The Long-run Influence of Institutions Governing Trade: the Case of Colonial and Pirates' Ports in Mexico

Abstract: In this paper we examine the long-term development impact of legal versus illegal overseas trade in colonial Mexico. While there is ample evidence that commercial activity may lead to sustained economic benefits, it is unclear whether these effects are driven by commercial activity per se or by the accompanying state institutions that positively impact development (e.g. tax-collection and legal enforcement). Using historical sources on the presence of smuggling and piracy in Mexican coasts from the 16th to 18th century we find that the presence of trade, either in its legal or illegal form, leads to significantly better development outcomes compared to neighboring areas where such activities were absent. Results are robust to instrumenting trade with natural harbors and are not driven by a mechanical effect of carrying out trade in the present, by the length of colonial presence, or by substantial geographical differences. These findings suggest that the positive impact of illegal trade may have compensated for the damaging effects of a weaker state presence and the culture of illegality surrounding it.