Bengt Söderlund
ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
Bengt Söderlund ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
ISBN 978-91-7731-139-3
DOCTORAL DISSERTATION IN ECONOMICS
STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2019
ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
This Ph.D. thesis consist of four self-contained chapters that study how geog- raphy and institutions affect trade and growth.
“The Importance of Business Travel for Trade: Evidence from the Liberaliza- tion of the Soviet Airspace” examines the impact of the cost of travel on bilateral trade.
“Dynamic Effects of Institutions on Firm-Level Exports” examines how institu- tions affect firm-level exports as trade-relations mature.
“Redirecting International Trade: Contracts, Conflicts, and Institutions” stud- ies how firm-level exports and offshoring are affected by weak institutions across various industries.
“Capital Freedom, Financial Development and Provincial Economic Growth in China” investigate the relationship between financial development and growth at the provincial level in China.
BENGT SÖDERLUND holds a B.Sc. in economics from the Stockholm School of Economics. His main research field is empirical trade and he is primar- ily interested in understanding how geography and institutions shape trade patterns and economic development.
Bengt Söderlund
ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
Bengt Söderlund ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
ISBN 978-91-7731-139-3
DOCTORAL DISSERTATION IN ECONOMICS
STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2019
ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
This Ph.D. thesis consist of four self-contained chapters that study how geog- raphy and institutions affect trade and growth.
“The Importance of Business Travel for Trade: Evidence from the Liberaliza- tion of the Soviet Airspace” examines the impact of the cost of travel on bilateral trade.
“Dynamic Effects of Institutions on Firm-Level Exports” examines how institu- tions affect firm-level exports as trade-relations mature.
“Redirecting International Trade: Contracts, Conflicts, and Institutions” stud- ies how firm-level exports and offshoring are affected by weak institutions across various industries.
“Capital Freedom, Financial Development and Provincial Economic Growth in China” investigate the relationship between financial development and growth at the provincial level in China.
BENGT SÖDERLUND holds a B.Sc. in economics from the Stockholm School of Economics. His main research field is empirical trade and he is primar- ily interested in understanding how geography and institutions shape trade patterns and economic development.
Essays on Trade, Institutions, and Growth
Bengt Söderlund
Akademisk avhandling
som för avläggande av ekonomie doktorsexamen vid Handelshögskolan i Stockholm
framläggs för offentlig granskning tisdagen den 18 juni 2019, kl 13.15,
rum Torsten, Handelshögskolan, Sveavägen 65, Stockholm
Essays on Trade, Institutions,
and Growth
Essays on Trade, Institutions, and Growth
Bengt Söderlund
ii ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
Dissertation for the Degree of Doctor of Philosophy, Ph.D., in Economics
Stockholm School of Economics, 2019
Essays on Trade, Institutions, and Growth
© SSE and the author, 2019 ISBN 978-91-7731-139-3 (printed) ISBN 978-91-7731-140-9 (pdf) Front cover illustration:
© Michael Markieta, 2019 Printed by:
BrandFactory, Gothenburg, 2019 Keywords:
International trade, trade frictions, aviation, business travel, institutions, firm-level trade, financial development, China, growth.
Foreword
This volume is the result of a research project carried out at the Depart- ment of Economics at the Stockholm School of Economics (SSE).
This volume is submitted as a doctoral thesis at SSE. In keeping with the policies of SSE, the author has been entirely free to conduct and pre- sent his research in the manner of his choosing as an expression of his own ideas.
SSE is grateful for the financial support provided by Jan Wallander and Tom Hedelius Foundation, which has made it possible to carry out the pro- ject.
Göran Lindqvist Tore Ellingsen
Director of Research Professor and Head of the Stockholm School of Economics Department of Economics
Stockholm School of Economics
Acknowledgements
First, I would like to express my sincere gratitude to my advisor Professor Erik Lindqvist for his continuous support, motivation, and immense knowledge. His dedicated guidance and encouragement have been a tre- mendous help in completing this thesis.
I would also like to thank Professors Kerem Cosar and Yoichi Sugita for supervising me and inviting me to visit their respective departments in the US and Japan.
My sincere thanks also goes to my coauthor Professor Patrik Tingvall for introducing me to the field of international trade and for providing great support throughout my education at the Stockholm School of Eco- nomics. I also thank my other co-author Professor Ari Kokki.
I thank Sören Eriksson, Örjan Sjöberg, Björn Larsson, Steven Jaffe, Mohan Pandey, Göran Edman, Drew MacQueen, users at airliners.net, and staff at the British Library and ICAO for helping me to gather, understand, and map historical flight patterns. This was invaluable in writing the first chapter of this thesis.
I thank the Jan Wallander and Tom Hedelius Foundation and the Swe- den-Japan Foundation for financial support.
Last but not the least, I would like to thank my family, my parents, and my brother for supporting me throughout my work completing this thesis.
Stockholm, April 6, 2019 Bengt Söderlund
Contents
Introduction 1 1. The Importance of Business Travel for Trade: 7
Evidence from the Liberalization of the Soviet Airspace
2. Dynamic Effects of Institutions on Firm-Level Exports 59 3. Redirecting International Trade: Contracts, Conflicts, and 93 Institutions
4. Capital Freedom, Financial Development and Provincial 127 Economic Growth in China
Introduction
This doctoral thesis is a collection of four independent research articles. In the first chapter of the thesis, titled “The Importance of Business Travel for Trade: Evidence from the Liberalization of the Soviet Airspace,” I in- vestigate the impact of the cost of travel on trade. In chapters two and three, called “Dynamic Effects of Institutions on Firm-Level Exports,” and
“Redirecting International Trade: Contracts, Conflicts, and Institutions,” I study the relationship between the institutional quality of countries and trade patterns. In the final chapter, titled “Capital Freedom, Financial De- velopment and Provincial Economic Growth in China,” I examine the rela- tionship between the development of financial institutions and growth in various provinces in China. Below follows a brief summary of each chapter.
The Importance of Business Travel for Trade: Evidence from the Liberali- zation of the Soviet Airspace
Trade economists are puzzled by the fact that countries trade much more with close neighbors then with countries far away, even though the world has become more globalized. One hypothesis for the lack of long-distance trade is that face-to-face interaction through business travel is important for trade and that transporting people is costly. In the first chapter of this the- sis, I investigate whether the cost of travel explains why countries tend to trade more with closer countries. I find that the cost of travel has a large negative impact on trade and that this effect could be an important factor in shaping geographic trade patterns.
It is hard to know to what extent travel affects trade and to what extent trade affects travel. For instance, if two countries start to trade more with
2 ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
each other it could create an incentive for airlines to introduce better flight connections between the countries, which would lower the time cost of travel. To tackle this issue, I study an event in history that solely affected the cost of travel between countries, namely the liberalization of the Soviet airspace.
During most of the Cold War, essentially no airlines had permission to overfly the Soviet Union. This added significant flight time to many inter- national routes, primarily between Europe and East Asia. Nearly every flight between these regions was routed over the North Pole or the Middle East. In 1985, however, Soviet leaders started to permit non-Soviet airlines to make non-stop over-flights over Soviet territory. The opening of Soviet airspace radically reduced travel time between Europe and East Asia.
I use the liberalization of the Soviet airspace to test how lowering the time cost of travel between Europe and East Asia affected trade between these regions. I first verify that the liberalization of the Soviet airspace af- fected flight patterns by collecting a vast set of detailed flight data. I then examine how trade flows between Europe and East Asia developed before and after 1985 and compare that to trade in the rest of the world.
I find that trade between Europe and East Asia increased much more compared to trade between country pairs that were not affected by the lib- eralization of the Soviet airspace after 1985. I also find the liberalization of the Soviet airspace had a greater impact on more complex goods, where face-to-face interaction is likely to be more important.
Taken together, this paper provides evidence that the time cost of trav- el is a key reason for why trade tends to take place between countries that are geographically close despite increased globalization.
Dynamic Effects of Institutions on Firm-Level Exports
To understand what shapes global trade patterns, it is key to understand the barriers between countries that limit trade. Typical barriers to trade are transport costs and tariffs; however, standard trade models tend to predict more trade than what we actually observe. The lack of trade suggests that there might be more important barriers to trade than transport costs and tariffs.
INTRODUCTION 3
One type of barrier to trade that has gained more attention in recent years is so-called institutional barriers to trade. Institutional barriers to trade are all costs of doing trade between countries related to laws, traditions, and norms of countries that affect transactions between people. One such bar- rier to trade is poor legal institutions. If a country is not able to guarantee a fair trial in the event of a legal dispute, that country is less attractive to do business with.
In this chapter I, together with my co-author Professor Patrik Tingvall, investigate how institutions affect firms’ behavior when exporting to other countries. More specifically, we examine if there is a learning effect where bad institutions pose a greater barrier for trade when a firm is starting to export, but that the effect diminishes over time. Such a learning effect could come about by a firm getting more accustomed with the country or getting to know its customers better.
To carry out the analysis we gather data that contain information on goods exports for a large set of Swedish firms along with data on various measures of institutional quality of countries in the rest of the world. We find that countries with weak institutions are less likely to receive exports by Swedish firms. We also find that when countries with poor institutions receive exports from Sweden, the trade flows are smaller and are less dura- ble compared to exports to countries with good institutions. In addition, we are also able to identify a learning effect where firms that export to countries with less developed institutions start exporting on smaller scale initially but increase the volume rapidly over time.
Redirecting International Trade: Contracts, Conflicts, and Institutions A defining trend of the global economy is that emerging economies, such as China and India, are becoming more important trading partners for firms in the developed world. This poses a difficult challenge for firms op- erating in Europe and North America, as they must enter new markets with weaker institutions.
In the third chapter, I, together with my co-authors Professors Ari Kokko and Patrik Tingvall, investigate the consequences of this shift. We do this by comparing exports and offshoring of Swedish firms to countries
4 ESSAYS ON TRADE, INSTITUTIONS, AND GROWTH
with strong and poor institutions. We are particularly interested in under- standing how the impact of weak institutions might affect different kinds of industries. If certain industries have an easier time transitioning to countries with weak institutions, the composition of Swedish exports could potential- ly change in favor of those industries.
We focus on two aspects of industries, namely to what extent the in- dustry requires relationship-specific investments and how exposed the in- dustry is to international trade disputes. Relationship-specific investments are specific to the buyer-seller relationship. If the transacting parties end up in an unresolved dispute, this investment will be lost. Good institutions re- duce the likelihood of not resolving disputes and that one party takes ad- vantage of the other. Hence, firms in industries that require more relationship-specific investments might have a harder time entering markets where institutions are weak.
Trade disputes, on the other hand, occur when countries disagree about how to interpret rules governing international trade. Firms that trade goods involved in a bilateral trade dispute can end up paying higher tariffs or be- ing subject to a quota. The risk of being affected by a trade dispute creates significant uncertainty. Uncertainty is likely to be more pronounced when a country with weak institutions are involved, where decision-making is less transparent, and decision-makers are more sensitive to pressure from vari- ous domestic interest groups.
We find that Swedish trade has experienced a shift from developed to emerging markets but that this has been moderated by low institutional quality in these countries. In particular, weak institutions in the destination markets seem to hamper Swedish exports from industries characterized by high degree of trade disputes. For offshoring, the results suggest that weak institutions have an especially detrimental effect in industries that exhibit high relationship-specificity.
INTRODUCTION 5
Capital Freedom, Financial Development and Provincial Economic Growth in China
An extensive body of theoretical and empirical literature suggests that weak financial institutions are detrimental for growth. China, however, has man- aged to combine rapid economic growth with a strictly regulated financial sector for more than three decades. The discrepancy between economic and financial development has raised the question of whether China might be an exception to general relationship between financial and economic development.
In the fourth chapter of this thesis I examine, together with my co- author Professor Patrik Tingvall, the relationship between finance and growth at the provincial level in China using a new set of measures of capi- tal freedom and financial development. We show that capital freedom and financial development are associated with both higher income and growth rates. In particular, we find that the marketization of financial institutions and strengthening of legal and governmental institutions have a particularly strong impact on income and growth in low-income provinces.
