Institutional distance and bilateral trade: does the rule of law substitute for trade agreements?

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BADR MOUGHAMIR, Zahra Mansouri This is a preprint; it has not been peer reviewed by a journal. https://doi.org/ 10.21203/rs.3.rs-9205154/v1 This work is licensed under a CC BY 4.0 License Status: Under Review Version 1 posted 4 You are reading this latest preprint version Abstract When two trading partners differ sharply in governance quality, can a regional trade agreement compensate for the resulting friction, or does it require a baseline of institutional compatibility to function? We construct a bilateral institutional distance measure fromWorld Governance Indicators (Rule of Law) and interact it with RTA status on a directed panel of 111 countries and 302,186 pair-year observations spanning 1996 to 2023. Estimation relies on Poisson pseudo-maximum likelihood with exporter-year, importer-year, and pair fixed effects, following the structural gravity specification of Yotov et al. (2016). The interaction coefficient is −0.072 (p = 0.004), indicating that each unit of institutional distance reduces the trade-creating effect of an agreement by roughly 7 percentage points. At zero distance the agreement raises trade by 20.3%; at a distance of 2.6 on the WGI scale the gain vanishes entirely. Quartile decomposition reveals a monotone gradient: the penalty concentrates in the third (−0.101, praw = 0.015, pHolm = 0.031) and fourth (−0.124, praw = 0.005, pHolm = 0.015) quartiles. The mechanism takes time. In the first five years after agreement entry the interaction is statistically indistinguishable from zero. It emerges at years five through nine (−0.079, p = 0.003) and peaks beyond fifteen years (−0.145, p < 0.001). Narrowing the treatment to FTAs eliminates the interaction, suggesting that the complementarity channel operates through non-tariff provisions—dispute resolution, customs cooperation, regulatory mutual recognition—rather than tariff reductions. A clean placebo lead on the interaction (p = 0.90), stability across six alternative specifications, and leave-one-out analysis confirm the finding. The design of trade agreements matters more than their existence when partners sit on different institutional ground. JEL Classification: F13 , F14 , F15 , C23 , P48 Institutional distance Regional trade agreements Structural gravity model PPML Rule of law World Governance Indicators Full Text Supplementary Files Orcidlogoepsconvertedto.pdf Cite Share Download PDF Status: Under Review Version 1 posted Reviewers agreed at journal 14 Apr, 2026 Reviewers invited by journal 10 Apr, 2026 Editor assigned by journal 25 Mar, 2026 First submitted to journal 23 Mar, 2026 You are reading this latest preprint version Research Square lets you share your work early, gain feedback from the community, and start making changes to your manuscript prior to peer review in a journal. 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Also discoverable on Platform About Our Team In Review Editorial Policies Advisory Board Help Center Resources Author Services Accessibility API Access RSS feed Manage Cookie Preferences © Research Square 2026 | ISSN 2693-5015 (online) Privacy Policy Terms of Service Do Not Sell My Personal Information {"props":{"pageProps":{"initialData":{"identity":"rs-9205154","acceptedTermsAndConditions":true,"allowDirectSubmit":false,"archivedVersions":[],"articleType":"Research Article","associatedPublications":[],"authors":[{"id":620938087,"identity":"c42a0088-35be-4b57-95dd-60e7bbf5c185","order_by":0,"name":"BADR MOUGHAMIR","email":"data:image/png;base64,iVBORw0KGgoAAAANSUhEUgAAAZAAAAAyAQMAAABI0h/eAAAABlBMVEX///8AAABVwtN+AAAACXBIWXMAAA7EAAAOxAGVKw4bAAAA/ElEQVRIiWNgGAWjYBACAzACAQkgTmCwYWAjVUsaAxshPahaGBgOMxC0xpz98LYPjDk2ifOjm59ueLjnfGKffAPjhx8M2+RxabHsSSuewbgtLXHjnWNmNxKe3U5sY2NgluxhuG3YgMthB3KMGRi3HU7cOCMBqOUAWAuDNAPDbUacWs6/gWlJ/wbUcg5sy2+gFnucWm5AbZkvkQOy5QBICxvIlkRcWixnPCtmSNyWZrxBIqcMqCXZuI0tsc2yx+B2Mi4t5vzJmxk+brORnT8jfdvNHwfsZOc3Hz5840fFbVtcWsAgARwOcC7I4wb41EOBPF5DR8EoGAWjYEQDAOT+XTurD0AJAAAAAElFTkSuQmCC","orcid":"https://orcid.org/0009-0006-4180-1842","institution":"Ibn Tofail University: Universite Ibn Tofail Kenitra","correspondingAuthor":true,"prefix":"","firstName":"BADR","middleName":"","lastName":"MOUGHAMIR","suffix":""},{"id":620938088,"identity":"217dfea2-d17f-475a-b834-9c5af7f61bc1","order_by":1,"name":"Zahra Mansouri","email":"","orcid":"","institution":"Ibn Tofail University: Universite Ibn Tofail Kenitra","correspondingAuthor":false,"prefix":"","firstName":"Zahra","middleName":"","lastName":"Mansouri","suffix":""}],"badges":[],"createdAt":"2026-03-24 00:50:10","currentVersionCode":1,"declarations":"","doi":"10.21203/rs.3.rs-9205154/v1","doiUrl":"https://doi.org/10.21203/rs.3.rs-9205154/v1","draftVersion":[],"editorialEvents":[],"editorialNote":"","failedWorkflow":false,"files":[{"id":107186115,"identity":"1733be87-2aed-45a3-a603-546969d9f6bf","added_by":"auto","created_at":"2026-04-17 18:59:14","extension":"pdf","order_by":1,"title":"","display":"","copyAsset":false,"role":"manuscript-pdf","size":362289,"visible":true,"origin":"","legend":"","description":"","filename":"manuscript.pdf","url":"https://assets-eu.researchsquare.com/files/rs-9205154/v1_covered_0ae94c38-7c45-4e87-aa8a-dbf670d2dc77.pdf"},{"id":107186114,"identity":"7b919225-8acd-43a8-a8f3-fafef6da5380","added_by":"auto","created_at":"2026-04-17 18:59:09","extension":"pdf","order_by":12,"title":"","display":"","copyAsset":false,"role":"supplement","size":12397,"visible":true,"origin":"","legend":"","description":"","filename":"Orcidlogoepsconvertedto.pdf","url":"https://assets-eu.researchsquare.com/files/rs-9205154/v1/69fa456fba9458051111783e.pdf"}],"financialInterests":"","formattedTitle":"Institutional distance and bilateral trade: does the rule of law substitute for trade agreements?","fulltext":[],"fulltextSource":"","fullText":"","funders":[],"hasAdminPriorityOnWorkflow":false,"hasManuscriptDocX":false,"hasOptedInToPreprint":true,"hasPassedJournalQc":"","hasAnyPriority":false,"hideJournal":false,"highlight":"","institution":"","isAcceptedByJournal":false,"isAuthorSuppliedPdf":true,"isDeskRejected":"","isHiddenFromSearch":false,"isInQc":false,"isInWorkflow":false,"isPdf":true,"isPdfUpToDate":true,"isWithdrawnOrRetracted":false,"journal":{"display":true,"email":"[email protected]","identity":"journal-of-industrial-and-business-economics","isNatureJournal":false,"hasQc":true,"allowDirectSubmit":false,"externalIdentity":"jibe","sideBox":"Learn more about [Journal of Industrial and Business Economics](https://www.springer.com/journal/40812)","snPcode":"40812","submissionUrl":"https://www.editorialmanager.com/jibe","title":"Journal of Industrial and Business Economics","twitterHandle":"","acdcEnabled":true,"dfaEnabled":true,"editorialSystem":"em","reportingPortfolio":"Springer Hybrid","inReviewEnabled":true,"inReviewRevisionsEnabled":false},"keywords":"Institutional distance, Regional trade agreements, Structural gravity model, PPML, Rule of law, World Governance Indicators","lastPublishedDoi":"10.21203/rs.3.rs-9205154/v1","lastPublishedDoiUrl":"https://doi.org/10.21203/rs.3.rs-9205154/v1","license":{"name":"CC BY 4.0","url":"https://creativecommons.org/licenses/by/4.0/"},"manuscriptAbstract":"\u003cp\u003eWhen two trading partners differ sharply in governance quality, can a regional trade agreement compensate for the resulting friction, or does it require a baseline of institutional compatibility to function? We construct a bilateral institutional distance measure fromWorld Governance Indicators (Rule of Law) and interact it with RTA status on a directed panel of 111 countries and 302,186 pair-year observations spanning 1996 to 2023. Estimation relies on Poisson pseudo-maximum likelihood with exporter-year, importer-year, and pair fixed effects, following the structural gravity specification of Yotov et al. (2016). The interaction coefficient is −0.072 (p = 0.004), indicating that each unit of institutional distance reduces the trade-creating effect of an agreement by roughly 7 percentage points. At zero distance the agreement raises trade by 20.3%; at a distance of 2.6 on the WGI scale the gain vanishes entirely. Quartile decomposition reveals a monotone gradient: the penalty concentrates in the third (−0.101, praw = 0.015, pHolm = 0.031) and fourth (−0.124, praw = 0.005, pHolm = 0.015) quartiles. The mechanism takes time. In the first five years after agreement entry the interaction is statistically indistinguishable from zero. It emerges at years five through nine (−0.079, p = 0.003) and peaks beyond fifteen years (−0.145, p \u0026lt; 0.001). Narrowing the treatment to FTAs eliminates the interaction, suggesting that the complementarity channel operates through non-tariff provisions—dispute resolution, customs cooperation, regulatory mutual recognition—rather than tariff reductions. A clean placebo lead on the interaction (p = 0.90), stability across six alternative specifications, and leave-one-out analysis confirm the finding. 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