France should be on average about 5% hgher than mports nto Argentna smply because the transparency ratng s about 10% hgher n France than n Argentna. Takng both nsttutonal ndcators nto account smultaneously, f the seven Latn Amercan countres n our sample (Argentna, Brazl, Chle, Colomba, Mexco, Peru, and Venezuela) were to enjoy the same transparency and enforceablty scores as the mean ratngs of the members of the European Unon, predcted Latn Amercan mport volumes would rse 32%. 15 Ths ncrease s of roughly the same sze as the 35% ncrease whch could be expected from lowerng Latn Amercan tarffs to the levels appled by the Unted States (or by the move to global free trade), holdng other thngs equal. 16 A much greater (54%) ncrease n average Latn Amercan GDP would be necessary to generate a comparable ncrease n mports, holdng all else equal. 17 As can be seen from Equaton 4.1, these thought experments nvolve several dstnct effects, even when all other ndependent varables are assumed to be held equal. The calculatons take nto account the drect effect of nsecurty on the nsurance markup and the substtuton effects assocated wth the change n prce, effects whch play out not only n substtuton among traded goods but also n substtuton between traded and nontraded goods. The latter effect requres the explct ncluson n the regresson of the traded goods prce ndex, and our Tornqvst approach ncludes that ndex n a smple, easly operatonalzed way. The coeffcents on the Tornqvst terms (the weghted ratos) have plausble sgns, mplyng, wth reference to Equaton 4.1, that γ 3 < 1 and σ + γ 3 > 1. The coeffcent on the weghted dstance term s hghly sgnfcant. Others have found a remoteness ndcator to be emprcally mportant n gravty models; our model offers theoretcal ratonalzaton for the mportance. 15 Usng the estmated coeffcents, the projected rse n the log of the mport rato as the nsttutonal ratngs rse to EU levels s.530*(ln(1.19)-ln(.98))+.385*(ln(.98)-ln(.62)), whch equals 0.28. The rse n the average mport rato tself would be exp[0.28]-1. 16 The percentage ncrease n the average trade rato expected when droppng the LA tarff rato from 1.065 to 1 s gven by exp[-4.75*ln(1.065)]-1. 17 The 0.28 rse n log relatve mports (footnore 15) s equvalent to, usng the GDP and GDP per capta coeffcents, (.860-.206)*ln(1.54), ndcatve of a 54% ncrease n relatve GDP.
Trade, Insecurty, and Home Bas p. 21 Fnally, our model of the mpact of the prce ndex on mports mples that β ˆ 3 / β ˆ 9, β ˆ 6 / β ˆ 10, and β ˆ 7 / β ˆ 11 should all be equal. An F-test on the estmated coeffcents does not reject that hypothess. 18 These results sgnal an mportant mpact of nsttutonal qualty on trade volume. In fact, n the contemporary world poor nsttutons appear to constran trade as much as tarffs do. The estmates justfy our frst and most mportant concluson: by lowerng transactons costs, nsttutonal support for secure exchange sgnfcantly rases nternatonal trade volume. Our second major fndng s that hgher ncome per capta reduces the share of expendture devoted to traded goods, all else equal. Ths result, whch stands n contrast to earler results n the gravty lterature, s consstent wth anecdotal evdence that as ncome per capta rses, so does the share of expendture devoted to nontraded servces. Prevous work wth the gravty model usually found an overall ncome elastcty close to one; so do we, when tarffs and nsttutons are gnored, as n the frst column of Table 4 (.837+.141=.978). However, when all the varables whch our theoretcal model requres are ncluded, as n the thrd and fourth columns of Table 4, we fnd an overall ncome elastcty less than 0.7 (.860-.206=.654;.866-.191=.675). Omsson by the earler lterature of varables correlated wth ncome per capta based upward the estmated ncome effect. Comparson across the columns of Table 4 reveals the bas clearly. Inapproprate excluson of the tarff and nsttutonal varables leads to the result shown n the frst column, wth a sgnfcantly postve coeffcent on GDP per capta. The coeffcent becomes nsgnfcantly dfferent from zero when the tarff term s added. Includng the nsttutonal varables as well drves the coeffcent nto the sgnfcantly negatve range. Econometrcally, these changes are drven by correlaton between GDP per capta and the omtted varables. The correlaton coeffcent between GDP per capta and the tarff rato s -.62. When the tarff rato s dropped from the regresson, part of the postve effect of lower tarffs on trade s msread as a 18 The F-statstc for the jont hypothess that β ˆ 3 / β ˆ 9 = β ˆ 6 / β ˆ 10 and β ˆ 6 / β ˆ 10 = β ˆ 7 / β ˆ 11 s F(2,47)=1.08.
Trade, Insecurty, and Home Bas p. 22 postve effect of hgher ncome per capta on trade. The correlaton between GDP per capta and the enforceablty rato s.55, and ts correlaton wth the transparency rato s.73. 19 When the nsttutonal varables are dropped from the regresson, part of the postve effect of securty on trade s msattrbuted to ncome per capta. Includng the theoretcally approprate regressors reveals that GDP per capta actually has a negatve effect; other thngs equal, a rse n ncome per capta lowers the share of a country s total ncome whch t spends on traded goods. Ths nterpretaton of the ncome parameters s dctated by our model. Import demand s (Equaton 2.2): m j =α j p σ σ j P 1 φ( y,n, P )y, where traded goods expendture s: γ φ( y,n, P )y = y 1 γ n 2 γ P 3 1+γ ( )y = y 1 +γ 2 (y / n ) γ 2 P 3 γ. β 1 s the coeffcent on ncome n Equaton 4.2, and β 2 s the coeffcent on ncome per capta. Therefore, γ 2 =β 2 s the reduced form elastcty of the traded goods expendture share wth respect to ncome per capta, holdng total ncome constant. Smlarly, γ 1 +γ 2 =β 1 1 s the reduced form elastcty of the traded goods expendture share wth respect to country sze, as measured by GDP, holdng GDP per capta constant. Omsson of the nsttutonal regressors does not dramatcally bas the estmate of the sze effect. Regardless of the model chosen, holdng GDP per capta and all else constant, a 10% rse n GDP leads to about an 8.5% rse n traded goods expendture, equvalent to a 1.5% drop n the traded goods expendture share. On the other hand, ncludng the prevously omtted varables leads to a dramatc shft n the estmated mpact of ncome per capta. We estmate that a 10% rse n ncome per capta would lead to a 2% declne n the traded goods expendture share. Our home bas result --- other thngs equal, doublng per capta ncome reduces the traded goods expendture share by 20% --- mples a very sgnfcant 19 Ths correlaton s gven n the data, but t does not mply that ncome per capta and nsttutonal qualty are necessarly lnked, nor does t nvaldate the thought experment reported above n whch nsttutons were mproved wthout a correspondng ncrease n ncome per capta.
Trade, Insecurty, and Home Bas p. 23 departure from homothetcty. Ths stands n contrast to the most recent appled trade lterature (Davs and Wensten, 1998; Davs, Wensten, Bradford and Shmpo, 1997). We concde wth Trefler (1995) n dentfyng the mportance of home bas but dverge from hm n tyng home bas to ncome per capta; Trefler uses ncome per capta as an ndcator of factor-augmentng technologcal dfferences across countres. Our aggregate results usng the reduced form trade expendture share bear some resemblance to earler dsaggregated work by Hunter and Markusen (1988). Of course, our model recognzes that the negatve effect of ncome per capta on the trade expendture share could be offset to some extent by an ndrect prce effect, snce the better nsttutons and lower tarffs of the hghncome countres lower the traded goods prce ndex. Combned ncome and prce effects explan why the data show a small postve correlaton (.13) between per capta GDP and total mports dvded by GDP. 20 Our thrd man contenton s that nsttutonal dfferences can generate a dsproportonately hgh volume of trade among hgh-ncome countres, a pattern whch happens to accord well wth trade patterns n the real world (Deardorff 1998, p.16). Why should hgh-ncome countres skew ther trade toward mports from other hgh-ncome countres n spte of the presumed smlarty of factor endowment? And what answer to the frst queston can be consstent wth the stylzed fact that low-ncome countres do not rely dsproportonately on mports from other low-ncome countres? Several solutons to the puzzle have been proposed (notably Markusen 1986). We offer an explanaton based on the prce markup assocated wth nsecure trade. Effectve nsttutons n the mportng country lower transactons costs, lower the prces of traded goods, and rase mports, holdng constant the characterstcs of the exportng country. The predaton model argues that the complete prce markup also depends on the qualty of nsttutons n the exportng country. Our emprcal results confrm that low securty n country lowers m j / m kj ; the predaton model also mples that both m j and m kj are low
Trade, Insecurty, and Home Bas p. 24 when the securty of country j s low. We cannot estmate ths second effect, because the mpact of the exporter s securty and of the expendture share α j are not separately dentfed. The predcton of the model, however, clearly concdes wth the observed pattern of trade. Trade among hgh-ncome countres wth hgh-qualty nsttutons ought to be hgh because the transactons costs assocated wth nsecurty are low; transactons costs mpose a double dsadvantage on trade among low-ncome, low-securty countres. Ths solves a problem alluded to n Deardorff s (1998, p.16) nformal exposton of an explanaton based on dentcal but non-homothetc preferences. Our story mples dsproportonate trade among consumers of the hgh-ncome good, but t does not mply counterfactually a smlarly dsproportonate amount of trade among low-ncome consumers. 5. Robustness In ths secton we brefly examne four questons: How do the estmated parameters dffer when lagged GDP s used as an nstrument for current GDP? How do they dffer when the base country s changed? How would they appear f we estmated a model of levels of mports rather than mport ratos? Can more general functonal forms be estmated? A more complex model than ours mght treat GDP as an endogenous varable. If a sngle shock can smultaneously shft both GDP and mports, then correlaton between the GDP regressor and the error term of the mport regresson could bas our parameter estmates. Wth ths n mnd, we reestmated Equaton 4.2 usng lagged GDP as an nstrument for current GDP. 21 Table 5. Relatve Import Demand, USA as the Base, Lagged GDP Varable Base Results Lagged GDP 20 The rato of mports to GDP s not an exact measure of the traded goods expendture share. It excludes expendture on the domestcally produced tradable good and ncludes expendture on goods whch are re-exported. 21 More precsely, usng data from World Development Indcators, we multpled the fgure for 1995 GDP n current local currency unts by the rato of the country s 1996 GDP deflator to ts 1995 GDP deflator and converted that result to 1996 dollars usng the offcal exchange rate.
Trade, Insecurty, and Home Bas p. 25 Log GDP Rato 0.859. (0.038). Log Instrumented GDP Rato. 0.855. (0.038) Log Per Capta GDP Rato -0.202. (0.107). Log Instrumented Per Capta GDP Rato. -0.225. (0.106) Log Dstance Rato -1.102-1.101 (0.058) (0.058) Log Transparency Rato 0.538 0.578 (0.171) (0.171) Log Enforceablty Rato 0.370 0.411 (0.204) (0.208) Log Border Rato 0.800 0.791 (0.174) (0.174) Log Language Rato 0.338 0.339 (0.083) (0.083) Log Tarff Rato -4.719-4.881 (2.191) (2.217) Weghted Log Dstance Rato 0.364 0.369 (0.138) (0.140) Weghted Log Border Rato -1.188-1.103 (1.416) (1.472) Weghted Log Language Rato 0.042-0.086 (1.467) (1.479) Constant -0.185-0.211 (0.137) (0.138) Number Observatons 2042 2042 R-squared.68.68 Robust standard error n parentheses, wth clusterng by mporter. The results, whch exclude German trade due to a data problem, 22 are presented n Table 5. The frst column s our usual specfcaton, the second uses lagged GDP. The new parameter estmates are well wthn one standard error of the old and strengthen, f anythng, the securty and home bas effects. In theory, there s no reason to suspect that the change of the base country k would make any dfference to the parameter estmates. In fact, we run nto two problems. We have no data on home consumpton of the exported good. Therefore, for any base country k, we lack a measure of m kk. Snce we have no denomnator for the relatve mport measure m k /m kk, we can never nclude any country s mports from the base country n the sample used n
Trade, Insecurty, and Home Bas p. 26 estmaton. Results could be senstve to the excluson of dfferng sets of 47 mport observatons. A second problem s ted to measurement error. Many of our ndependent varables take the form ln(x /x k ). The measurement error assocated wth x k depends on the choce of k, so the parameter estmates may vary wth the choce of the base country. 23 Table 6 presents the results of estmatng the full model wth the USA, Brazl, and Chna as alternatve base countres. As usual, these are OLS estmates of the model wth robust standard errors generated usng panel data technques (Whte correcton wth clusterng by mporter). The new results are consstent wth our conclusons n the prevous secton. Although the sgnfcance of the enforceablty measure falls slghtly wth the alternatve bases, the transparency ndex and the composte securty ndex retan ther strong effects. Moreover, as shown n Table 7, regardless of base country, omttng the tarff and securty varables from the model generates a postve and sgnfcant estmate of the GDP per capta coeffcent, mplyng (msleadngly) that the traded goods expendture share rses as ncome per capta rses. However, ncludng all the varables called for by the theoretcal model, we fnd nstead a negatve relaton between ncome per capta and the traded goods expendture share (although when Chna s used as the base country ths relatonshp s sgnfcant only at the 10% level). Varable Table 6. Relatve Import Demand, Alternatve Base Countres USA Base Brazl Base Chna Base USA Base Brazl Base Chna Base Log GDP Rato 0.86 0.86 0.85 0.87 0.86 0.85 (.04) (.04) (.04) (.04) (.04) (.04) Log GDP Per Capta Rato -0.21-0.19-0.17-0.19-0.17-0.15 (.11) (.09) (.10) (.12) (.10) (.12) Log Dstance Rato -1.10-0.97-1.07-1.10-0.97-1.06 (.06) (.04) (.05) (.06) (.04) (.05) Log Transparency Rato 0.53 0.51 0.58... (.17) (.22) (.26)... Log Enforceablty Rato 0.39 0.57 0.37... (.20) (.35) (.23)... 22 World Development Indcators does not nclude German GDP deflators. 23 Ths s also a loose justfcaton for allowng an ntercept.
Trade, Insecurty, and Home Bas p. 27 Relatve Composte Securty... 0.29 0.28 0.26... (.07) (.07) (.07) Log Border Rato 0.75 0.93 0.55 0.75 0.92 0.55 (.16) (.16) (.15) (.16) (.16) (.15) Log Language Rato 0.33 1.13 0.84 0.34 1.14 0.84 (.08) (.12) (.15) (.08) (.12) (.15) Log Tarff Rato -4.75-4.42-3.91-4.81-4.80-4.26 (2.1) (1.6) (1.8) (2.3) (1.8) (2.1) Wgt. Log Dstance Rato 0.38 0.35 0.49 0.45 0.39 0.53 (.14) (.14) (.15) (.13) (.13) (.14) Wgt. Log Border Rato -1.09-0.43-0.21-1.39-0.76-0.48 (1.3) (1.2) (1.2) (1.4) (1.2) (1.2) Wgt. Log Language Rato 0.00-1.01-1.05-0.12-0.63-0.67 (1.4) (0.9) (1.0) (1.4) (0.8) (0.8) Constant -0.17-0.70-0.95-0.18 0.43 0.06 (.14) (.30) (.27) (.15) (.12) (.14) Number Observatons 2135 2135 2135 2135 2135 2135 R-squared.70.73.61.70.73.61 Robust standard errors wth clusterng by mporter n parentheses. Table 7. Coeffcents on Per Capta Income Varable Varable USA Base Brazl Base Chna Base Model excludng tarffs and securty 0.141 0.160 0.156 (.058) (.057) (.058) Full model -0.206-0.186-0.165 (.105) (.090) (.099) Robust standard errors wth clusterng by mporter n parentheses. It has been suggested that the large trade volumes of the Unted States may exercse undue nfluence on our results. In fact, comparng Table 8 to Table 6 shows that the nfluence of nsttutonal qualty on relatve trade volumes s slghtly greater when US trade s excluded from the regresson (wth the Tornqvst weghts approprately recalculated). Table 8. Relatve Import Demand, US Trade Excluded Varable Brazl Base Chna Base Brazl Base Chna Base Log GDP Rato 0.85 0.84 0.86 0.85 (.04) (.04) (.04) (.04) Log GDP Per Capta Rato -0.21-0.19-0.19-0.16 (.09) (.10) (.10) (.12) Log Dstance Rato -0.96-1.06-0.95-1.05
Trade, Insecurty, and Home Bas p. 28 (.04) (.05) (.04) (.05) Log Transparency Rato 0.55 0.61.. (.22) (.27).. Log Enforceablty Rato 0.64 0.44.. (.32) (.22).. Relatve Composte Securty.. 0.30 0.29.. (.07) (.07) Log Border Rato 0.99 0.56 0.99 0.56 (.17) (.16) (.16) (.16) Log Language Rato 1.18 0.95 1.19 0.96 (.12) (.15) (.13) (.14) Log Tarff Rato -4.51-4.03-4.91-4.43 (1.62) (1.85) (1.86) (2.18) Wgt. Log Dstance Rato 0.29 0.41 0.31 0.44 (.13) (.14) (.12) (.13) Wgt. Log Border Rato -0.19-0.14-0.79-0.71 (1.14) (1.16) (1.18) (1.18) Wgt. Log Language Rato -2.17-2.57-1.42-1.80 (1.57) (1.62) (1.37) (1.36) Constant -0.80-1.07 0.45 0.07 (.29) (.27) (.13) (.14) Number Observatons 2042 2042 2042 2042 R-squared.72.60.72.59 Robust standard errors wth clusterng by mporter n parentheses. We have argued above that our model of relatve mports has many advantages. However, we can also estmate a dfferent model whch, whle mantanng the same sprt as ours, avods the problems assocated wth choce of a base country. We estmate the model n levels rather than n relatve form, ncludng a complete set of exporter dummes to pck up the exporter-specfc α j terms of Equaton 2.2, the exporter-specfc S j D of Equaton 1.5, whatever constant term may have canceled out of the prce markup gven by Equaton 2.3, and whatever constant term may belong n the traded goods expendture share functon whch underles Equaton 2.4. Ths gves us Equaton 5.1: (5.1) ln m j =β j +β 1 ln( y ) +β 2 ln( y / n ) +β 3 ln d j +β 6 ln( 1+ b j ) +β 7 ln( 1 + l j ) +β 8 ln 1+ (1 a j )t +β 10 w j ln( 1 + b j ) j +β 11 j ( ) +β 4 ln( s 1 ) +β 5 ln( s 2 ) ( ) +β 9 w j ln( d j ) w j ln( 1 + l j ) +υ +ε j j
Trade, Insecurty, and Home Bas p. 29 where β j s a vector of 48 exporter dummes. As Table 9 shows, the results of estmatng ths levels model, apart from the jump n R-squared attrbutable to the exporter-specfc ntercepts, are smlar to those already presented. The securty varables are stll estmated to have a postve effect. The pont estmates of the coeffcents on the nsttutonal varables are smlar, and the sgnfcance levels are only slghtly less. Moreover, the coeffcent on the ncome per capta varable behaves as already descrbed movng from very sgnfcantly postve to margnally sgnfcantly negatve as the tarff and securty varables are added to the model. Fnally, we expermented wth more general functonal forms. We tred a translog specfcaton of defensve capacty nstead of usng S = s 1 S k Wald test could not reject the hypotheses that the coeffcents on all the second s 1k ρ 1 s 2 s 2 k ρ2. A order terms were jontly zero, so we returned to the log-lnear specfcaton. We also tred to estmate a translog as an approxmaton to the trade share functon ( ) ( ) φ y,n, P φ y k, n k, P k but found that we could not dentfy all the necessary parameters wth nformaton on 47 countres. Varable Table 9. Alternatve Models of Relatve Import Demand Rato Form: USA Base Rato Form: USA Base Levels Form Levels Form GDP Varable 0.837 0.860 0.878 0.882 (0.045) (0.037) (0.042) (0.036) GDP Per Capta Varable 0.141-0.206 0.140-0.167 (0.058) (0.105) (0.061) (0.100) Dstance Varable -1.134-1.097-0.985-0.930 (0.054) (0.056) (0.053) (0.053) Transparency Varable. 0.530. 0.519. (0.169). (0.174) Enforceablty Varable. 0.385. 0.358. (0.199). (0.219) Border Varable 0.908 0.753 0.719 0.733 (0.140) (0.160) (0.213) (0.221) Language Varable 0.314 0.331 1.145 1.209 (0.081) (0.082) (0.158) (0.153) Traff Varable. -4.753. -3.809. (2.146). (1.997)
Trade, Insecurty, and Home Bas p. 30 Weghted Dstance Varable 0.420 0.382 0.230 0.120 (0.164) (0.137) (0.151) (0.127) Weghted Border Varable -1.807-1.092-1.897-1.775 (1.474) (1.332) (1.331) (1.255) Weghted Language Varable 1.390-0.001 0.480-0.384 (1.639) (1.448) (0.976) (0.963) Constant 0.055 (0.158) -0.169 (0.135) Exporterspecfc Exporterspecfc Number Observatons 2135 2135 2182 2182 R-squared.69.70.997.998 Robust standard error wth clusterng by mporter gven n parentheses. Columns 1 and 2 repeat results gven n Table 4, above. 6. Summary and Concluson Abundant anecdotal evdence suggests that transactons costs assocated wth nsecure exchange sgnfcantly mpede nternatonal trade. Predaton by theves or by corrupt offcals generates a prce markup equvalent to a hdden tax or tarff. Insecure enforcement of contracts can have the same effect. These prce markups sgnfcantly constran nternatonal trade where legal systems poorly enforce commercal contracts and where economc polcy lacks transparency and mpartalty. Ths paper bulds a structural model of mport demand n an nsecure world and estmates the model usng data collected by the World Economc Forum. We fnd that a 10% rse n a country s ndex of transparency and mpartalty leads to a 5% ncrease n ts mport volumes, other thngs equal. Sgnfcant costs are assocated wth nsttutonal weakness. They beg for serous consderaton as we try to solve the mystery of the mssng trade (Trefler, 1995). We fnd that the share of total expendture devoted to traded goods declnes as ncome per capta rses, other thngs equal. Ths result stands n sharp contrast to the frequent practce of usng homothetc preferences n trade models and to recent fndngs that homothetc preferences cannot be rejected by statstcal tests. The latter fndng s replcated here when tarffs and the nsttutonal varables are excluded. Based on ths, we clam that omtted varable
Trade, Insecurty, and Home Bas p. 31 bas accounts for others falure to reject homothetcty. The home bas effect of hgher ncome tends to be counterbalanced by a declne n the prce ndex of traded goods as ncome per capta rses, so that there s n the end a small postve correlaton between ncome per capta and mport expendture as a share of GDP. Fnally, the paper suggests an explanaton for the stylzed fact that hghncome, captal-abundant countres trade dsproportonately wth each other. These countres are also, n our data, the countres wth strong nsttutons for the defense of exchange. Snce the traded goods prce markup depends on the degree of nsecurty n both the exportng and the mportng countres, trade among the rch countres wll be relatvely unhampered by securty-related transactons costs, whle trade among poor countres wll be doubly dsadvantaged.
Trade, Insecurty, and Home Bas p. 32 Appendx The followng table reports results parallel to those of Table 4 usng nterpolated f.o.b. mport volumes rather than reported c..f. volumes: Appendx Table 1. Relatve Import Demand FOB, USA as the Base Varable OLS 1 OLS 2 OLS 3 OLS 4 Tobt Log GDP Rato 0.860 0.870 0.877 0.882 0.925 (0.044) (0.042) (0.038) (0.039) (0.025) Log GDP Per Capta Rato 0.126 0.057-0.196-0.174-0.235 (0.060) (0.106) (0.105) (0.121) (0.059) Log Dstance Rato -1.134-1.121-1.106-1.105-1.144 (0.054) (0.060) (0.058) (0.058) (0.042) Log Transparency Rato.. 0.651. 0.743.. (0.180). (0.105) Log Enforceablty Rato.. 0.362. 0.283.. (0.180). (0.134) Relatve Composte Securty... 0.314.... (0.079). Log Border Rato 0.894 0.830 0.784 0.778 0.698 (0.140) (0.155) (0.159) (0.161) (0.194) Log Language Rato 0.315 0.322 0.325 0.333 0.343 (0.082) (0.081) (0.082) (0.082) (0.112) Log Tarff Rato. -1.665-3.688-3.692-3.720. (2.140) (2.131) (2.320) (0.932) Weghted Log Dstance Rato 0.329 0.331 0.272 0.361 0.190 (0.171) (0.170) (0.140) (0.140) (0.095) Weghted Log Border Rato -1.812-1.726-1.161-1.436-1.001 (1.444) (1.402) (1.334) (1.394) (0.947) Weghted Log Language Rato 1.247 1.274-0.233-0.440 0.592 (1.649) (1.582) (1.520) (1.487) (0.805) Constant 0.046 0.057-0.226-0.228-0.198 (0.158) (0.153) (0.144) (0.157) (0.105) Number Observatons 2135 2135 2135 2135 2159 R-squared.69.69.70.70 Log Lkelhood -3872. OLS: Robust standard error wth clusterng by mporter gven n parentheses.
Trade, Insecurty, and Home Bas p. 33 References Anderson, James E. (1979), "A Theoretcal Foundaton for the Gravty Equaton," Amercan Economc Revew 69:1, March, pp. 106-116. Anderson, James E., and Douglas Marcouller (1998), "Trade and Securty, I: Anarchy," Boston College. Anderson, James E. and Lesle Young, (1999), Trade and Contract Enforcement, Boston College. Bergstrand, Jeffrey H. (1985), The Gravty Equaton n Internatonal Trade: Some Mcroeconomc Foundatons and Emprcal Evdence, Revew of Economcs and Statstcs 67:3, August, pp. 474-81. Bergstrand, Jeffrey H. (1989), The Generalzed Gravty Equaton, Monopolstc Competton, and the Factor-Proportons Theory n Internatonal Trade, Revew of Economcs and Statstcs 71:1, February, pp. 143-53. Brunett, Aymo, Gregory Ksunko, and Beatrce Weder (1997), "Insttutonal Obstacles to Dong Busness: Regon-by-Regon Results from a Worldwde Survey of the Prvate Sector," World Bank Polcy Research Workng Paper 1759. Casella, Alessandra and James Rauch (1998), Overcomng Informatonal Barrers to Internatonal Resource Allocaton, NBER Workng Paper No. 6627, June. Davs, Donald, and Davd Wensten (1998), An Account of Global Factor Trade, NBER Workng Paper No. 6785, November. Davs, Donald, Davd Wensten, Scott Bradford and Kazushge Shmpo, (1997), Usng Internatonal and Japanese Regonal Data to Determne When the Factor Abundance Theory of Trade Works, Amercan Economc Revew 87:3, June, pp. 421-446. Deardorff, Alan (1998), Determnants of Blateral Trade: Does Gravty Work n a Neoclasscal World? n Jeffrey A. Frankel, ed., The Regonalzaton of the World Economy, Chcago: Unversty of Chcago for the NBER. Ftzpatrck, Gary, and Marlyn Modln (1986), Drect-Lne Dstances: Internatonal Edton,Metuchen and London: Scarecrow Press. Frankel, Jeffrey, Ernesto Sten and Shang-jn We (1998), Contnental Tradng Blocs: Are They Natural or Supernatural? n Jeffrey A. Frankel, ed., The Regonalzaton of the World Economy, Chcago: Unversty of Chcago for the NBER. Grossman, Gene (1998), "Comment," n Jeffrey A. Frankel, ed., The Regonalzaton of the World Economy, Chcago: Unversty of Chcago for the NBER. Grossman, Herschel, and Mnseong Km (1995), "Swords or Plowshares: A Theory of the Securty of Clams to Property," Journal of Poltcal Economy 103, pp. 1275-1288 Hellwell, John F. (1998), How Much Do Natonal Borders Matter?. Washngton: Brookngs Insttuton Press. Hummels, Davd (1999), Toward a Geography of Trade Costs, mmeo, Unversty of Chcago. Hunter, Lnda, and James Markusen (1988), Per-Capta Income As a Determnant of Trade, n Robert C. Feenstra, ed., Emprcal Methods for Internatonal Trade, Cambrdge: The MIT Press, pp.89-109. Markusen, James R. (1986), Explanng the Volume of Trade: An Eclectc Approach, Amercan Economc Revew 76:5, December, pp. 1002-1011. McCallum, John (1995), Natonal Borders Matter: Canada-US Regonal Trade Patterns, Amercan Economc Revew, 85:3, June, pp. 615-623. Trefler, Danel (1995), The Case of the Mssng Trade and Other Mysteres, Amercan Economc Revew, 85:5, December, pp. 1029-1046. We, Shang-jn (1997), "Why s Corrupton so Much More Taxng than Tax: Arbtrarness Klls," NBER Workng Paper 6255, November 1997. World Economc Forum (1997), The Global Compettveness Report 1997 (Geneva: World Economc Forum).
For the referees, not for publcaton Appendx II. The Reduced Form of the Contract Model Let γ be the probablty of a match on the long sde of the market. The buyers and sellers prces n the absence of an enforced contract are p b = p * + (1 )b for buyers and p * for sellers. Let the contract prce be denoted p C. Equlbrum requres that on the long sde of the market, traders should be ndfferent between havng a contract and enterng the ex post market wthout a contract. Ths mples p b = p C + (1 )p b p C = p b. The certanty equvalent prces are p b for buyers and p s p b + (1 )p * for sellers. All traders on the short sde of the market accept contracts. The probablty that a seller wthout an enforceable contract can fnd a buyer n the ex post market s equal to (1.7) γ = (1 θ)s[θp b + (1 θ)p * ] d[p b ] θs[θp b +(1 θ)p * ] where p b = γp * + (1 γ)b for excess demand equlbrum. The numerator s the number of traders from the short sde whose contracts fal to be enforced. The denomnator s the number of traders from the long sde who do not have enforced contracts. Ths model has a unque equlbrum γ and assocated buyers and sellers prces and volumes for gven (θ, p *,b). The actual volume exchanged s that on the short sde of the market, read off the supply curve at the equlbrum value of the certanty equvalent supply prce. s[p s (p *,θ,b)], where p s ( ) s the expected prce to supplers as reduced form functon of the barganed prce, the probablty of enforcement and the outsde opton of the buyers. The tarff equvalent of the mperfect enforcement s obtaned by frst defnng the hypothetcal buyers prce whch would clear the market at the actual trade volume: p t (p *,θ,b) = {p d[p] = s[p s (p *,θ,b)]. Then the ad valorem tarff equvalent s (1.8) T(p *,θ,b) = p t (p *, θ,b) p s (p *,θ, b) 1
For referees, not for publcaton p. 2 It s straghtforward but tedous to show that the ad valorem tarff equvalent s decreasng n θ, (see Anderson and Young, 1999) hence better enforcement ncreases trade.