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Poor institutions as a comparative advantage

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An Erratum to this article was published on 31 October 2016

Abstract

Classic theories of comparative advantage point to factor productivity and factor abundance as determinants of specialization and trade. Likewise, geography and topography can determine trade patterns. Institutions, however, are increasingly seen as important sources of comparative advantage. A global drug prohibition regime implies that institutional quality matters more than traditional sources in the drug trade. This paper theoretically models trade patterns of illicit goods and confirms the role of institutions empirically with respect to the drug trade. In particular, illicit enterprises gain force in countries where resources are scarce, drug enforcement is uncertain, and institutions are weak in absolute terms and relative to neighboring countries. I propose several policy alternatives that emphasize economic opportunity for the poor and institutional quality that complement drug prohibition.

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Notes

  1. There is penal flexibility across borders regarding the possession of small quantities of prohibited substances (Roberts and Chen 2013).

  2. http://www.unodc.org/unodc/en/treaties/index.html?ref=menuside.

  3. That is, the paper takes prohibition as given and does not consider the implications of legalization. For economic arguments against prohibition see Miron and Zwiebel (1995). See Skaperdas (2001) for an outline of economic costs derived from organized crime.

  4. We can assume that this is a subset of the continuum of all goods, where illicit goods make up the more complex goods when considering the journey from conception to point of sale.

  5. Using this data rather than self-reported crime rates or trade flows, although less than ideal, avoids the problem of correlation between underreporting and unobservable country characteristics (see Soares and Naritomi (2010)).

  6. The World Fact Book does not report data by year, nor does it indicate when a country was first considered prominent in the production or transit of illicit drugs. Therefore, the data are treated as a single cross-section based on the 2015 report.

  7. Countries on the CIA’s list that were neither producer or transit countries were noticed for consumer demand of illicit drugs. I classify these countries, along with countries that do not appear in the Fact Book, as ‘neither’.

  8. Nine countries in the EFW sample are producers only, 48 are transit only and 24 are both.

  9. Estimating a Spatial Durbin Model (SDM) was considered and tried; however, tests indicate that the constructed spillover variable, as well as the other control variables, accounts for spatial dependence in the fitted logit model (Moran’s I z-score = 0.56, p value = 0.29). More importantly, the estimation method presented here allows for an intuitive presentation of the results. Any spatial dependence not controlled for leaves estimates unbiased but inconsistent, so I estimated the benefits of using the logit model outweighed the potential cost of not using the SDM.

  10. The data and methodology are available here: http://diegopuga.org/data/rugged/.

  11. A full description of methodology can be found here: http://www.transparency.org/cpi2014/in_detail. Likewise, the appendix includes sources and their respective summaries.

  12. I assume a linear relationship regarding institutional quality and find a significantly negative relationship between it and the probability of being a trafficking country; however, relaxing the linear relationship assumption and splicing the variable into quartiles to allow for different slopes results in similar findings as shown in the appendix. Also, note that including control variables for global location, such as continent or subcontinent, presents identification issues because being a South American country perfectly predicts being a trafficking country.

  13. The neighbors include Armenia (IQ = 4.25), Bulgaria (IQ = 3.07), Greece (IQ = 5.69), and Iran (IQ = 5.96). Data on Syria is not available.

  14. The neighbors include Austria (IQ = 9.15), Czech Republic (IQ = 5.95), Hungary (IQ = 5.36), Poland (IQ = 5.69), and the Ukraine (IQ = 3.92).

  15. One exception is Canada. This is likely attributable to the country’s ruggedness.

  16. I differentiate here between corruption of the rule of law and corruption in politics and business, which was the measure included in the estimated model and was shown to not play a significant role in developed trade patterns.

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Author information

Authors and Affiliations

  1. Department of Economics, Ohio University, Athens, OH, 45701, USA

    Cortney Stephen Rodet

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  1. Cortney Stephen Rodet
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Correspondence to Cortney Stephen Rodet.

Additional information

An erratum to this article is available at http://dx.doi.org/10.1007/s10602-016-9229-3.

Appendices

Appendix 1

The results in Table 4 show the regression coefficients and robust standard errors when separately identifying producing and transit countries according the CIA.

Table 4 Separate logit regressions for producer and transit countries
Full size table

The results in Table 5 show the regression coefficients and robust standard errors when splicing the institutional quality indices into quartiles to allow for different slopes. The first quartile is the reference group.

Table 5 Probability of being a trafficking country where institutional quality variable is spliced
Full size table

Appendix 2

Transparency International uses various sources, and the experts include business leaders and scholars tracking corruption in individual countries. The following is an explanation of its sources for constructing the Corruption Perceptions Index:

  1. 1.

    African Development Bank (AFDB) Governance Ratings

    The AFDB is a regional bank engaged in promoting development and social progress in countries on the continent. The bank gauges a country’s institutional framework and assesses its ability to effectively use development assistance using the bank’s Country Policy and Institutional Assessment (CPIA). The CPIA intentionally parallels questionnaires used by the World Bank and the Asian Development Bank. Data are available at https://cpia.afdb.org/?page=data.

  2. 2.

    Bertelsmann Foundation Sustainable Governance Indicators

    The Bertelsmann Siftung is a think tank working to improve education, economic efficiency, healthcare and international understanding. It is an independent, non-partisan group designing and launching its own projects, including the Sustainable Governance Indicators (SGI), which examines governance and policymaking in all OECD and EU member states using quantitative data and qualitative assessment by recognized country experts. Data are available at http://www.sgi-network.org/2015/Democracy/Quality_of_Democracy/Rule_of_Law/Corruption_Prevention

  3. 3.

    Bertelsmann Foundation Transformation Index

    The Transformation Index gauges good practices and management of 129 countries using detailed assessments of two experts per country using a battery of 52 questions divided into 17 criteria. The assessments undergo blind peer review by other experts. Data are available at http://www.bti-project.org/index/

  4. 4.

    Economist Intelligence Unit Country Risk Ratings

    The Economist Intelligence Unit (EIU) is a research body conducting global research and consultation. Country Risk Ratings provide in-depth analysis of risks of financial exposure in more than 140 countries, including assessment of public governance, the use of public funds and general accountability. Data are available at http://www.eiu.com

  5. 5.

    Freedom House Nations in Transit

    Freedom House is an independent watchdog organization supporting the expansion of freedom around the world. The Nations in Transit report measures democratization in 29 nations and administrative areas throughout Central Europe and Newly Independent States. It includes a component assessing various forms of public corruption and the quality of governance. Data are available at https://freedomhouse.org/report/nations-transit

  6. 6.

    Global Insight Country Risk Ratings

    The Global Insight country risk rating system provides a six-factor analysis of 203 countries/territories, including political, economic, legal, tax operational and security risk. Over 100 in-house country specialists assess a particular country. The form of corruption assessed is that related to starting, owning and running a business. Data are available at http://www.ihs.com/products/global-insight/country-analysis/

  7. 7.

    IMD World Competiveness Yearbook

    IMD is a Swiss business school recognized globally for evaluating countries’ competiveness along 333 criteria. It combines hard data with qualitative surveys of senior business leaders, including a component on bribery in business. Data are available at http://www.imd.org/wcc

  8. 8.

    Political and Economic Risk Consultancy (PERC)

    PERC consults companies doing business in East and Southeast Asia. It produces a range of risk reports on Asian countries, including on socio-political variables such as corruption. It collects surveys in face-to-face interviews and emails with business leaders. Data are available at http://www.asiarisk.com/

  9. 9.

    Political Risk Services (PRS) International Country Risk Guide (ICRG)

    PRS produces political, economic, and financial risk ratings for 140 countries/territories important to international business. ICRG staff collects political information and translates into a point system using an established formula. The survey assesses risk related to corruption between business and political spheres. Data are available at www.prsgroup.com

  10. 10.

    World Bank (WB) Country Policy and Institutional Assessment (CPIA)

    The CPIA rates countries against a set of 16 criteria grouped in four clusters, including economic management, structural policies, policies for social inclusion and equity, and public sector management and institutions. The last cluster includes an assessment of public sector transparency, accountability and corruption. Data are available at http://data.worldbank.org/data-catalog/CPIA

  11. 11.

    World Economic Forum (WEF) Executive Opinion Survey (EOS)

    The WEF is an independent international organization committed to improving the state of world. The EOS is an annual survey of business executives that includes components addressing bribery, use of public funds, and ethics. Data are available at http://www.weforum.org/

  12. 12.

    World Justice Project (WJP) Rule of Law Index (RLI)

    The WJP is an independent, non-profit organization committed to promoting the rule of law around the world through practical programs, including the RLI. The RLI assesses a nation’s adherence to the rule of law based on surveys of the general public and local experts. It includes 68 questions addressing the use of public funds for private gain among government officials, including the executive, judicial, legislative branches of government as well as police and military. Data are available at http://worldjusticeproject.org/rule-of-law-index/.

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Rodet, C.S. Poor institutions as a comparative advantage. Const Polit Econ 28, 167–192 (2017). https://doi.org/10.1007/s10602-016-9224-8

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