Trade Openness, Institutional Change and Economic Growth

This paper explores the relationship between trade openness and economic growth through a change in institutions. To do so, the paper creates a theory of endogenous institutional change where there are three social groups, each one owns a specific production factor. An ellite (landowners) controlling the political power fix higher taxes to extract rents from the other groups of the society (capitalists). This reduces investment in capital, the source for endogenous growth. Endogenous institutional change is done by allowing the rival group (capitalists) to invest in a military action which expels out the group in power. The model studies optimal taxation, growth and institutional change under two scenarios, autarky and free trade. The model is calibrated according to the Western European experience in the Modern Age. Generally, economies opened to trade will experiment higher growth and earlier institutional change although economies specializing in manufacturing products tend to grow more and rise the institutional change earlier. These results are qualitatively very robust to change in parameter values.