Working Paper: CEPR ID: DP6419
Authors: Gianmarco I.P. Ottaviano
Abstract: The effects of the quality of institutions on economic development and comparative advantage have been so far investigated separately. This paper proposes a theoretical framework in which trade patterns and growth rates are jointly determined by international differences in contract enforcement that affect firms' organizational decisions. In a two-country dynamic Ricardian model with endogenous innovation and hold-up problems, the value chain consists of two activities, innovation and production. Entry in the market happens through R&D and entrants face two decisions. The 'location decision' determines where to place R&D laboratories and production plants. Through the 'ownership decision' firms choose whether to perform innovation and production within the same vertically integrated structure or not. In this framework, the quality of contract enforcement drives the ownership decision, which affects R&D returns, research intensity and growth. Balance of payments adjustments cause movements in relative wages, which affect the location decision and, therefore, the pattern of sectoral specialization and international trade.
Keywords: economic growth; incomplete contracts; innovation; theory of the firm
JEL Codes: D23; F10; L23; O30; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Quality of contract enforcement (D86) | Firms' ownership decisions (F23) |
| Firms' ownership decisions (F23) | Research intensity (I23) |
| Research intensity (I23) | Economic growth (O49) |
| Quality of contract enforcement (D86) | Research intensity (I23) |
| Quality of contract enforcement (D86) | Economic growth (O49) |
| Systemic innovation (O35) | Organizational forms (L22) |
| Organizational forms (L22) | Balance of payments (F30) |
| Systemic innovation (O35) | Quality of contractual environment (L14) |