On the role of trust and migration networks in global value chains

22 December 2016
Versione stampabile

2 PM, Seminar Room, Department of Economics and Management

Speaker: Rainer Lanz, World Trade Organization

Abstract 

Integration into global value chains (GVCs) promises countries benefits in terms of GDP and productivity growth. GVCs also increase the interconnectedness of countries as they are characterised by supplier‑buyer relationships, complex transactions and capital flows. These characteristics render the quality of contract enforcement or, more broadly, the rule of law as an important determinant of integration into GVCs. However, countries that are promised the largest gains from integrating into GVCs often have rather weak formal institutions that hinder them from doing so. In this paper, we show that informal institutions can act as substitutes for formal institutions and thus facilitate the integration of developing economies with weak rule of law into GVCs. We apply the gravity model to estimate the determinants of bilateral value added trade within GVCs and show that the importance of formal institutions for GVC trade increases with distance. We provide evidence that this effect can be explained by informal institutions. In particular, we find that the presence of trust, as measured by genetic distance between countries, and migrant networks, two variables related to distance, significantly reduce the effect of formal institutions on bilateral value added flows within GVCs. Hence, countries with weak formal institutions can equally integrate into GVCs and tap into the benefits that GVCs offer by focusing on trade partners that share common informal institutions.