Subhayu Bandyopadhyay and Suryadipta Roy
Abstract This paper analyzes the effects of corruption on trade flows for a panel of nations. The novelty of the paper lies in our focus on tradeflows at the industry level. Such a focus is important because the emerging literature on trade and institutions suggests that the pattern of comparative advantage between nations may be driven by international differences in institutions, among other factors. Wefind that exports of certain goods by the developed nations are negatively affected by higher domestic corruption in these nations. Interestingly, corruption in the trading partner also reduces exports of certain goods. Imports seem somewhat less vul-nerable to corruption. The analysis uncovers considerable heterogeneity in the effects of corruption on different industries.
1 Introduction
It is widely agreed that institutional quality matters greatly for international trade.
Strong and supportive institutions are supposed to reduce the uncertainty involved in international transactions, and thereby reduce the transactions cost of trade. On the contrary, high levels of bureaucratic corruption, weak rule of law, or lack of
The views expressed are those of the authors and do not necessarily represent official positions of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.
S. Bandyopadhyay (&)
Federal Reserve Bank of St. Louis, Research Division, PO Box 442, St. Louis, MO 63166-0442, USA
e-mail: [email protected] S. Bandyopadhyay
IZA, Bonn, Germany S. Roy
Department of Economics, Earl N. Phillips School of Business, High Point University, High Point,, NC 27262, USA
e-mail: [email protected]
© Springer India 2016
M. Roy and S. Sinha Roy (eds.), International Trade and International Finance, DOI 10.1007/978-81-322-2797-7_6
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contract enforcement increase the uncertainty about the size of expected gains from carrying out an international transaction, and thereby deter international trade. Nunn and Trefler (2014) have surveyed the theoretical literature and empirical evidences on the role of domestic institutional quality of countries in affecting their com-parative advantage. While trade theorists have traditionally focused on the role of factor endowments and technological differences between countries in predicting trade patterns, it has been observed that trade volumes are much lower than the levels predicted by the theoretical models, and high income capital-abundant countries trade disproportionately with each other rather than with the low income labor-abundant countries (see Trefler1995). While this case of“missing trade” led to the emergence of the so-called New Trade Theories (N-T) developed by Helpman and Krugman (1985) that emphasized the role of increasing returns to scale and imperfect competition, the literature has recently focused on institutional differences between countries as a major explanatory factor of bilateral trade pat-terns that was not adequately studied by the erstwhile trade theories. The idea is that international transactions occur in the context of asymmetric information, oppor-tunistic behavior, and transactions costs that in turn are governed by the institutional quality of countries (see Belloc2006).
Anderson and Marcouiller (2002) view institutional quality reflected in cor-ruption and imperfect contract enforcement as indicators of transactions costs of trade. Using the gravity model of trade, theyfind that poor institutions affect trade as much as formal trade barriers like tariffs. Ranjan and Lee (2007) investigate a particular aspect of institutions—contract enforcement, and find that their proxy measures of contract enforcement affect the volume of trade in both differentiated and homogeneous goods. de Groot et al. (2004) have investigated the effect of various measures of institutional quality from the World Governance Indicators, andfind better institutional quality to lead to higher bilateral trade. In similar lines, Mohlmann et al. (2010) view institutional differences between countries as mea-sures of intangible trade barriers, and point to heterogeneous effects of such barriers on bilateral trade in homogeneous and heterogeneous goods. Implementing a Poisson estimator on panel data on bilateral tradeflows between countries, Francois and Manchin (2013)find that bilateral trade depends on both institutional quality as well as infrastructure. Thus by now, there is a broad consensus on the critical role that institutions play in promoting bilateral trade, and the pernicious effect of poor institutional quality in hampering trade between countries—both at the aggregate level as well as at the sectoral level.
The above studies however, do not take into account the heterogeneous effect of institutions on the level of economic development of countries in affecting bilateral trade. Marjit et al. (2014) have studied this interaction between corruption and economic development in affecting trade openness of countries. Viewing corruption as a labor-intensive activity and by introducing corruption as a source of (negative) factor endowment in the Heckscher–Ohlin–Vanek model of trade, they show that corruption distorts relative factor endowment of countries and thereby has impact on comparative advantage and resulting trade patterns. While their paper empiri-cally investigates if the effect of corruption on aggregate trade openness (measured
by Trade-GDP ratio) depends on factor abundance, the current paper investigates the interaction between corruption and economic development on bilateral trade between countries at a disaggregated level using sectoral trade data. The motivation is as follows: given that high income developed countries usually specialize and export more differentiated products that use more capital-intensive production methods in contrast to the underdeveloped countries that specialize more on homogeneous goods using (relatively) more labor-intensive techniques, greater corruption should impact relative factor endowments and have independent effect on bilateral trade beyond its effects on aggregate trade openness. We investigate this hypothesis empirically by implementing the gravity model of trade using bilateral export and import data for seven manufacturing industries according to the 3-digit ISIC Rev. 2 classification that vary based on factor intensities, extent of scale economies, and degree of product differentiation. The major findings can be summarized as follows. First, based on the country pair and year fixed effects specifications, we find strong evidence of negative impact of domestic corruption on the high income exporters, in that greater corruption in these countries is associated with reduced bilateral exports in case of textiles, industrial chemicals, rubber products, and transport equipment industries as well as a modest negative impact in the tobacco industry. Similarly, greater corruption in the trading partners is associated with reduced exports for the high income exporters in the electric machinery, transport equipment, industrial chemicals, and rubber products industry.
Second, the negative effects of domestic corruption on the developed countries are more pronounced on exports than imports. Domestic corruption is not found to be associated with any reduction in imports. On the other hand, there is some evidence of positive effect of domestic corruption for the relatively developed countries’ imports in case of the transport equipment industry. We also find substantial heterogeneity in the impact of partner country corruption on imports. Greater partner country corruption is associated with higher imports for the relatively advanced countries in the electric machinery and in the transport equipment industry, and lower imports in the textiles and in the footwear industry. Third, the effect of corruption seems to depend on the degree of product differentiation in that the corruption terms as well as their interaction with per capita income are found to be not significant in case of the tobacco industry—arguably the least differentiated and most homogeneous sector in our sample.
The paper is conceptually related to the literature on the role of institutions as a source of comparative advantage as surveyed in Nunn and Trefler (2014). However, while the focus in these papers is mainly on how domestic institutions shape the comparative advantage of countries, the current paper is more interested in inves-tigating the deleterious impact on bilateral trade of one particular aspect of insti-tutional quality—namely the corruption level of countries, in different industries and how the above effect varies systematically between the high income and the low income countries. In its application of the gravity model to explain bilateral trade in different sectors, the paper is methodologically linked to the literature on the gravity model of sectoral trade (see van Bergeijk and Brakman (2010) for a comprehensive survey on the role of the gravity model in international trade).
The rest of the paper is organized as follows. Section2 presents the gravity model and the different empirical specifications to be estimated. Section3discusses the data sources and presents the main results. Section4 concludes the paper and discusses some avenues for further research.