Institutions as a Source of Comparative Advantage
Tomohiro Ara
University of New South Wales

November, 2011

Abstract
It is empirically well-known that institutions — more specifically contract enforcement— are an important determinant of comparative advantage (Levchenko, 2007; Nunn, 2007).
It is also widely known that only a small fraction of firms can export their product and thepercentage of exporters varies drastically across sectors (Bernard and Jensen, 1999; Bernard,Eaton, Jensen, and Kortum, 2003). The existing theoretical literature has so far dealt withthese two stylized facts separately, however, and the unified frameworks incorporating thesetwo pieces of evidence have not been developed enough to address the following questions: (i)How is institutional quality related to comparative advantage and aggregate productivity?
(ii) Does higher quality of institutions lead to a larger share/number of exporters?
To investigate these relationships, the current paper develops a general-equilibrium Ricardian model of North-South trade in which both institutional quality and firm heterogeneity
play a prominent role in determination of comparative advantage. By adopting the conceptof “partial contractibility” (Acemoglu, Antràs, and Helpman, 2007), the model assumes thateach country is different in terms of contracting institutions (i.e., the degree of contractibility
for relationship-specific investments by suppliers), and each sector is different in terms ofcontract intensity. Furthermore, each firm within each sector is different in terms of theirproductivity à la Melitz (2003). These three-demensional differences endogenously pin down
the international pattern of specialization and trade in general equilibrium.
I show that a country with relatively better institutions (North) has comparative advantage in more contract-dependent products and is a net exporter of customized products,
thereby leading on average to the higher aggregate productivity in North. The model also
demonstrates that, relative to comparative-disadvantage sectors, the ratio of exporters todomestic firms is higher in more comparative-advantage sectors. Surprisingly, in some sectors, while the number of domestic producers is bigger in South, the number of exporters
is larger in North. This implies that the so-called home-market effect (i.e., exports tend
to reflect the characteristics of the home market) does not always work in the presence ofimperfect institutions and heterogeneous firms.
Keywords: Contracting institutions, firm heterogeneity, comparative advantage
JEL Classification: D23, F12, F14, L33, O43

References[1] Acemoglu, D., Antràs, P., and Helpman, E. (2007), “Contracts and Technology Adaptation.”
American Economic Review, 97(3), 916-43.
[2] Bernard, A. B., Eaton, J., Jensen, J. B., and Kortum, S. (2003): “Plants and Productivity
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[3] Bernard, A. B. and Jensen, J. B. (1999): “Exceptional Exporter Performance: Cause, Effect,or Both?” Journal of International Economics, 47(1), 1-25.
[4] Levchenko, A. (2007): “Institutional Quality and International Trade.” Review of Economic
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[5] Melitz, M. J. (2003): “The Impact of Trade on Intra-Industry Reallocations and Aggregate
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[6] Nunn, N. (2007): “Relationship Specificity, Incomplete Contracts, and the Pattern of Trade.”
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