This paper studies the effect of institutions on trade flows, using a gravity model approach. We start from a standard gravity equation that incorporates geographical proximity, language, trade policy and common history. These factors reflect the costs of trade across geographical and cultural...

To serve foreign markets, firms can either export or set up a local subsidiary through horizontal Foreign Direct Investment (FDI). The conventional proximity-concentration theory suggests that FDI substitutes for trade if distance between countries is large, while exports become more important...