It is widely acknowledged that firms require an efficient regulatory environment: if transaction costs generated by business regulations are not onerous, firms grow more and develop more quickly, attract more foreign direct investment, and employ more workers. But what does it induce alterations in the basic institutional framework? In this paper we intend to test North’s thesis by which as trade expands and the size of the market grows, transaction costs increase requiring that more and more resources should be devoted to improving existing regulations and, then, reducing such costs. The paper is structured as follows. Section 1 introduces. Section 2 provides the theoretical background. Section 3, based on World Bank data on 30 Chinese cities, investigates whether there is a correlation at urban and provincial levels between efficient business regulations on one side and economic outcomes (gross domestic product, foreign direct investment, employment, etc.) on the other. Section 4 addresses the pilot question mentioned above and tests whether simpler and less costly ways of meeting legal requirements for starting and running a business are associated with long-run trade. Section 5 discusses results in the light of theoretically assumed causal links and proposes a 2SLS regression model, whereby a geographical instrumental variable is used to investigate the causal relationship between business regulations and exports.
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