The Institutional Determinants of Bilateral Trade Patterns

Table 1.

Some data on governance as illustration: countries at various levels of quality.

Note: Indicator scores have been scaled from -2.5 to +2.5 (see Kaufmann et al., 2002).

We intend to analyse not only the effects of institutional quality on trade, but also the
effect of similarity in governance quality. In this way, we capture both the country-specific
effects of good governance on trade, and the bilateral influence of institutional distance on
patterns of trade.⁶ We expect that institutional homogeneity results in similar, hence
familiar, informal business procedures, which may reduce transaction costs. To capture
similarity in institutional quality, we constructed dummy variables for the various
dimensions of governance that we introduced before. If the values for an indicator of
institutional quality in two countries are both either above or below the sample mean, we
interpret this as indicating institutional homogeneity for this pair of countries; the argument
being that both countries have either a relatively low or high score on the indicated
dimension of governance. The corresponding dummy variable takes a value of one for such
a pair of countries and zero if countries rank on opposite sides from the sample mean.
Although arguably a rough method to proxy institutional homogeneity, the estimated effect
of homogeneity on trade, measured in this way as a discrete impact, is clear and concise in
its interpretation.

Bilateral Trade Flows and Institutions

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