Natural Openness and Good Government

Abstract

This paper offers a possibly new interpretation of the connection between openness and good governance. Assuming that corruption and bad governance drive out international trade and investment more than domestic trade and investment, a "naturally more open economy" -- as determined by its size and geography -- would devote more resources to building good institutions and would display lower corruption in equilibrium. In the data, "naturally more open economies" do exhibit less corruption even after taking into account their levels of development. "Residual openness" -- which potentially includes trade policies -- is found not to be important once "natural openness" is accounted for. Moreover, "naturally more open economies" also tend to pay better civil servant salaries relative to their private sector alternatives -- indicative of the marginal benefit of good governance in a society's revealed preference. These patterns are consistent with the conceptual model.