geographical distance and bureaucratic distortions per unit of value may be lower,
relatively. Other products, for example, are more heterogeneous and time-sensitive. They
are more prone to costs of search, transport, delay and bureaucratic procedures. As a result,
the impact of geographical distance and the quality of governance on trade may be higher
for these products. Also, the differences across sectors in the extent of product
differentiation may lead to different profit margins. Products with low profit margins may
respond more to transaction costs and distance. Thus, interesting questions arise in this
respect. Does distance matter more for specific sectors than for others? Do institutions have
a differentiated impact on trade, across sectors? Which indicators of governance matter
most? Is the effect of similarity in institutions on trade different from a sector-specific point
of view, than from an aggregate angle?
All of these questions may be relevant from a policy perspective. Conclusions drawn
from aggregate gravity estimations may differ qualitatively and quantitatively from
conclusions on the relevant sector level. For example, the discussion on the enlargement of
the European Union has emphasized the importance of trade costs and convergence of
formal institutions of potential entrants towards Union standards (cf. Nahuis, 2002). Given
the economic structure of the entrant countries, we may expect trade to concentrate in
certain sectors for exports to and imports from these countries respectively. It would then
be important to find out specifically which aspects of institutions matter for exports and
imports, in order to assess the necessity and direction of institutional reforms.
16
Bilateral Trade Flows and Institutions