How Overlap in Informal Institutions Affects International Economic Relations
Abstract: This paper investigates the effect of differences in informal institutions on economic relations between countries. Starting point is the argument by North (1990) and Williamson (2000) that firms evolve in a symbiotic relationship with their institutional environment. This argument implies that firms are less effective when moving to different institutional contexts that do no fit firms’ knowledge, objectives, and organizational structure. The paper argues that this effect causes firms to opt for FDI in countries with a large degree of overlap in informal institutions. More specifically, the larger the segment of the population in a country that has the same values as people in the firm’s home environment, the more effective firms will be able to operate in that country. To test this proposition, we construct a ‘cultural overlap’ measure on basis of a set of values from the World Values Survey. We show that it has significant effects on MNE location decisions. We conclude that cultural overlap is a theoretically and empirically relevant determinant of international economic relations.