Question Gasper Finance & Economics

Discuss the institutional analysis theory of international trade

discuss the institutional analysis theory of international trade.

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Answer Internal Staff

The term ‘Institutions’ refers to a wide range of social structures affecting economic outcomes. The comparative institutional analytic framework makes a simple claim. It contends that the pursuit of any substantive goal is necessarily mediated through different institutional processes that will affect outcomes, so that institutional analysis is required and such analysis must be comparative. Institutional analysis theory has huge impact across subject areas, including regional governance in the European Union and global trade governance in the World Trade Organisation. All institutional processes reflect biases in participation.

Institutional differences could be a source of comparative advantage in international trade. Dependence on institutions—enforcement of contracts and property rights—is a technological feature of the production process in some industries. This would be the case, for example, if production could not rely on spot markets for inputs, and instead required establishing complex relationships between the factors. According to the Ricardian view, better institutions imply that those institutions are relatively more productive in the institutionally dependent sectors, resulting in gains from trade. An institution without a comparative advantage in producing institutionally dependent good stands to gain from trade. This is because it stops producing the institutionally dependent goods, and thus no longer suffers the cost of its weak institutions. Poor quality of institutions may indeed manifest itself in lower productivity in the institutionally intensive sectors, for a variety of reasons. However, there is evidence that lack of proper contract enforcement also leads to significant distortions. Thus, modelling institutional comparative advantage in the basic Ricardian framework may be too reduced-form and miss important parts of the story.

The Grossman-Hart-Moore view lends itself to modelling institutional comparative advantage; contracts are more incomplete in countries with worse institutions. Incorporating institutional differences into the Hecksher-Ohlin model of trade presents different conclusions from those obtained under Ricardian view.