Institutional Quality and Homogeneity, and Types of International Transactions

This paper investigates the conditions under which institutional homogeneities rather than qualities affect international flows. This issue is important for the validity of harmonization, because no matter which direction negotiations over harmonization take, harmonization is an attempt to enhance homogeneity between the institutions of different countries. Estimation results indicate that when the qualities of trading countries are equally high, while improving institutional qualities does not increase international flows, institutional homogeneity increases transactions, suggesting the validity of harmonization of institutions. We also examine whether institutions have a larger effect on foreign direct investment (FDI) than on trade in goods. While previous studies on institutions and trade investigate each transaction separately, our study treats different types of transactions simultaneously. The empirical results on relative effects show that institutional qualities and homogeneities have a larger effect on FDI than on trade in goods, implying that better and similar institutions decrease domestic transaction and production costs more than trade costs.