Asset Specificity and International Trade

10 March 2008 at 10:53 pm Peter G. Klein 1 comment

| Peter Klein |

The May 2007 issue of the Quarterly Journal of Economics featured a nice piece by Nathan Nunn, “Relationship-Specificity, Incomplete Contracts, and the Pattern of Trade.” The paper constructs an aggregate, country-level measure of asset specificity and relates it to characteristics of a country’s contract-law regime and its patterns of international trade. When asset specificity is high, firms tend to rely on contracts or vertical integration, rather than spot markets, so countries with good legal protection for contracts are more likely to specialize in the production of goods requiring specific investments.

Is a country’s ability to enforce contracts an important determinant of comparative advantage? To answer this question, I construct a variable that measures, for each good, the proportion of its intermediate inputs that require relationship-specific investments. Combining this measure with data on trade flows and judicial quality, I find that countries with good contract enforcement specialize in the production of goods for which relationship-specific investments are most important. According to my estimates contract enforcement explains more of the pattern of trade than physical capital and skilled labor combined.

One can quibble about the data and variables, such as the proxy for asset specificity (the absence of organized exchange or a publicly listed price for an input) and use of national input-output tables to construct measures of vertical integration, but overall this strikes me as an impressive piece of work, a clever combination of transaction cost economics and international trade theory. Check it out.