DP5751 | Legal Costs as Barriers to Trade

Publication Date

17/07/2006

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Abstract

Recent evidence shows that the 'home bias puzzle' in international trade may be associated with the mere presence of national borders (McCallum (1995)). In this paper we provide a theoretical framework to explain why borders may matter so much for trade. Our argument is that even between perfectly integrated and similar countries the legal system differs, so that legal costs are higher when business is done abroad. Using a matching model of trade, we show that legal costs asymmetry produce home bias in an essentially different way than traditional trade costs. To estimate the relevance of legal costs in displacing trade we estimate gravity equations augmented with variables capturing the extent of legal asymmetries. Evidence from inter-national trade across OECD countries and intra-national trade across French support the view that legal asymmetries act as relevant obstacles to trade.