Institutions, trade, and growth

Countries with better institutions and countries that trade more grow faster. Countries with better institutions also tend to trade more. These three stylized facts have been documented extensively. Here we investigate the partial effects of institutions and trade on growth. We argue that crosscountry regressions of the log-level of per capita GDP on instrumented measures of trade and institutional quality are uninformative about the relative importance of trade and institutions in the long run, because of the very high correlation between the latter two variables. In contrast, regressions of changes in decadal growth rates on instrumented changes in trade and changes in institutional quality provide evidence of a significant effect of trade on growth, with a smaller role for improvements in institutions. These results are suggestive of an important joint role for both trade and institutions in the very long run, but a relatively larger role for trade over shorter horizons.