Trade openness, institutional change and economic growth

This paper creates a theory of endogenous growth with endogenous institutional change to analyse the impact that trade openness has on economic growth through a change in institutions in pre-industrial societies. An elite (landowners) controlling the political power expropriates another social group (capitalists). This reduces investment in physical capital, the source of endogenous growth. The rival group (capitalists) can take a military action to expel the group in power. I study optimal expropriation, growth and institutional change under two scenarios, autarky and free trade. The simulation results suggest that for a vast majority of cases economies open to trade generally experience higher growth and earlier institutional change. This is the consequence of the fact that the elite reduces the expropriation rate when the economy opens up to trade. In addition, economies specialising in manufacturing products tend to grow more and introduce institutional change earlier. This is consistent with the divergent pattern in growth and institutions that Western European Economies were experiencing during the modern era and the industrial revolution.