Gunboat Diplomacy
Political Bias, Trade Policy, and War
14 November 2019
Brendan Cooley
Ph.D. Candidate
Princeton University
bcooley (at) princeton.edu
Trade and War: Received Wisdom
“Free trade serves the cause of economic progress, and it serves the cause of world peace.”
\(\qquad\) – Ronald Reagan, Nov. 1982
“Commercial relations draw states into a web of mutual self-interest that constrains them from using force against one another.”
\(\qquad\) – Oneal and Russett (1999)
Dominant Paradigm: Trade mediates preexisting conflicts of interest
- Conflicts of interest: territorial, ideological, otherwise
- War disrupts trade, imposes opportunity costs
Gunboat Diplomacy
Examples
- Perry Expeditions (1852-1854)
- Opium Wars (1839-1842; 1856-1860)
- Euromaidan and War in Donbass (2014-present)
Commercial Policy Objectives
- Governments are mercantilistic, desiring
- Some degree of trade protection at home
- Trade liberalization or market access abroad
Market Access Externalities
- Protectionist barriers shift profits from foreign to home firms
- Trade policy generates conflicts of interest between mercantilist governments
International Anarchy
- Efforts to address externalities can include threats, displays, and uses of military force
- Bargaining critique (Fearon 1995): absence of war does not imply absence of coercion
A Theory of Trade Policy in the Shadow of Power
Model
- “New Trade” International Economy
- Krugman (1980), Venables (1987); Ossa (2012)
- Mercantilist/Politically-Biased Governments
- Grossman and Helpman (1994), Bueno De Mesquita et al. (2003), Jackson and Morelli (2007)
- Liberal governments afford consumers greater influence over the trade policymaking process
- Ultimatum Coercive Bargaining
- Fearon (1995), Fey and Kenkel (2019)
Results
- Trade and Conflict
- Liberal governments experience smaller conflicts of interest (Proposition 3)
- Most liberal governments never fight wars (Proposition 4)
- When shadow of power absent, trade increasing as governments become more liberal (Proposition 5)
- Trade Policy in the Shadow of Power
- Trade policies reflect balance of military power, powerful countries more protectionist in equilibrium (Proposition 6)
Trade and peace are correlated in equilibrium, but not because trade causes peace
Literature
- Trade and War
- Angell (1911), Polachek (1980), Gowa and Mansfield (1993), Morrow (1999), Barbieri and Levy (1999), Mansfield and Pevehouse (2000), Gartzke, Li, and Boehmer (2001), McDonald (2004), McDonald and Sweeney (2007), Gartzke (2007), Benson and Niou (2007), Philippe, Mayer, and Thoenig (2008), Hegre, Oneal, and Russett (2010), Copeland (2014)
- Power and Trade
- Hirschman (1945), Krasner (1976), Gourevitch (1978), Pollins (1989b), Pollins (1989a), Antràs and Padró i Miquel (2011), Chatagnier and Kavakli (2015), Carroll (2018)
- Political Economy of Trade Policy
- Mayer (1984), Grossman and Helpman (1994), Kono (2008), Gawande, Krishna, and Olarreaga (2009), Ossa (2011), Ossa (2012), Ossa (2014)
- Democracy and Trade
- Mansfield, Milner, and Rosendorff (2000), Milner and Kubota (2005)
- Democracy and War
- Lake (1992), Snyder (1993), Oneal and Russet (1997), Schultz (1998), Oneal and Russett (1999), Schultz (2001), Fearon (2008), Coe (n.d.)
The Commercial-Democratic Peace
Trade and War Onset
Model Overview
- Two goverments (\(i, j\)), ultimatum bargaining over tariffs
- Payoffs depend on international economic effects of tariffs and latent protectionism of governments
International Economy
- Mass of firms in each country (“industry”), produce differentiated varieties
- Outside sector (“agriculture”)
- Profit-shifting motivations for tariffs
Domestic Political Economy
- Governments maximize weighted combination of consumer welfare and industry profits
- Variation in preferences (open-protectionist)
- Tension in trade policy
- Tariffs increase profits
- Decrease consumer welfare
International Bargaining
- Threat point: regime change
- Power: probability government wins a war for regime change
- Victorious governments impose new preferences on vanquished governments
- Ultimatum offer: pair of tariffs
- Private information over wars costs \(\implies\) war in equilibrium
Bargaining Environment
- “Home” (\(i\)) government makes TIOLI trade policy offer to “foreign” (\(j\)) \(\widetilde{\boldsymbol{\tau}} = \left\{ \widetilde{\tau}_i, \widetilde{\tau}_j \right\} \in [1, \bar{\tau}]^2\)
- Foreign accepts or rejects
- Information about \(j\)’s costs of war (\(c_j\)) held privately, distributed uniform on \([\ubar{c}_j, \bar{c}_j]\)
Definition 1: A subgame perfect bargaining equilibrium is pair of strategies, \(\widetilde{\boldsymbol{\tau}}^\star(a_i, c_i)\) and \(\omega^\star(\widetilde{\boldsymbol{\tau}}; a_j, c_j)\) such that \[ \omega^\star(\widetilde{\boldsymbol{\tau}}; a_j, c_j, \rho) = \text{argmax}_{\omega \in \left\{\text{accept}, \text{war} \right\}} \widetilde{G}_j \left(\widetilde{\boldsymbol{\tau}}, \omega; a_j, c_j, \rho \right) \] and \[ \widetilde{\boldsymbol{\tau}}^\star(a_i, c_i, \rho) \in \text{argmax}_{\boldsymbol{\tau} \in [1, \overline{\tau}]^2} \mathbb{E}_{f(c_j)} \left[ \widetilde{G}_i \left(\widetilde{\boldsymbol{\tau}}, \omega^\star(\widetilde{\boldsymbol{\tau}}; a_j, c_j, \rho); a_i, c_i, \rho \right) \right] \]
- \(\widetilde{G}\) - government utility
Assumption 1: \(\bar{c}_j \leq \kappa_j\) and \(c_i < \kappa_i(\bar{c}_j)\) where \(\kappa_j\) and \(\kappa_i(\bar{c}_j)\) are positive constants defined in the Appendix.
Economy (Overview)
Primitives
- Income: \(I_i(\tau_i) = w_i L_i + r_i(\tau_i)\)
- Factor endowments: \(L_i = L_j = L\)
- Mass of “manufacturing” firms producing differentiated products, indexed \(\nu_i\)
- Monopolistic competition (New Trade, Krugman 1980)
- No entry \(\implies\) positive profits in equilibrium (short-run)
Domestic Conflict of Interest
\[\begin{equation*} V_i(\tau_i) = \alpha^\alpha (1 - \alpha)^{1 - \alpha} \frac{I_i(\tau_i)}{P_i(\tau_i)^\alpha} \end{equation*}\]
\[\begin{equation*} \Pi_i(\tau_i, \tau_j) = \int_{v_i} \Pi_i(p_i(\nu_i)) = (p_i^\star - w_i) \left( x_{ii}^\star(\tau_i) + x_{ji}^\star(\tau_j) \right) \end{equation*}\]
Economy (Overview)
Primitives
- Income: \(I_i(\tau_i) = w_i L_i + r_i(\tau_i)\)
- Factor endowments: \(L_i = L_j = L\)
- Mass of “manufacturing” firms producing differentiated products, indexed \(\nu_i\)
- Monopolistic competition (New Trade, Krugman 1980)
- No entry \(\implies\) positive profits in equilibrium (short-run)
Domestic Conflict of Interest
\[\begin{equation*} V_i(\color{bcYellow} \tau_i \color{black}) = \alpha^\alpha (1 - \alpha)^{1 - \alpha} \frac{I_i(\color{bcYellow} \tau_i \color{black})}{P_i(\color{bcYellow} \tau_i \color{black})^\alpha} \end{equation*}\]
\[\begin{equation*} \Pi_i(\color{bcYellow} \tau_i \color{black}, \tau_j) = \int_{v_i} \Pi_i(p_i(\nu_i)) = (p_i^\star - w_i) \left( x_{ii}^\star(\color{bcYellow} \tau_i \color{black}) + x_{ji}^\star(\tau_j) \right) \end{equation*}\]
Economy (Overview)
Primitives
- Income: \(I_i(\tau_i) = w_i L_i + r_i(\tau_i)\)
- Factor endowments: \(L_i = L_j = L\)
- Mass of “manufacturing” firms producing differentiated products, indexed \(\nu_i\)
- Monopolistic competition (New Trade, Krugman 1980)
- No entry \(\implies\) positive profits in equilibrium (short-run)
Domestic Conflict of Interest
\[\begin{equation*} V_i(\tau_i) = \alpha^\alpha (1 - \alpha)^{1 - \alpha} \frac{I_i(\tau_i)}{P_i(\tau_i)^\alpha} \end{equation*}\]
\[\begin{equation*} \Pi_i(\tau_i, \color{bcYellow} \tau_j \color{black}) = \int_{v_i} \Pi_i(p_i(\nu_i)) = (p_i^\star - w_i) \left( x_{ii}^\star(\tau_i) + x_{ji}^\star(\color{bcYellow} \tau_j \color{black}) \right) \end{equation*}\]
Economy (II)
Consumption
- Agricultural consumption: \(Y_i\) (homogenous and numeraire, \(p_i^y = 1\))
\[\begin{equation*} \begin{split} \max_{X_i, Y_i} & \quad X_i^\alpha Y_i^{1 - \alpha} \\ \text{subject to} & \quad P_i(\tau_i) X_i + Y_i \leq I_i(\tau_i) \end{split} \end{equation*}\]
- Industrial consumption: \(P_i X_i = \alpha I_i\)
- Constant elasticity of substitution (CES) preferences over industrial varieties
\[\begin{equation} \label{eq:CES} X_i = \left( \int_{\nu_i} x_{ii}(\nu_i)^{\frac{\sigma - 1}{\sigma}} d \nu_i + \int_{\nu_j} x_{ij}(\nu_j)^{\frac{\sigma - 1}{\sigma}} d \nu_j \right)^{\frac{\sigma}{\sigma - 1}} \end{equation}\]
\[\begin{equation} \label{eq:P} P_i = \left( \int_{\nu_i} p_{ii}(\nu_i)^{1-\sigma} d \nu_i + \int_{\nu_j} p_{ij}(\nu_j)^{1-\sigma} d \nu_j \right)^{\frac{1}{1 - \sigma}} \end{equation}\]
Economy (III)
Tariffs and Prices
\[ p_{ij} = \tau_i p_j(\nu_j) \]
- \(p_{ij}\) - price in country \(i\) of industrial goods produced in \(j\)
- \(\tau_i - 1\) - ad valorem tariff imposed by \(i\) on industrial imports from \(j\)
Production
\[\begin{equation} \label{eq:Pi} \begin{split} \max_{p_i(\nu_i)} & \quad \Pi_i \left( p_i(\nu_i) \right) = \left( p_i(\nu_i) - w_i \right) \left( x_{ii}^\star(\nu_i) + x_{ji}^\star(\nu_i) \right) \\ \text{subject to} & \quad x_{ii}^\star(\nu_i) = p_i(\nu_i)^{-\sigma} P_i^{\sigma - 1} \alpha I_i \\ & \quad x_{ji}^\star(\nu_i) = (\tau_j p_i(\nu_i))^{-\sigma} P_j^{\sigma - 1} \alpha I_i \end{split} \end{equation}\]
- \(x_{ii}^\star(\nu_i)\) - domestic consumption of variety \(\nu_i\)
- \(x_{ji}^\star(\nu_i)\) - exports of variety \(\nu_i\)
Tariff Revenue
\[\begin{equation} \label{eq:revenue} r_i(\tau_i) = (\tau_i - 1) p_j x_{ij}^\star(\tau_i p_j) \end{equation}\]
- \(x_{ij}^\star(\tau_i p_j)\) - total industrial imports
Economic Equilibrium
- \(\bm{w} = \left\{ w_i, w_j \right\}\)
- \(\bm{L} = \left\{ L_i^x, L_i^y \right\}_{ i \in \left\{ i, j \right\} }\)
Definition 2: An economic equilibrium is a function \(h : \left\{ \bm{\tau} \right\} \rightarrow \left\{ \bm{w}, \bm{L} \right\}\) mapping trade policy choices to endogenous wages and labor allocations such that goods and factor markets clear given equilibrium prices and corresponding demands.
Assumption 2: \[ \alpha < \frac{2}{3} \frac{\sigma}{\sigma - 1} \]
Proposition 1: If Assumption 2 is satisfied, then a unique economic equilibrium exists with \(L_i^x, L_i^y, L_j^x, L_j^y > 0\) and \(w_i = w_j = 1\) for all \(\bm{\tau} \in [1, \bar{\tau}]^2\).
- Wages constant, positive tariffs…
- raise revenue
- increase industry profits
- do not manipulate terms of trade (Bagwell and Staiger 1999)
Domestic Political Economy
Government Preferences (I)
\[\begin{equation} \label{eq:G} G_i(\bm{\tau} | \color{bcYellow} a_i \color{black}) = \color{bcYellow} a_i \color{black} V_i(\tau_i) + \Pi_i(\tau_i, \tau_j) \end{equation}\]
- \(V_i(\tau_i)\) - consumer welfare
- \(\Pi_i(\tau_i, \tau_j)\) - firm profits
- increasing in \(\tau_i\), decreasing in \(\tau_j\)
\(\color{bcYellow} a_i \color{black}\) is measure of government’s sensitivity to interests of consumers
Assumption 3: \(a_i \in (\ubar{a}, \bar{a}]\) for all \(i\) where \(\ubar{a}\) is a positive constant defined in Appendix C and \(\bar{a}\) is an arbitrarily large but finite number.
Lemma 1: \(\tau_i^\star(a_i) \in (1, \bar{\tau})\)
Government Preferences (II)
Government Preferences (II)
Government Preferences (II)
Government Preferences (III)
Government Preferences (III)
Government Preferences (IV)
- Lemma 2: \(G_i(\tau_j)\) is strictly decreasing in \(\tau_j\).
- Lemma 3: \(\tau_i^\star(a_i)\) is strictly decreasing in \(a_i\).
Noncooperative Equilibrium (I)
Definition 3: A noncooperative equilibrium is a pair of policies \(\left\{ \tau_i^\star(a_i), \tau_j^\star(a_j) \right\}\) such that \[ \tau_i^\star(a_i) = \argmax_{\tau_i \in [1, \bar{\tau}]} G_i(\tau_i; a_i) \] and \[ \tau_j^\star(a_j) = \argmax_{\tau_j \in [1, \bar{\tau}]} G_j(\tau_j; a_j) \]
Noncooperative Equilibrium (II)
Conflicts of Interest and Regime Change (I)
Optimal Puppet Regimes
\[ \max_{\color{bcYellow} a \color{black} \in (\ubar{a}, \bar{a}]} G_i( \tau_i^\star(a_i), \tau_j^\star(\color{bcYellow} a \color{black}) | a_i ) \]
- When a government wins a war, it earns the right to replace the vanquished government with a “puppet” that prefers lower barriers to trade
- Losing governments have puppet’s policies imposed on them
Proposition 2: \(a^\star = \bar{a}\)
War Outcomes
\[\begin{equation*} \label{eq:Gbar} \overline{G}_i(a_i) = G_i(\tau_i^\star(a_i), \tau_j^\star(\color{bcYellow} \bar{a} \color{black}); a_i) \end{equation*}\]
\[\begin{equation*} \label{eq:Gubar} \ubar{G}_i(a_i, a_j) = G_i(\tau_i^\star(\color{bcYellow} \bar{a} \color{black}), \tau_j^\star(a_j); a_i) \end{equation*}\]
Conflicts of Interest
\[\begin{equation} \label{eq:Gamma} \Gamma_i(a_i, a_j) = \overline{G}_i(a_i) - \underline{G}_i(a_i, a_j) \end{equation}\]
- Utility difference between (costlessly) winning a war for regime change and being replaced by a puppet
Conflicts of Interest and Regime Change (II)
Proposition 3: \(\Gamma_i(a_i, a_j)\) is decreasing in \(a_i\) and \(a_j\)
- Recall war outcomes
\[\begin{equation*} \overline{G}_i(a_i) = G_i(\tau_i^\star(a_i), \tau_j^\star(\bar{a}); a_i) \end{equation*}\]
\[\begin{equation*} \ubar{G}_i(a_i, a_j) = G_i(\tau_i^\star(\bar{a}), \tau_j^\star(a_j); a_i) \end{equation*}\]
- Increasing \(a_i\) reduces difference between \(\tau_i^\star(a_i)\) and \(\tau_i^\star(\bar{a})\)
- Increasing \(a_j\) reduces difference between \(\tau_j^\star(a_j)\) and \(\tau_j^\star(\bar{a})\)
Bargaining Environment
- \(\rho \in [0, 1]\) - probability \(i\) wins war (military strength)
War Values
\[\begin{align*} \hat{G}_j(a_j, a_i) &= \underbrace{(1 - \rho) \bar{G}_j(a_j) + \rho \ubar{G}_j(a_j, a_i)}_{W_j(a_j, a_i)} - c_j \\ &= (1 - \rho) \Gamma_j(a_j, a_i) + \ubar{G}_j(a_j, a_i) - c_j \end{align*}\]
- \((1 - \rho)\) - probability \(j\) wins the war
Lemma 4: \[ \omega^\star(\tilde{\bm{\tau}}; a_j, c_j, \rho) = \begin{cases} \text{war} & \text{if } \hat{G}_j(a_j, a_i) \geq G_j(\tilde{\bm{\tau}}; a_j) \\ \text{accept} & \text{otherwise} \end{cases} \]
Results
Lemma 5: If \[ W_j(a_j, a_i) - G_j(\tau_j^\star(\bar{a}), \tau_i^\star(a_i); a_j) = \Gamma_j(a_j, a_i) \leq \ubar{c}_j \] then \[ \tilde{\bm{\tau}}^\star = \left\{ \tau_i^\star(a_i), \tau_i^\star(\bar{a}) \right\} \] and \[ \omega^\star(\tau_i^\star(a_i), \tau_j^\star(\bar{a}); a_j, c_j, \rho) = \text{accept} \] for all \(c_j \in [\ubar{c}_j, \bar{c}_j]\).
Lemma 6 (Zone of Peace): For every \(\ubar{c}_j \in [ 0, \bar{c}_j )\) there exists a \(a_j(\ubar{c}_j, a_i)\) such that for all \(a_j \in [ a_j(\ubar{c}_j, a_i), \bar{a} )\) the probability of war is 0.
Liberal Peace
Proposition 4 (Liberal Peace): \(a_j(\ubar{c}_j, a_i)\) is weakly decreasing in \(a_i\).
Proposition 5 (Liberal Trade): If \(a_j \geq a_j(\ubar{c}_j, a_i)\) then trade in manufactured goods is increasing in \(a_i\).
- \(a_i \uparrow \implies \tau_i^\star(a_i) \downarrow \implies x_{ij}^\star(\tau_i^\star(a_i)) \uparrow\)
Power and Protection (I)
Probability of War
\[\begin{equation} \label{eq:prwar} \begin{split} \text{Pr} \left\{ c_j \leq W_j(a_j, a_i) - G_j(\tilde{\bm{\tau}}; a_j) | \tilde{\bm{\tau}}, a_i, a_j \right\} = F \left( W_j(a_j, a_i) - G_j(\tilde{\bm{\tau}}; a_j) \right) \end{split} \end{equation}\]
War Value (\(i\))
\[ \hat{G}_i(a_i, a_j) = \rho \Gamma_i(a_i, a_j) + \ubar{G}_i(a_i, a_j) - c_i \]
Induced Objective Function
\[\begin{equation} \label{eq:Gtildei} \begin{split} \tilde{G}_i \left( \tilde{\bm{\tau}}; a_i, c_i, \rho \right) = \underbrace{\left( 1 - F \left( W_j(a_j, a_i) - G_j( \tilde{\bm{\tau}}; a_j ) \right) \right) \left( G_i( \tilde{\bm{\tau}}; a_i ) \right)}_{\neg \text{war}} + \\ \underbrace{F \left( W_j(a_j, a_i) - G_j(\tilde{\bm{\tau}}; a_j) \right) \left( \hat{G}_i(a_i, a_j) \right)}_{\text{war}} \end{split} \end{equation}\]
Power and Protection (II)
Proposition 6 (Power and Protection): If \(a_j < a_j(\ubar{c}_j, a_i)\) and peace prevails, government \(i\)’s trade barriers are increasing in its military strength, i.e. \(\tilde{\tau}_i^\star(a_i, c_i, \rho)\) is increasing in \(\rho\).
Implications (I)
Commercial Peace: Globalization or Liberalism?
- Barriers to trade (globalization) result of governments’ choices
- Liberalization of government preferences increases trade and reduces incentives for conflict
- Economic exchange or policy liberalization as root cause of peace?
- Market access and conflict: McDonald (2004), McDonald and Sweeney (2007); Chatagnier and Kavakli (2015)
- However, level market access depends on distribution of power in international system
- Political economy of foreign policy belligerence
- Gerschenkron (1943), Fordham (2019), Fordham (1998), Kleinberg and Fordham (2013)
Shadow of Power in International Political Economy
- Equilibrium trade policies balance
- Domestic political interests
- Foreign military constraints
- Trade policies are not a sufficient statistic for government preferences
- Goldberg and Maggi (1999); Mitra, Thomakos, and Ulubasoglu (2006); Gawande, Krishna, and Olarreaga (2009); Gawande, Krishna, and Olarreaga (2012); Ossa (2014); Gawande, Krishna, and Olarreaga (2015)
Implications (II)
Preferences, Institutions, and the Democratic Peace
- Hypothesis: Democracies more liberal in trade policy preferences than autocracies
- Democratic political institutions and consumer influence over policymaking (Mayer 1984; Grossman and Helpman 1996; Milner and Kubota 2005)
- Conclusion: Democracies trade more, fight less
- Democratic peace: Oneal and Russett (1999), Reiter (2017)
Conclusion
Conflicts of Interest versus Bargaining Failures
- Given a conflict of interest, what prevents peaceful settlement? (Fearon 1995)
- What do governments want? and why do their objectives bring them into conflict with one another? (Moravcsik 1997; Bils and Spaniel 2017)
Thank You
Title Slide Image Credit: Charles Severin (American lithographer, born between 1808-1820; died ca. 1860). 1853 (creation). The American Expedition, Under Commodore Perry, Landing in Japan, July 14, 1853, Overall view. visual works; prints (visual works); planographic prints; lithographs. https://library.artstor.org/asset/SS35100_35100_35234600
Table of Contents
Sections
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