NBER WORKING PAPER SERIES INTRINSIC OPENNESS AND ENDOGENOUS INSTITUTIONAL QUALITY. Yang Jiao Shang-Jin Wei

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1 NBER WORKING PAPER SERIES INTRINSIC OPENNESS AND ENDOGENOUS INSTITUTIONAL QUALITY Yang Jiao Shang-Jin Wei Working Paper NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA November 2017 We thank Robin Burgess, Donald Davis, Jonathan Eaton, Ruixue Jia, Reka Juhasz, Amit Khandelwal, Yingyi Qian, Stephen Redding, Michael Song, Jon Vogel, David Weinstein and seminar or confernece participants at Columbia, Tsinghua, and ADB for helpful comments, and Joy Glazener for editorial assistance. All remaining errors are our own responsibilities. This paper is a significant rewriting and expansion of Wei (2000b), which has not been submitted for publication. The research was conducted in part when Jiao was a Summer Intern and Wei was Chief Economist of Asian Development Bank. The views in the paper are entirely those of the authors and do not necessarily represent those of any organization with which they are or have been associated, nor of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications by Yang Jiao and Shang-Jin Wei. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including notice, is given to the source.

2 Intrinsic Openness and Endogenous Institutional Quality Yang Jiao and Shang-Jin Wei NBER Working Paper No November 2017 JEL No. F1,O1 ABSTRACT Quality of public institutions has been recognized as a crucial determinant of macroeconomic outcomes. We propose that a country's intrinsic level of openness (due to population size, geography, or exogenous trade opportunities) affects its incentives in investing in better institutions. We present a simple theory and extensive empirical evidence validating the role of intrinsic openness in determining governance quality. This suggests an indirect but important channel for globalization to improve welfare by raising the quality of governance. Yang Jiao Economics Department Columbia University yang.jiao.0606@gmail.com Shang-Jin Wei Graduate School of Business Columbia University Uris Hall Broadway New York, NY and NBER shangjin.wei@columbia.edu

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43 7 6 Marginal Cost Marginal Benefit Institutional Quality q

44 gvnment exprop risk CPI ctr corrupt PR index PR index PR index PR index

45 ln(population) in degree line USA BRA IDN PAK NGA BGDJPN RUS MEX IRN ETH PHL EGY DEU CODTHA TUR VNM FRA COL MMRITA GBR ZAF KOR KEN DZA CAN ARG POL ESP AFG AGOAUS BFA CMR IRQ SDN TZA UKR SAUUGA VEN CIV GHA MYS UZB MAR PRK KHM CHL AZEAUT BLR BEL BEN TCD BDI DOM BOL ECU MDG MOZ NPL PER SYR YEMLKA ROU GTM KAZ NLD ZMB SEN NER MWI ZWE MLI GIN HTI CUB GRC PRT CZE HNDHKG ISR SOM RWA TUN SSD BGR HUN JORLBY NIC PRY PNG LAO SLV COG CRI CAF BIH HRV FIN DNK ERI SGP KGZ SLE LBN NZL IRL NOR GEO MRT LBR PAN PRI ALB JAM ARM MDA SVK CHE SWE TGO TJK ARE TKM URY LTU KWTOMN MNG BWA NAM LSO LVA GMB GAB GNB XKX MKD SVN SWZ EST BHR CYP MUS TTO QATDJI FJI TLS COM BTN GNQMNE GUY SLB MAC CPV SUR LUX BRN MDV BLZ BHS MLT PYF ISL NCL BRB VUT STP GUM LCA WSM CHI CUW VIR AND KIR FSM ABW VCT GRD SYC IMN ATG TON MNPASM BMU DMA CYMMHL GRL FRO KNA SMR LIE MAF GIB MCO TCA VGB PLW NRU TUV INDCHN ln(population) in 1960

46 15 Canada China Japan US EU Year

47 Diff Political Risk Index HKG Dif f Weighted Tarif f Lag

48 Diff Political Risk Index MLI Dif f Weighted Tarif f Lag

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58 General Government Expense/GDP SMR SYC BTN TLS AUT BEL FIN SWE HUN GRC ln(population) DNK FRA ITA SVN PRT DEU NLD ISL NOR ISR LSO SVK SRB POL BIH GBR MLT UKR BRA BLR LUX HRV CAN ESP CYP JPN LVA KWTIRL BGR LTU CZE MDA EST JAM JOR ZAF TUR USA AUS ROU RUS CHE MDV MAC MAR COLEGY MNG BOL CRI YEM ALB GEO KOR HND ARM AZE MRT CHL IRN COGSLV HKG PRY KAZPER THA SGP IDN

59 General Government Employee Compensation/GDP LSO DNK JOR SMR SYC ISL CYP MAR MLT NOR PRT FIN SWE ZAF FRA BIH SRB BRA KWT SVN BOL BEL CAN CRIHND GRC HUN AUT POL LTU EST HRV ISR LVA ESP ITA IRLPRY UKR GBR BLR YEM USA MDA BGR NLD AUS IRN LUXBTN JAM MDV MNG MRT ROU TUR SVK SLV RUS DEU CHE EGY ALB COL THA PER JPN CHL KOR MAC ARM IDN COG GEO HKG SGP AZE TLS CZE KAZ ln(population)

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