INSTITUTIONS, GOVERNANCE AND INTERNATIONAL TRADE: Opening the Black Box of OECD and GDP per Capita Effects in Gravity Equations

Ineffective institutions and bad governance increase transaction costs and reduce international transport flows. In this paper, we empirically investigate this basic notion, and we show that it can account for several, so far, somewhat puzzling results in the empirical literature estimating gravity equations of bilateral trade. More specifically, we show that differences in the quality and effectiveness of institutions offer an explanation for the tendency of OECD countries to trade disproportionately with each other, and with non-OECD countries, as well as for the positive effect of GDP per capita on bilateral trade.