Regime Type, Property Rights, & International Trade in Developing Countries

Photo by Ian Taylor on Unsplash

By Srijan Shukla

Abstract: Since the conception of the post-World War II global economic order, many have wondered whether regime type has any association with a country’s economic fortunes. The subsequent decades have generated ambiguous evidence regarding its influence on economic development and trade patterns. In this debate over democracy vs. autocracy, the idea of effective economic rights as distinct from political rights often gets neglected. This article finds that effective economic rights—defined as “quality of government” and “contract enforcement”—have a significant positive relationship with developing countries’ international trade flows.  However, the presence or absence of free and fair elections and regime continuity have a significant negative relationship with trade flows. Using these findings, this article forwards the concept of de jure vs. de facto economic rights in a country, which has significant repercussions on its trading patterns and, consequently, its economic development.

Introduction

In the post-World War II era, the global economy saw several significant waves of economic growth.[1] The first wave saw war-torn countries in western Europe and Japan jumping on the globalization bandwagon, helping them rebuild yet again. In the second wave, other east and southeast Asian countries joined the globalization party that aided them in developing world-class industrial economies. And finally, in the post-Cold War era, the remaining countries—from China and India to the post-Soviet republics in Eastern and Central Europe—have accepted globalization, helping them pull millions out of poverty.

As these waves of economic growth changed the structure of the global order from time to time, so did the waves of democratization.[2] However, these two waves of democratization and globalization were not always parallel. Sometimes, economic growth took off without any democratization. China continues to be the preeminent example. And sometimes, even decades after democratization, such as in India, economic growth remains elusive. While scholars continue to debate whether democratization is a precondition for growth, several empirical examples suggest otherwise.[3] This brings us to the core puzzle of this article: If not for the overarching regime type, what specific features of a state help facilitate economic growth?

The focus of this article is to analyze the international trade patterns of forty-seven developing countries, as opposed to their overall economic development. In the post-Industrial Revolution era, not a single country managed to facilitate economic growth without substantial participation in international trade.[4] The evidence unambiguously indicates that trade is a precondition for economic development. Therefore, trade patterns of various countries help shed light on whether regime type matters for development.

Rather than considering a regime as a monolith, it is more useful to problematize it, looking at how economic and political rights vary within the same regime. This article argues that it is effective economic rights that are positively associated with trade flows as opposed to regime type. Thus, while many democracies do have de jure economic rights, these are not necessarily enforced in practice. Similarly, many autocracies have no political rights but have effective economic rights. This gulf between de jure and de facto economic rights essentially drives the variation in trade patterns across countries. The following article finds strong evidence for this phenomenon.

De facto economic rights—as conceptualized by developmental organizations like the World Bank—are characterized by stable economic rights, which includes property rights, a stable and credible judicial system, contract enforcement, relatively less corruption, strong corporate governance, and an overall steady rule of law. While political rights regulate political behavior, they do not necessarily regulate economic behavior. This is what makes these stable economic rights necessary for trade to take place and grow.[5]

Using cross-sectional data, this paper finds a statistically significant positive association between developing countries’ aggregate trade flows and the presence of effective economic rights, on the one hand. On the other hand, it shows a significant negative association between trade flows and regime type, including the presence (or absence) of free and fair elections and regime continuity. Lastly, it shows a negative relationship between trade and regime continuity. 

Often, regime continuity is considered a symbol of stability, which is believed to aid trade and commerce. However, this article finds that just the continuity or change of the overarching regime is not sufficient as long as the underlying de facto economic rights remain unchanged. Thus, overarching regime type and continuity alone have a zero or negative relationship with trading patterns. This distinction between de facto and de jure economic rights speaks to the strand of political economy literature that considers institutions a “credibility device.”[6] For country A to trade with country B, the former must be convinced that the latter will adhere to a given contract. This presence or absence of credible economic rights is the key determinant of trade flows, not the nature of the overarching regime itself.

The first section of this paper provides a brief literature review highlighting the distinction between political and economic rights and their repercussions on trade flows. The second section outlines the theory and the hypotheses of the article. The third section discusses the data and the research design. Finally, the fourth section discusses the results from the regression analysis and its interpretations.

Literature Review

Since the mercantilist era, political economists have debated the state's role in development and, more specifically, in a country’s international trading regime.[7] This continues to be a passionately debated topic with material ramifications for citizenries across nation-states. However, in the post-World War era, especially in the aftermath of the Cold War, the proliferation of market economies was no longer limited to liberal democratic states. In such a landscape, the need to understand the link between regime type and a country’s foreign trade flows becomes even more significant.

We can broadly divide scholars and intellectuals into two schools of thought regarding whether democracies are more conducive to foreign trade and development: democracy optimists and pessimists.[8]

The optimists, represented by scholars such as Hayek (1944), Friedman (1962), and Olson, view  political and economic freedoms as complementary and interdependent.[9] “According to this point of view, there is an inherent affinity between democratic government and market-oriented rights, for democracy is the best guarantor of limited government and hence of free enterprise,” writes Goldsmith.[10] Several studies corroborate this view when looking at specific literature on the political economy of trade and foreign direct investment (FDI).

Aidt and Gassebner (2010) underline the importance of regime type and show that autocracies trade substantially less than democracies.[11] Mansfield, Milner, and Rosendorff (2000) show that a dyad comprising two democracies is twice as likely to sign a free trade agreement than a mixed pair of democracy and autocracy.[12] Milner and Kubota explain the rampant proliferation of economic globalization in the aftermath of the Cold War across developing countries.[13] They argue, “Regime change toward democracy is associated with trade liberalization, controlling for many factors.” Like other optimists, they argue that the democratization of a regime forces its political leadership to cater to a larger section of the citizenry, which makes it adopt more free trade policies. These policies increase average consumer welfare and lower trade protection, favoring a much smaller rent-seeking capitalist elite. Jensen (2003) shows that democracies attract 70 percent more FDI as a percentage of the GDP than autocracies, predominantly because the former substantially minimizes the political and regulatory risk more than the latter.[14]

On the other side is the pessimistic view of democracy, highlighted by scholars such as Huntington and Nelson (1976). They argue that economic growth and political freedoms are at odds. “To restate the pessimistic view in simplified terms, democratic politics leads to demand for welfare spending, which in turn blocks social saving and the accumulation of capital, consequently impeding economic growth,” adds Goldsmith.[15]

Studies of the pessimistic view demonstrate how democracies are not all that great for foreign trade and investments. Xinyuan (2002) provides a critique of Mansfield, Milner, and Rosendorff study, and shows that it's not just the regime type but the actual decisions made by their leaders that result in more or less trade liberalization.[16] On a more structural level, Bhagwati (1988) introduced the idea of the “law of constant protectionism,” which argued that in democratic regimes, trade protectionism usually moves from one instrument to the other but never really goes away.[17] A more contemporary version of this theory was provided by Kono’s (2006) “optimal obfuscation,” which showed how in democratic regimes, trade protectionism moved away from “tariffs” to “non-tariff barriers” and “quality non-tariff barriers.”[18]

There is also a third view that problematizes the idea of regime type. According to this view, it is not the regime type but rather the presence of economic rights  via property rights and contract enforcement, which positively affect a country’s trade flows.[19] In the eighteenth century, Smith wrote, “'Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which people do not feel themselves secure in possession of their property, in which the faith of contracts is not supported by the law. . .”[20] In essence, Smith was referring to effective economic rights.

Besley and Ghatak (2009) show that property rights affect economic activity through four main aspects.[21] Effective property rights reduce expropriation risks, minimize the cost of property rights protection, facilitate gains from trade, and property acts as collateral supporting more transactions.

Going back to the aforementioned strain of political economy literature, Li and Resnick (2003) highlight how democracy has a competing effect on FDI inflows.[22] “We find that both property rights protection and democracy-related property rights protection encourage FDI inflows while democratic institutions improve private property rights protection,” they write. “After controlling for the positive effect of democracy via property rights protection, democratic institutions reduce FDI inflows.”

This brings out the distinction between political and economic rights within a regime. As Leblang (1996) argues, it is important to look at institutions that regulate economic behavior and not just political behavior when looking at regime type.[23]

Therefore, the contrast between de jure and de facto economic rights is significant. A democracy can have de jure economic rights, but those are not enforced on the ground. Conversely, a regime with no political rights can have strong de facto economic rights. For example, in Chile, the state often confiscated private property under its democratic leader Salvador Allende, but under his deeply autocratic successor, Augusto Pinochet, there were reasonably strong de facto property rights in place.[24]

Theory and Hypotheses

This article situates its theoretical basis on a distinction between the presence of de jure vs. de facto economic rights within a regime. Here, we expect that while de facto economic rights should have a positive association with trade flows, the broad regime type itself should have no or even a negative association with a country’s trade flows. The implicit argument is that regime type as an overarching idea does not capture the key characteristics that might be associated with increased trade.[25] Thus, the hypotheses are as follows.

The Economic Rights Hypothesis: Effective economic rights should positively affect the country's trade flows.

The Free and Fair Elections Hypothesis: The presence or absence of free and fair elections should have no or a negative relationship with the country’s trade flows.

The Regime Continuity Hypothesis: Regime continuity, measured through the number of consecutive years a regime has been in power, should have no or a negative relationship with the country’s trade flows.

Research Design & Data

The following empirical analysis uses a set of dependent, independent, and control variables to test the hypotheses above. For this analysis, we use the 2021 Quality of Government Standard Dataset and employ the ordinary least squares (OLS) method. We begin by listing the variables chosen for the regression.

Dependent Variables

A country’s trade flows are represented through its exports, imports, and the aggregation of those two parts. This paper uses three models to test our hypotheses. The idea behind using these three models is that there are some countries where the scale of exports is substantially larger than imports and vice versa, resulting in distorted overall trade figures. Therefore, considering aggregate trade, exports, and imports separately helps us reduce the likelihood of any such misrepresentation.

In the first model, the dependent variable is total imports as a percentage of a country’s gross domestic product (GDP). The dependent variable in the second model is total exports as a percentage of GDP, while the third model takes aggregate trade as a percentage of GDP as its dependent variable. This data has been taken from the World Bank.[26]

Independent Variables

For the independent variables, the idea is to use two sets of variables: one which represents effective economic rights and another for regime type.

Economic Rights: To capture this, we use three distinct variables.

The first variable, Government Quality, is derived from the PRS Group’s International Country Risk Guide’s Indicator of Quality of Government variable.[27] The variable provides a mean value of the ICRG variables – corruption, law and order, and bureaucracy quality—scaled from zero to one. Higher values indicate a higher quality of government. This index will help capture the theoretical foundation of de facto economic rights. Stable law and order, relatively low corruption, and a stable bureaucratic system are essential to facilitate trade. This represents the general but fundamental notion of property rights in a country.

The second variable, Contract Enforcement, is taken from the World Bank’s Ease of Doing Business Report.[28] This “measures the gap between an economy’s performance and regulatory best practice on Enforcing Contracts indicator components. It is calculated as the simple average of the scores for Time (days), Cost (% of claim value), and Procedures (number). The scores range from 0 to 100, where 0 represents worst regulatory performance and 100 the best regulatory performance.” This is an essential variable for capturing the presence of contract enforcement and regulatory stability.

Lastly, the Minority Shareholder Rights (MSR) variable compiles “ten key legal provisions identified as most relevant to the protection of minority shareholder rights are coded by a team of legal scholars between 0 and 1. The sum of the scores for each of the ten legal provisions is the value of the variable, ranging from 0 to 10,” according to the 2021 QOS Standard Dataset. This data has been taken from the Guillen and Capron Shareholder Protection Index.[29] Protection of minority shareholder rights is considered a key requirement in good corporate governance.

Regime Type: To capture this, we use two specific variables.

First, the Free and Fair Elections variable from the Bertelsmann Transformation Index measures the extent to which political representatives are "determined by general, free, and fair elections.”[30] The variable ranges on a scale of one to ten and measures the quality of democracy in 137 countries.

Secondly, Consecutive Years of Current Regime Type measures regime stability in a country.[31] This variable will now be referred to as Regime Continuity. It is an important aspect of regime type. It helps capture the stability of a given political dispensation and helps us test whether that has any bearing on trade flows.

Control Variables

Per standard trade and political economy models, this study uses three control variables. First, FDI Inflows captures the inflow of foreign direct investment in a country.[32] Second, Log of Gross National Income Represents the Gross National Income of various countries.[33] Third, and most importantly, we use Trade Freedom, from Heritage Foundation’s Index of Economic Freedom, to represent the trade freedom score.[34] This score comprises a country’s trade-weighted average tariff rate and non-tariff barriers. “Weighted average tariffs is a purely quantitative measure… the presence of NTBs affects its trade freedom score by incurring a penalty of up to 20 percentage points. The country's trade freedom ranges between 0 and 100, where 100 represents the maximum degree of trade freedom.”

The regression equations used in the three models are as follows:

MODEL I:

IMPORTS = a + β1(Government Quality) + β2(Contract Enforcement) + β3(MSR) + β4(Free and Fair Elections) + β5(Regime Continuity) + β6(FDI Inflows) + β7(Trade Freedom) + β8(LOG_GDP) + e

MODEL II:

EXPORTS = a + β1(Government Quality) + β2(Contract Enforcement) + β3(MSR) + β4(Free and Fair Elections) + β5(Regime Continuity) + β6(FDI Inflows) + β7(Trade Freedom) + β8(LOG_GDP) + e

MODEL III:

TRADE = a + β1(Government Quality) + β2(Contract Enforcement) + β3(MSR) + β4(Free and Fair Elections) + β5(Regime Continuity) + β6(FDI Inflows) + β7(Trade Freedom) + β8(LOG_GDP) + e

Results and Interpretation

The regression results validate this article’s three hypotheses. There is a statistically significant positive relationship between Trade and Government Quality and Enforcing Contracts, respectively. However, there is a significant negative relationship between Trade, Free and Fair Elections, and Regime Continuity.

The regression analysis table below has 47 observations and the R-Squared is around the 0.75 mark for all three models. The regression utilized robust standard errors to correct for a possibly endogenous relationship between Government Quality and Contract Enforcement. 

In our third model, which takes Trade as the dependent variable, there is a statistically significant relationship between Quality of Government and Trade at the 99 percent confidence level. The relationship between Trade and Enforcing Contracts is positive and significant at the 95 percent level, with a coefficient of 0.742. Meanwhile, the relationship between Trade and Minority Shareholder Rights, though positive, is not statistically significant.

These results remain broadly the same across the import and export models, but the Quality of Government coefficient estimates come down to 70.28 and 105.7, respectively. This finding seems to be in line with the theoretical expectations. The value of effective economic rights, quality governance, and contract enforcement is context-specific. This is most important when a country is trying to develop a comprehensive trading relationship with the world because this is where credibility matters the most. But this value diminishes if a country can only import, which involves mostly making and not receiving payments.

Now let’s consider the other set of independent variables. In the third model, there is a statistically significant negative relationship between Trade, Free Elections, and Regime Continuity, with coefficients of -6.102 and -0.256 respectively. These results remain the same through the other two models. This validates hypotheses two and three.

Regression Results for the Three Models

Figure 1: Regression Results

The above empirical analysis strongly supports our hypotheses. Across developing and transitioning countries, there is a significant positive association between effective economic rights and trade. However, just the overarching regime type or merely its continuity is not a significant variable in trade. This finding raises questions about regime stability as a precondition for trade and development. Stability might be a significant variable, but not by itself. If the underlying economic rights regime is not meaningful, any regime type or continuity cannot help a country’s trade position.

This study makes a modest contribution to the political economy literature. On the one hand, it highlights the difference between political and economic rights within a regime. On the other hand, it reflects the difference between de jure and de facto economic rights within a regime. Therefore, it is possible that a country might not have significant political rights but does indeed have de facto economic rights, which in turn bolsters its participation in global trade. These de facto economic rights are a credibility device for the home country vis-á-vis foreign firms, agencies, and governments.

This evidence also sits well with observational work that has seen huge trade flows and rampant economic development in non-democratic regimes, but with specific economic rights deemed necessary by foreign firms, countries, and individuals alike. Whether it is contemporary China or Japan during the nineteenth and early-twentieth century, effective economic rights are a far better facilitator of economic development than simple regime type and continuity, which does not consider institutional credibility.

Conclusion

In the debate over the impact of democracy vs. autocracy on trade and development, what seems to be neglected is the idea of effective economic rights as distinct from political rights. Building on that concept, this paper found strong evidence to support the claim that it is effective economic rights, not regime type or its continuity, which have a positive relationship with a country’s trade flows. The paper discussed the difference between de jure and de facto economic rights in developing countries. If a regime changes but the country continues to have effective economic rights, its trade flows might remain steady. This finding speaks to the strand of political economy literature that sees institutions as a “credibility device.”

Future research could assess the causal effect of effective economic rights on trade flows. This paper's findings are merely associational, as this analysis was conducted with a small sample size. Future research could test these ideas with much larger panel data covering both developing and developed countries and spanning several decades.

In policy terms, this article speaks to policymakers and analysts in developing countries who seek to design institutions to bolster their economy’s trade and development position. They should look to invest as much in de facto economic rights and institutions as much as de jure. As this article shows, foreign firms or governments usually reward the former. Thus, an institutional facade without credible stuffing might not be that useful. 

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About the Author

Srijan Shukla is an M.A. student in international business and politics at the New York University and the Managing Editor of NYU Journal of Political Inquiry. He was formerly the foreign affairs reporter for ThePrint in New Delhi, India. He did his bachelors from McGill University in political science and economics. 

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Endnotes

1. Peter Vanham,  “A Brief History of Globalization,” World Economic Forum, January 17, 2019, https://www.weforum.org/agenda/2019/01/how-globalization-4-0-fits-into-the-history-of-globalization/. 

2. Samuel P. Huntington, “Democracy's Third Wave,” Journal of Democracy 2, no. 2, 1991, pp.12–34.  

3. Mancur Olson, “Dictatorship, Democracy, and Development,” American Political Science Review 87, no. 3 (1993): pp. 567–76. 

4. Jagdish Natwarlal Bhagwati, In Defense of Globalization (Oxford: Oxford University Press, 2007), pp. 51-68. 

5. Arthur A. Goldsmith, “Democracy, Property Rights and Economic Growth,” Journal of Development Studies 32, no. 2, 1995, pp. 157–74. 

6. Drew Fudenberg, “Explaining Cooperation and Commitment in Repeated Games,” Advances in Economic Theory, (1991): 89–131.

7. David Hume, A Treatise of Human Nature (Buffalo, NY: Prometheus Books, 1992);Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations: Representative Selections (Indianapolis, IN: Bobbs-Merrill, 1961).

8. Goldsmith, “Democracy,” pp. 159-62.

9. Goldsmith, “Democracy,” pp. 159-62.

10. Goldsmith, “Democracy,” pp. 159-62.

11. Toke S. Aidt and Martin Gassebner, “Do Autocratic States Trade Less?” The World Bank Economic Review 24, no. 1, 2010, pp. 38–76.

12. Edward D Mansfield, Helen V. Milner, and B. Peter Rosendorff, “Free to Trade: Democracies, Autocracies, and International Trade,” American Political Science Review 94, no. 2,2000, pp. 305–21.

13. Helen V. Milner, and Keiko Kubota, “Why the Move to Free Trade? Democracy and Trade Policy in the Developing Countries,” International Organization 59, no. 1, 2005.

14. Nathan M. Jensen, “Democratic Governance and Multinational Corporations: Political Regimes and Inflows of Foreign Direct Investment,” International Organization 57, no. 3,2003, pp. 587–616. 

15. Goldsmith, “Democracy”, 159.

16. Xinyuan Dai, “Political Regimes and International Trade: The Democratic Difference Revisited,” American Political Science Review 96, no. 1,2002, pp. 159–65. 

17. Jagdish N. Bhagwati, Protectionism (London: MIT Press, 1988), pp. 17-43.

18. Daniel Y. Kono, “Optimal Obfuscation: Democracy and Trade Policy Transparency,” American Political Science Review 100, no. 3,2006, pp. 369–84.

19. Leblang, David A, “Property Rights, Democracy and Economic Growth,” Political Research Quarterly 49, no. 1,1996, pp. 5-26; Goldsmith, “Democracy,” pp. 157-74; Timothy Besley and Maitreesh Ghatak, “Property Rights and Economic Development,” Handbook of Development Economics, (Amsterdam: Elsevier, 2012), pp. 6-40. 

20. Goldsmith, “Democracy,” pp. 160.

21. Besley and Ghatak, “Property Rights,” pp. 6-40.

22. Quan Li and Adam Resnick, “Reversal of Fortunes: Democratic Institutions and Foreign Direct Investment Inflows to Developing Countries,” International Organization 57, no. 1,2003, pp. 175–211. 

23. Leblang, “Property Rights,” pp. 5-26.

24. Goldsmith, “Democracy,” pp. 162.

25. Teorell, Jan, Aksel Sundström, Sören Holmberg, Bo Rothstein, Natalia Alvarado Pachon & Cem Mert Dalli,“The Quality of Government Standard Dataset,” University of Gothenburg: The Quality of Government Institute,January 2021,, http://www.qog.pol.gu.se doi:10.18157/qogstdjan21

26. World Bank, “World Development Indicators,” https://datatopics.worldbank.org/world-development-indicators/. 

27. PRS Group, “International Country Risk Guide,” https://www.prsgroup.com/explore-our-products/international-country-risk-guide/. 

28. The World Bank, “Ease of Doing Business,” https://databank.worldbank.org/source/doing-business. 

29. Guillén, Mauro F., and Laurence Capron, “State Capacity, Minority Shareholder Protections, and Stock Market Development,” Administrative Science Quarterly 61, no. 1,2016,pp. 125-160.

30. Bertelsmann Transformation Index 2021, https://bti-project.org/en/?&cb=00000. 

31. Carles Boix, Michael Miller, Sebastian Rosato, Boix-Miller-Rosato Dichotomous Coding of Democracy, 1800-2015,” 2018,https://dataverse.harvard.edu/dataset.xhtml?persistentId=doi:10.7910/DVN/FJLMKT. 

32. World Bank, “World Development Indicators.”

33. World Bank, “World Development Indicators.”

34. Heritage Foundation, “Index of Economic Freedom,” 2021, https://www.heritage.org/index/explore.