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Description:
The past literature presents ambiguous evidence about the bidirectional and causal influences between countries´ institutional framework and their trading activity. In our analysis, we investigate the relationship between institutions and trade constructing a measure of institutions from the information given by the International Country Risk Guide and using a methodology that can control for omitted variables bias, endogeneity in the regressors, as well as cross-country heterogeneity. We examine the long-run effects of the political institutional framework on trade for a panel of 87 countries for the period from 1990 to 2007. We employ recent panel econometric methods for testing and estimating in the presence of non-stationarity, investigate panel causality and use methods that are robust to slope heterogeneity. Our results imply that an improved political institutional framework is a cause of increased trading activity.