Development Spillover and Institutional Changes: A Trade Economy Political Perspective

In this paper I theoretically argue that people weigh specialization gains against trade costs when they decide whether to specialize and trade or self-produce all goods by themselves. Trade costs relate to institutional quality. Thus, more people participate in trade under better institutions. I also show that the better the institution of an economy’s trade partner, the more prosperous the economy is, thanks to expanded trade. Moreover, when more people trade, more people would like to fight for a better institution and may induce institutional changes. Better initial institutions or lower trade costs facilitate institutional improvements; but with very high initial institutional quality, people may lose their incentive to protest. I also provide historical evidence consistent with the theory.