Does international trade cause detrimental specialization in developing economies? Evidence from countries south of the Suez Canal* MICHIEL GERRITSE 1 Erasmus University Rotterdam December, 2018 ABSTRACT When opening up to trade, countries specialize according to their comparative advantage. However, developing countries are often disadvantaged in production that requires contract enforcement or other institutions. In those countries, trade liberalization can eliminate the demand for contract enforcement, implying a detrimental impact on institutional development. This paper evaluates this argument of detrimental specialization. To identify the causal impact of trade isolation on specialization, I examine the impacts of a war-induced closure of the Suez canal on agricultural trade of the East African countries that suffered longer trade routes. Trade isolation of developing countries hurts the sectors that require good institutions—the opposite of what the detrimental specialization argument predicts. I offer a potential explanation by combining the standard models of international trade and endogenous institutions. Keywords: international trade, specialization, institutional development, quasi-natural experiment JEL-codes: F63; O19; N77; F11; F12; O43; F43 * This article has benefited from comments from Gerrit Faber, Steven Brakman, Aart Gerritsen, Janneke Pieters, Reitze Gouma, Marcel Timmer, Markus Eberhardt, Maarten Bosker, Andrei Levchenko, Haiwei Tang and participants in the ETSG (Münich), UEA (Lisbon), DEGIT (Geneva), InsTED (Sao Paolo) and several seminars, who provided ideas and comments that helped improve the paper. This article was partly written while visiting the London School of Economics. 1 Erasmus School of Economics, Burg. Oudlaan 50, 3062 PA Rotterdam, the Netherlands. email:
[email protected] 1 1. Introduction International trade helps countries develop in the long run.