Economic Interdependence and Armed Conflict: Some Qualifications of the Liberal Case

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1 Economic Interdependence and Armed Conflict: Some Qualifications of the Liberal Case Gerald Schneider University of Konstanz (based on co-authored work with Margit Bussmann (Konstanz) Günther G. Schulze (Freiburg), Vera E. Tröger (Berne)) October 30, 2003, NTNU

2 Structure 1. Commercial Liberalism a) the peace-through-trade-hypothesis b) the trade-disruption hypothesis 2. Revised versions of Commercial Liberalism 3. Globalization and Interstate War 4. Globalization and Intrastate War 5. The Impact of War on Stock Markets 6. Summary

3 The two hypotheses of Commercial Liberalism 1. The peace-through-trade hypothesis Montesquieu 1748 The natural effect of commerce is to bring about peace. Two nations which trade together, render themselves reciprocally dependent; if the one has an interest in buying and the other an interest in selling; and all unions are based upon mutual needs. John Oneal/Bruce Russett 1999 Fearful of the domestic political consequences of losing the benefits of trade, policy-makers avoid the use of force against states with which they engage in economically important trade. Liberalism, that is, sees democratic governance, economic interdependence, and international law as the means by which to supersede the security dilemma rooted in the anarchy of the international system. For states no much linked by these ties, however, the threat of violence remains. In addition, liberal states must fear those illiberal states that remain outside the Kantian confederatio

4 2. The trade-disruption hypothesis Norman Angell 1938: nations persisted in methods of security which condemned them to Insecurity so great that the end must be destruction. William Nordhaus 2002 While historians have documented the many miscalculations involved in war, little has been written on faulty economic forecasts.

5 D Costs and benefits of foreign policy B' A' B A D' Z' Z Cooperation Conflict The optimal level of conflict (adapted from Polachek 1980)

6 The opportunity costs argument Solomon W. Polachek, JCR, 1980:...the price of being belligerent is an implicit price that increases with the level of trade. Ceteris paribus, the greater the amount of trade, the higher the price of conflict, and the less the amount of conflict that is demanded.

7 Trade disruption thesis K. Barbieri and J. Levy in Schneider, Barbieri and Gleditsch Although contemporary liberal and realist theories disagree about the effects of trade on conflict, they appear to agree on the effects of conflict on trade. Both imply that trade and other forms of economic interchange between states will cease or be drastically reduced once states are engaged in serious conflicts with each other. The liberal hypothesis that trade deters conflict is based on the premise that conflict will substantially reduce trade or adversely affect the terms of trade. Realist theories imply that trade, particularly in strategic goods, will terminate between adversaries because of relative gains concerns But see also J. Morrow, JCR 1997 (reprinted in Schneider et al. Globalization and Armed Conflict).

8 The Problems of the Opportunity Costs Argument 1) Bordering on the tautological 2) Some possible alternatives do not offer additional analytical leverage e.g. Signaling games -3) The statistical and the formal models rely on different units of analysis 4) Discrepant findings

9 Consequcences: - Unpacking the trading state - Governments depend on different domestic economic interests - Three sector model - Military sector taxes the other sectors

10 Trade and Hostility Preferences Tariffs Hostility Export sector - - Import sector + - Military sector - + Median voter - -

11 Revised liberal explanations of interstate war 1. The incentives for governments to use force can grow in times of expanding economic interdependence if - government popularity depends on the military sector - as long as the costs of hostility are not exceedingly large 2. A tacit war coalition between the export sector and the military sector is built as long as the gains from decreasing tariffs exceed the costs of war. 3. Diversionary theories of war ( the likelihood of war grows in times of economic crisis ) possess murky microfoundations.

12 Average Number of Dispute and War Onsets in Various Categories of States, (Nation years) Average number of new MIDs (Standard deviation) Initiat or Target Aggre gate Average number of new wars (Standard deviation) Initiat or Target Aggre gate Free trader (n=1,052) Protectionist (n=2,192)

13 Conflict Conditional impact Unconditional impact Interdependence

14 Peace through Trade: The Domestic Level Can the liberal argument be used at the domestic level without modifications? Probably not liberalization especially when undertaken prematurely, before strong financial institutions are in place increased instability one fact remains clear: instability is not only bad for economic growth, but the costs of the Instability are disproportionately borne by the poor. Joseph E. Stiglitz Globalization and its Discontents. London: Allen Lane, p. 67.

15 Theoretical underpinnings: Distributional theories of trade policy making 1. Heckscher-Ohlin (Stolper-Samuelson) 2. Ricardo-Viner Strategic explanations: 1. Alesina/Drazen: War of attrition model to explain the delay of economic reforms 2. Bargaining models with outside options Hypotheses: 1) Economically open countries are less prone to domestic conflict. (long-term effects) 2) The process of economic liberalization increses the risik of domestic violence (short-term effects).

16 Expected influence of different variables on civil war Independent variable Openness Liberalization Development + Development 2 Democracy + Democracy 2 Population Peace years + +

17 Effects of foreign economic openness and liberalization on civil war, CIVIL WAR All variables at mean Peace years increased by one SD; Other variables at mean Population increased by one SD; Other variables at mean Development increased by one SD; Other variables at mean Development decreased by one SD; Other variables at mean Democracy increased by one SD; Other variables at mean Democracy decreased by one SD; Other variables at mean Liberalization increased by one SD; Other variables at mean Openness increased by one SD; Other variables at mean % % % % % % +9.8 % %

18 Qualification of the trade disruption thesis Collective beliefs matter 1. Markets react negatively to escalations and positively to cooperative events 2. War-induced stock market rallies occur if an escalatory move lowers the anticipated costs. 3. Markets can punish false compromises. Hence, not all cooperation is rewarded. 4. International crises increase the uncertainty of the stock market and lead to more volatility.

19 New Tests of the Trade Disruption Thesis: Research Design - Time period: 1990 to Four stock market indices (CAC, DAX, DJI, FTSE) - Three long-lasting conflicts: a) Iraq-Security Council and its members b) Israel-Palestinians c) Ex-Yugoslavia - Combination of event data analysis and financial econometrics - ARMA/ARCH Models - Unit of analysis: Days - Sources: KEDS and King/Lowe

20 12000 Stock Price DJI FTSE DAX CAC Year

21 Iraq against the UN 60 Sum of Goldstein Values per Day Irak Conflict Year

22 Palestine conflict: sum of daily goldstein values Israel-Palestinians 80 Yugoslavia conflict: sum of daily goldstein values Ex-Yugoslavia

23 Impact of three wars on the (differenced) Dow Jones Index C 1, , , ,0019 GOLF_SUMGOLD -0, , , ,0001 GOLF_SUMGOLD(-1) 0, , , ,2205 PAL_SUMGOLD -0, , , ,5162 PAL_SUMGOLD(-1) 0, , , ,3293 YUG_SUMGOLD 0, , , ,4655 YUG_SUMGOLD(-1) 0, , , ,8351 C 40, , , ,0003 ARCH(1) 0, , , GARCH(1) 0, , , GOLF_SEVERITY(-1) 7, ,5499 0, ,6927 PAL_SEVERITY(-1) 19, , , ,1999 YUG_SEVERITY(-1) 32, ,2058 2, ,0036 R-squared 0, Mean dependent var 2, Adjusted R-squared 0, S.D. dependent var 69,28182 S.E. of regression 64,06953 Akaike info criterion 10,20496 Sum squared resid Schwarz criterion 10,26357 Log likelihood ,45 F-statistic 18,82936 Durbin-Watson stat 2, Prob(F-statistic) 0

24 Conclusion 1. Commercial liberalism is largely right. 2. Qualifications are: - Interstate war is possible in times of growing trade ties. - Poor countries that embark onto a course of foreign economic liberalization are sometimes facing an increased likelihood of domestic conflict. - War-induced stock market rallies are rational and the evidence is largely in support of the disruption thesis. 3. Next step: Beef up the findings with case studies!!!

Globalization and Political Violence: Refining Commercial Liberalism. DIW February 1, 2010

Globalization and Political Violence: Refining Commercial Liberalism DIW February 1, 2010 Commercial Liberalism A Great Illusion or a vision in need of some refinements Norman Angell 1910: The Great Illusion