Trade Liberalization and Institutional Quality: Evidence from Vietnam

Recent cross-country research shows that there is a causal relationship between foreign direct investment and quality of institutions. The literature on cross-country studies has been criticized because differences in legal systems and other institutions across countries are difficult to control for. An in-depth case study of a particular country’s experience can provide a useful complement to cross-country regressions. Using the unique dataset from provincial competitiveness survey and a rising foreign direct investment from joining the World Trade Organization, I find that variations in economic institutions across provinces in Vietnam can be explained by the flow of foreign investment. To overcome endogeneity problems, I use minimum distance from each province to main economic centres as an instrument for proxy of trade liberalization agreement. The instrumental variable approach shows that the direction of influence is from greater foreign investment to better institutions. The results hold after controlling for various additional covariates. It is also robust to various alternative measures of institutions. I also find that trade liberalisation agreement has greater short term impacts on institutional quality in the Northern provinces