Input concentration and business climate

The business climate’s impact on economic growth and development has been the subject of a variety of recent studies many of which attempted to measure the impacts of various doing business indicators on aggregate trade performance. Only a few studies addressed the question of how the business climate can influence specialisation and structure of trade. Levchenko (2007) proposed that institutional quality can be a source of comparative advantage and analysed its impact on trade using a model that captures differences in institutional quality through a framework of incomplete contracts. The study proposed to proxy the industry-level dependence on institutional quality with a measure of input concentration as a proxy for product complexity and found that institutional aspects can significantly influence trade flows. Costinot (2009) identified the impact of institutional quality on the productivity of various sectors by taking into account different levels of job task complexity associated with production of different goods and found that especially in complex industries good institutions can be a complementary source of comparative advantage. Nunn (2007) analysed the impact of contract enforcement on exports in the context of industry differences in relation- specificity as proxied by shares of customized inputs. He found that good contract enforcement is especially important for the export performance of relationship-specific sectors and that this has a crucial impact on the pattern of trade: “contract enforcement explains more of the global pattern of trade than countries’ endowments of physical capital and skilled labour combined” (Nunn, 2007, p.594). All of the above studies used inter alia the rule of law indicator from the World Bank’s Governance Indicators database as a proxy for institutional quality.

The present chapter follows this literature and attempts to measure the extent of comparative advantage stemming from interactions of regulatory quality, as measured by country-level indicators of regulatory quality, rule of law and control of corruption, with product complexity, as measured by an industry-level indicator of intermediate input dispersion. The former three indicators are the components of the World Bank’s Governance Indicators database that seem the most appropriate for measuring the quality of enforcement of commercial contracts.9 The choice of the sector-dependence indicator follows Levchenko (2007) and Chor (2010) who proposed to measure the product complexity with the Herfindhal index of intermediate inputs dispersion. The index is calculated for the United States10 based on input-output information from the version 7 of the GTAP database. The specific hypothesis is the one posited in the literature that the higher the intermediate input dispersion in a given industry (and thus the higher the complexity of products) the more important the quality of the legal framework for export performance.

 
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