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Archive: On Political Economy

International Interactions Policy Blog

International Interactions is a peer-reviewed journal with direct relevance to a wide and interdisciplinary audience. Readers include political scientists, economists, historians, mathematicians, statisticians, anthropologists, sociologists, and other social science researchers with an interest in international relations, as well as informed professionals in business and government.

Launched in 2019, the International Interactions blog synthesizes scholarly findings for a practitioner audience. Each blog post describes the policy takeaways of a recent II article, in the authors’ own words, for use by engaged policymakers who can apply this research to current issues and challenges. 

Below, you’ll find an archive of posts relating to Political Economy, plus links to the full journal articles. Access all categories alongside the latest post on the blog’s main page.

Why Do States Contribute to the Global Refugee Governance? Fiscal Burden-Sharing in the Post-2011 Syrian Refugee Crisis | March 2022

Hirotaka Fujibayashi , Why Do States Contribute to the Global Refugee Governance? Fiscal Burden-Sharing in the Post-2011 Syrian Refugee CrisisInternational Interactions (2022). Free Access until May 31, 2022>>

Funding is a crucial aspect of contemporary refugee governance. Up to date, however, research has not paid adequate attention to individual state-level motivations to provide financial contributions aiming to protect refugees and assist their host countries. My recent publication in International Interactions seeks to address this shortcoming by asking: Why are some states motivated to financially contribute to tackling global refugee crises, while others are reluctant to do so or are even tempted to free-ride (i.e. do nothing)?

In addressing this question, I offer two competing perspectives of the potential impact of refugee migration on individual states’ decisions concerning whether and how much to contribute to a given refugee crisis. On one hand, from the perspective of international collective actions but also in line with the literature on international migration and foreign aid nexus, we can expect those states that have received a larger number of refugees fleeing the crisis to have a greater incentive to contribute. On the other, from the perspective of burden-sharing, those states receiving more refugees and asylum-seekers are expected to have a lower incentive to contribute because they would not see such a commitment as necessary, or it may even be impossible to take on the extra financial burdens.

An important implication of both perspectives is that shifts in the scale of bilateral refugee movements are correlated with states’ motivations to provide financial contributions. For countries which are at a lower risk of mass refugee arrivals principally for geographical reasons, this correlation is expected to be positive. Meanwhile, in cases where that risk is comparatively high, the inverse is true and states will likely reduce their interests to provide financial contributions in response to an increase in the number of refugees they host. In short, given the complex geographic dynamics of refugee migration, the suspected correlation could be conditioned by each state’s geographic proximity to a refugee crisis. Therefore, I propose another hypothesis which examines whether the scale of refugee migration and bilateral distance interact in their effects on states’ provisions of financial contributions to tackle a given refugee crisis.

I test these hypotheses using a cross-sectional time-series dataset that compiles data on the annual contributions made by every UN-member state (except Syria and its neighboring states) towards the global humanitarian response plans to tackle the post-2011 Syrian refugee crisis, from 2012 to 2020. The resulting two-part random-effects models with standard errors clustered by donor state offer several interesting findings.

First, the findings provide support for my hypothesis that states receiving a relatively larger number of Syrian refugees have a greater incentive to financially contribute to tackling the post-2011 Syrian refugee crisis. Notably, however, this explanation only holds under the condition that donor states have a large geographical distance to Syria. By contrast, states in greater geographical proximity to Syria exhibit little interest in taking on the additional financial burden of supporting Syrian refugees staying outside of their territories, especially as the number of Syrian refugees they host increases.

Though these findings surely deserve more detailed analysis in the future, by highlighting some of the underlying motivations of individual states to provide financial contributions aiming to ameliorate the post-2011 Syrian refugee crisis, my study contributes to both policy-oriented and academic debates on the sharing of financial burdens in today’s global refugee governance. Full article >>

Initiator conditions and the diffusion of digital trade-related provisions in PTAs | January 2022

Manfred Elsig & Sebastian Klotz, Initiator conditions and the diffusion of digital trade-related provisions in PTAsInternational Interactions (2021). Free Access until March 31, 2022>>

E-commerce and digital trade are on the agenda of the World Trade Organization (WTO) again. With the Work Programme on E-commerce, the WTO launched in 1998 a first platform for discussions and negotiations. Over the past 24 years, however, little progress towards establishing global rules for e-commerce was achieved. Interest in the topic only revived in 2019 when 76 WTO Members agreed on a Joint Statement on E-commerce. In preparation for the WTO’s 12th Ministerial Conference, scheduled originally for 2021, WTO Members were making further progress on various topics such as spam, electronic signatures and authentication, e-contracts, online consumer protection, and open government data.

Given the newfound momentum for designing multilateral rules, the WTO trade negotiators may find inspiration in the e-commerce and digital trade chapters of preferential trade agreements (PTAs) – trade agreements signed outside the realm of the WTO. Partly due to the slow progress in the WTO over the past two decades, many WTO Members decided to negotiate trade-related rules for e-commerce in their PTAs. Since 2000, more than 300 PTAs have been signed, almost 200 of which include digital trade-related provisions. Multilateral and preferential trade agreements are indeed known to have a dialectical relationship. The WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), for instance, was inspired by specific IPR rules in previous PTAs.

Against this backdrop, it is important to better understand digital trade-related provisions in PTAs and how they diffuse. In this Research Note, Manfred Elsig and Sebastian Klotz explore the origins and diffusion of 91 digital trade-related provisions in 347 PTAs signed between 2000 and 2019. These provisions cover topics such as technology neutrality, non-imposition of custom duties, paperless trade, and electronic signatures, as well as data protection, localization, and cross-border transfer.

Interestingly, the authors find that almost half (48%) of these provisions were initially introduced in PTAs which the United States (US) is party to. This suggests an ambitious first-mover attempt at setting rules that would subsequently be diffused via the PTA network – and potentially to any future multilateral agreements. Looking closer, however, the authors find no evidence that provisions introduced by the US diffuse more effectively through the PTA network than provisions introduced by other countries. In other words, PTA negotiators do not simply adopt provisions because they were first introduced by the US. Rather, the diffusion of digital trade-related provisions is found to be more influenced by initiator conditions, such as their economic interests and stakes in the digital economy and the pre-existence of domestic digital policies. Finally, the authors find that the initial degree of legalization of the provisions themselves matters for their diffusion – legally enforceable provisions diffuse faster through the PTA network than so-called soft law provisions. Full article >>

Success of economic sanctions threats: coercion, information and commitment | November 2021

Dawid Walentek, Joris Broere, Matteo Cinelli , Mark M. Dekker, and Jonas M. B. Haslbeck, Success of economic sanctions threats: coercion, information and commitmentInternational Interactions (2021). Free Access until January 31, 2022>>

Our recent publication in International Interactions contributes to the debate on the effectiveness of economic sanctions threats. In the literature on conflict in international relations, various game theoretic models of threat effectiveness share several characteristics and produce similar predictions to guide empirical research. Our article discusses the three main hypotheses – coercion, information, and public commitment – arising from the formal models that study threats’ effectiveness. The expectations resulting from these can be summarized as follows: first, the coercive hypothesis posits that threats are more likely to succeed if the expected target’s cost resulting from economic sanctions is high; second, the informational hypothesis proposes that threats are more likely to succeed if the diplomatic ties between a sender and a target of economic sanctions are strong; third, the public commitment hypothesis states that threats are more likely to succeed if the sender of economic sanctions is a democracy.

In line with previous research on the effectiveness of sanctions threats, this article finds evidence in support of the coercive hypothesis. The expected economic cost of sanctions to the target state is a strong predictor of a threat’s success. When the data are tested to determine whether the effect of expected economic costs on success is different for threats-only versus imposed sanctions, the results show no meaningful difference.

Next we examine the informational hypothesis, where uncertainty about economic or political costs is expected to affect the effectiveness of threats. Our proxy for uncertainty is not statistically significant in relation to the success of sanctions threats; thus, we do not find evidence in favor of the informational hypothesis. However, we also assess the relative effectiveness of threats-only versus imposed sanctions for various levels of uncertainty. Here, we find a meaningful difference between the two. These findings indicate that, the less states know about each other (in our research measured by the distance on a diplomatic network), the less likely mere threats of economic sanctions are to succeed, relative to imposed sanctions.

Finally, we consider the public commitment hypothesis. As the proxy for domestic audience cost (the level of democracy of the sender) is not significantly statistically related to the success of sanctions threats, we found no evidence in favor of the public commitment hypothesis. The success rate of sanctions threats does not seem to be influenced by senders’ level of democracy. However, there is a statistically significant difference between the relative effectiveness of threats-only compared to imposed sanctions for this variable. We find that, as the democracy level of the sender state increases, so does the effectiveness of the mere threat of economic sanctions, relative to imposed sanctions.

The findings in our article support and further enrich current scholarship on the effectiveness of sanction threats. The article contributes to the literature by unifying the diverse scholarship on threat effectiveness. Our work also assesses the conditions under which threats of economic sanctions are more successful – relative to imposed sanctions. In addition, the article proposes a novel and clear specification of uncertainty, and argues that diplomatic relations between states can be used as a measure of uncertainty for conflict in international relations. This enables us to move beyond a dyadic approach and towards a more network-based understanding of coercion among states. Full article >>

 

Utilitarianism or Cosmopolitanism? A Study of Education’s Impact on Individual Attitudes toward Foreign Countries | October 2021

Gong Chen, Utilitarianism or Cosmopolitanism? A Study of Education’s Impact on Individual Attitudes toward Foreign CountriesInternational Interactions (2021). Free Access until December 31, 2021>>

In a recently published book, Caplan (2018) argues that public investment in education is a waste of time and money. Specifically, he sees education as a tool that signals to employers an employee’s intelligence, diligence, productivity, and suitability for employment. In this regard, educational credentials serve to indirectly inform employers of the employee’s value in domestic labor markets. Nonetheless, since these abilities and traits pre-exist regardless of one’s academic achievements, formal education does not teach students useful skills for employment. Arguably, returns on investment in education, as suggested by Caplan, may not be large enough at the micro level, but education plays other critical roles at the macro level, beyond individual and national boundaries. First, education represents human capital. In an open economy, when people’s skill levels are consistent with their country’s factor endowments, they become “winners” in global markets and may thus favor trade liberalization and economic interdependence. Second, schooling socializes individuals to be trusting, informed, and open-minded toward foreign cultures, so those who are educated are less likely to be xenophobic, chauvinistic, or ethnonationalist. Accordingly, education is conducive to international cooperation and interstate relations by fostering pro-globalization and pro-foreigner public opinions, either in a utilitarian or socializing way. Aside from mere signaling in domestic labor markets, education has the potential to ameliorate intergroup attitudes cross-nationally, which can lay the (mass attitudinal) groundwork for a more collaborative, harmonious, and peaceful world community.

Many social science studies have lent credence to the significant relationship between education and pro-outsider attitudes, but debates over the underlying mechanism persist. On the one hand, according to the factor endowments model in international trade, highly-educated citizens (regarded as capital owners and skilled workers) in developed capital-abundant countries, for instance, can materially benefit from economic linkages with less-developed labor-abundant countries. Based on utilitarian cost-benefit analyses, individuals with higher educational attainment are more likely to hold a favorable image of other states, on account of economic welfare gained through bilateral trade. On the other hand, from a social psychological viewpoint, education cultivates social trust, facilitates intergroup contact and information, and expands breadth of social perspective, all of which can mitigate ingroup-versus-outgroup categorization. As a result, well-educated people are less susceptible to ingroup bias and more tolerant of cultural otherness. This article attempts to systematically delve into the “education-outgroup attitudes” black box and test which approach exerts a greater influence over individual attitudes toward foreign countries.

My research builds on and contributes to the existing literature in two manners. First, I make comparisons between the utilitarian effect (based on international trade theory) and the socializing effect (based on social identity theory) of education on outgroup attitudes, and find evidence for the latter approach. In particular, I generalize the extant findings on education and trade preferences by examining attitudes toward foreign countries and including both developed and developing economies. In theory, individuals are beneficiaries of free trade on condition that their skill levels are in line with their country’s relative factor abundance. Following the factor endowments model, international political economy scholarship has consistently found that better-educated people in developed countries are more pro-trade, but scholars largely overlook the other side of the coin: Less-educated people in developing countries are also expected to be pro-trade, which nevertheless lacks sufficient empirical evidence due to data limitations. Besides, I focus not on trade policy preferences but on attitudes toward foreign countries in this article. If citizens do correctly make economic evaluation on trade as suggested by previous research, it is plausible to propose that they apply and extend this evaluation to important trading partners whose markets and/or imports can considerably affect their employment and economic situation. In this case, outgroup attitudes are contingent upon not only individual education levels but also their country’s as well as trading partners’ factor endowments. Therefore, in a break with past studies on trade preferences, I distinguish between the utilitarian impact of education on opinion of foreign countries in developed and developing countries.

Second, with respect to the socializing approach, I further investigate three potential pathways—social trust, information, and breadth of social perspective—linking schooling to outgroup attitudes. As a complement to prior work predominantly centering on citizens or nations in the West, this study uses images of the United States, China, and Japan in East Asia as examples and finds that the positive educational effect is mainly mediated by an expanded social perspective—an internationalist, cosmopolitan worldview. Echoing the microfoundations of constructivism in international relations, world politics and state behavior are fundamentally explained by identity. Given an inclusive superordinate identity and a broad social perspective, well-educated citizens are less likely to assess interstate relations in a mutually exclusive, zero-sum way. In this regard, global policymakers may more comprehensively consider education’s benefits beyond employment, economic growth, and poverty relief. More generally, international cooperation and globalization have been confronted with and challenged by rising ethnopopulism, trade protectionism, and xenophobia in recent years. As some researchers point out, the strongest anti-foreign attitudes primarily come from unskilled less-educated people intolerant of socioeconomic problems caused by immigration, trade, interconnection, and openness. Apart from welfare spending and skill training, another complementary policy suggestion is the cultivation of an internationalist, cosmopolitan outlook in schooling. In practice, developing and expanding education may be a slow yet promising method to construct a shared “global we” identity and protect a collaborative international community from extreme ethnocentrism and nationalism. Full article >>

State intervention, external spoilers, and the durability of peace agreements | May 2021

Sema Hande Ogutcu-Fu, State intervention, external spoilers, and the durability of peace agreementsInternational Interactions (2021). Free Access until July 31, 2021>>

How does state intervention in civil conflict affect post-agreement durability? Intervention in civil conflict is widely studied because it is such a common occurrence. According to Uppsala Conflict Data Program, at least one state intervener was involved in thirty-eight of the forty-four conflicts which ended between 1985 and 2004. However, the literature generally ignores how state interventions during conflict affect the durability of the peace agreements that follow. In this study, I argue that state interveners continue to influence their war-time allies even after peace agreements have been reached.

A peace agreement establishes a new status quo in the post-agreement state. State interveners can use their leverage to influence the fragile post-agreement order in one of two ways: to break it down or to build it up, depending on how satisfied they are with the new order. Therefore, the durability of a peace agreement depends on state interveners’ level of satisfaction with the post-agreement order. Information about interveners’ satisfaction or lack thereof can be garnered from the economic and political signals they send after the agreement is reached.

As sixty-seven percent of the post-agreement states analyzed experienced interventions from multiple states during conflict, I also explored how multiple interventions influence peace agreement durability. Complementing the previous argument, I find that whether intervener states converge or diverge in their levels of satisfaction with the new status quo is a crucial factor that influences peace agreement durability. An intervener state that is not satisfied with the new order can take actions to spoil other interveners’ implementation efforts.

To support these two arguments, I studied the durability of internal peace agreements signed between 1985 and 2004 and qualitatively examined Angola-UNITA negotiations and Mozambique-RENAMO negotiations. I find that improving economic and political interactions between state interveners and the post-agreement state improves agreement durability. I also find that, as the divergence between each state intervener’s economic and political interactions with the post-agreement state grows, the durability of the peace agreement decreases. Intervener states’ satisfaction with the post-agreement status quo is thus a primary determinant of durable peace. Full article >>

Conflict and cooperation with trade partners | February 2021

Timothy M. Peterson & Yuleng Zeng, Conflict and cooperation with trade partnersInternational Interactions (2021). Free Access until  April 30, 2021>>

Global trade continues to expand each year—at least before the COVID-19 pandemic decimated commerce within and between states. Given the growth of global trade, and in light of prominent theories linking trade to common interests, escalating political tensions between major trade partners such as the US and China (as well as between Japan and South Korea and between China and India) are puzzling. A glance at the current global political climate might even call into question the claim that trade promotes peace. While it is probably premature to expect costly armed conflict to result from escalating political conflict among trade partners in the contemporary era, recent events motivate a reconsideration of exactly how trade influences international politics.

To address this puzzle, we reconsider theories on bilateral trade, exposure to the global economy, and international politics. We argue and demonstrate that states generally initiate both more conflict and more cooperation with major trade partners; and while higher exposure to the global economy reduces conflict initiation against major trade partners, it also reduces cooperation. Simultaneously, higher exposure to the global economy is associated with more initiation of cooperation with non-major trade partners. Using events data spanning 1995-2012, we find empirical support for our expectations.

Our approach departs from previous work in three key ways. First, we examine a broader range of conflictual and cooperative interactions together. This expands the current focus on inter-state armed conflict, which has become rarer over time. Second, we assume leaders are responsive to interests opposed to trade as well as to those who benefit. While the latter aspect has been the key assumption of most studies, we argue it could be misleading to ignore the former possibility that leaders could, at times, advocate for interests harmed by trade. Third, we reconceptualize what it means to be a “major trade partner,” presenting a new definition that varies with the dispersion of a state’s trade across partners rather than merely dollar value or GDP composition of trade.

Our study advances the existing theories of trade and conflict, reinforcing concerns regarding the potential for backlashes against liberal trade policies. It also helps explain contemporary political disputes among major trade partners beyond the scope of armed conflict. For instance, our findings suggest that, in a counterfactual situation in which either or both countries were less exposed to the global economy, recent political conflict between some major trade partners would have been higher still. Additionally, some of the disputes (e.g., failure to maintain lower trade barriers) should instead be interpreted as declining cooperation.  Full article >>

 

Group identification, uncertainty, and the duration of genocide and politicide | January 2021

Gary Uzonyi, Group identification, uncertainty, and the duration of genocide and politicideInternational Interactions (2020). Free Access until  March 31, 2021>>

Episodes of genocide and politicide show remarkable variation in duration. Some end within months; others endure for decades. Why do some persist while others end soon after they start? This study argues that uncertainty influences the duration of killing. When a government has difficulty identifying members of a target group, it is less certain whether it has accomplished its violent goals vis-à-vis the group. Therefore, the more uncertain the government is about the source of the threat it faces, the longer its killing will last. This occurs when regimes are highly risk-averse and because they hold exaggerated beliefs about the threat they face when they possess little reliable information about their opponent. Killing continues until the regime eliminates its enemy or the atrocities reveal enough information about the opposition’s strength that the parties can negotiate an end to the violence. Statistical analysis of all episodes of genocide and politicide since 1955 supports these claims.

This study subsequently traces the uncertainty mechanism in one case of genocide (Burundi 1972) and one case of politicide (El Salvador 1980-1989) as illustrative examples. The findings suggest that the duration of atrocity is indeed linked to the difficulty of identifying groups and threats. In this way, uncertainty influences the government’s costs for killing which aligns with the literature emphasizing opportunity as a determinant of violence. This work also reinforces the argument that uncertainty increases the likelihood of violence. While uncertainty about resolve, capabilities, and the probability of victory have each been studied in-depth, uncertainty about the composition of one’s enemy has been less frequently examined and provides opportunities for fruitful future research. In sum, this work makes clear the important role of identification in influencing the duration of violence. Full article >>

 

A Rational Design Approach to IO Structures | November/December 2020

Doron Ella, Categorization in international organizationsInternational Interactions (2020). Free access until January 31, 2021 >>

This paper seeks to explain why some international organizations (IOs) officially categorize their member-states while others do not. Specifically, it explores what drives actors to incorporate and employ categorization mechanisms and why they vary among IOs. Consequently, it also examines the specific problems categorization mechanisms are intended to solve. Categorization is defined as a mechanism that classifies member-states into different groups within the IO, assigning them differentiated rights and/or obligations, and it can be considered an aspect of IOs’ membership structure. Here, I focus on categorization mechanisms that classify members according to various aspects of their material capabilities; grant differentiated degrees of control over the IO to certain category-groups; offer certain provisions of special treatment; grant certain groups additional or special obligations toward the IO; and usually incorporate flexibility provisions.

Building on theories of rational design, I argue that categorization is intended to provide a solution to cooperation problems in IOs and assist in preventing possible defections of participating member-states. I suggest three hypotheses. First, I hypothesize that categorization is more likely to be incorporated and employed in IOs with heterogeneous membership in terms of capabilities and/or preferences, since categorization regulates members’ cooperation by allowing them to comply according to their capabilities, making IOs more sustainable and politically viable for longer periods of time. Second, I hypothesize that categorization is more likely to be employed in IOs that deal with issues characterized by high levels of uncertainty, since members know they can initially cooperate within their designated category, and later, as international and domestic realties change, shift to other categories that better accommodate their evolving capabilities. And third, I hypothesize that categorization is more likely to be incorporated in IOs that require deep cooperation (and therefore are highly institutionalized), since such mechanisms allow states with high compliance costs to initially join the organization and be subsequently classified according to the readjustments they are currently capable of making. This also assists in maintaining cooperation within the institutional framework by lowering the defection incentives for less capable or wiling states.

To test these hypotheses, I created a new dataset on categorization, encompassing information on 156 IOs established between 1868 and 2015, and ranging across 12 issue-areas: trade, finance, security, the environment, human rights, politics, standardization, economic development, culture, education and training, science and technology, and Multilateral Development Banks. A multivariate logistic regression with robust standard errors is used to estimate the empirical relationships between the variables.

The empirical evidence provides support for all three hypotheses suggested in this paper, albeit with some reservations regarding the effects of preference heterogeneity. Indicators for capabilities heterogeneity, uncertainty, and depth of cooperation, when tested through various statistical models, all reach statistical significance and are influential in terms of both their coefficients and predicted probabilities. Structural control variables that address scope of membership and issue-scope, as well as the temporal variable that addresses year of establishment, have not proved to be significant to the decision to incorporate categorization. This is while the United States, as a major power deeply involved in the IOs’ establishing process, proved highly influential in the decision to incorporate categorization within IOs. The statistical analysis indicates that members’ heterogeneity, in terms of capabilities, has a considerable positive effect on the likelihood of incorporating categorization mechanisms in IOs. This seems to indicate, the establishing actors may consider categorization as a legitimate alternative to less palatable solutions, such as exclusion, for problems stemming from divergent power distributions.

The empirical analysis also reveals that IOs take uncertainty about the state of the world into consideration in deciding whether to incorporate categorization. Therefore, by clarifying current and future distribution of possible costs and benefits, categorization assists in reducing states’ uncertainties about the consequences of cooperation, and thereby lowers the incentives to defect from current cooperative agreements. Categorization, in this sense, ameliorates problems that stem from ever-changing international realities and uncontrollable externalities, and functions as a balanced maintenance mechanism.

I also provide empirical evidence for the hypothesis that posits that IOs requiring deep cooperation are more likely to include categorization mechanisms. Categorization, as such, assists in minimizing the compliance costs of less powerful participant states, raises their incentives to join and delegate power to IOs that are considered highly institutionalized, and at the same time lowers members’ incentives to defect by increasing payoffs for cooperation. Full article >>

Promoting Democracy, Bottom-Up and Top-Down | August 2020

Paulina Pospieszna & Patrick M. Weber, Amplifying and nullifying the impact of democratic sanctions through aid to civil societyInternational Interactions (2020). Read now >>

Both aid and sanctions constitute foreign policy tools used to promote democracy. Yet, it is unclear how effectively incentives and coercion enhance democratization. Since sanctions and aid are often employed concurrently, the goal of this study is to determine their joint effect on democratization in target/recipient countries.

We argue that sending democracy aid through civil society organizations enhances the effectiveness of sanctions as a democracy promotion tool, as it empowers civil society to introduce democratic changes. Thus, in addition to the top-down pressures exerted on the target government by sanctions, civil society further applies bottom-up pressure.

Our empirical results show that democratic sanctions by the European Union and the United States are more likely to have a positive effect when aid flows bypass the government. Conversely, aid channeled through the public sector hampers the generally positive effects of sanctions on democracy. In order to estimate these joint effects, we employ a new comprehensive dataset on economic sanctions: the EUSANCT Dataset which integrates and updates existing databases on sanctions for the period between 1989 and 2015, merged with disaggregated OECD aid data and V-Dem democracy scores. Full article >>

Sanctions Threats and the Costs of Uncertainty | July 2020

Clayton Webb, Re-examining the costs of sanctions and sanctions threats using stock market dataInternational Interactions (2020). Read now >>

Talk isn’t always cheap.

Economic sanctions involve the application of economic pressure to achieve political goals. The annual reductions in the flows of goods and services caused by sanctions are relatively minor as a share of national income but it is generally understood that economic sanctions, like other barriers to trade, exact economic costs on the firms that are directly affected by sanctions. While many are willing to acknowledge these costs as the price of statecraft, most research assumes that sanctions threats are relatively costless for sender states.

This paper develops a general theoretical framework for understanding the potential economic consequences of sanctions threats. Sanctions and sanctions threats create uncertainty for firms with commercial interests in targeted states. This uncertainty makes it difficult to value future cash flows to these firms. This uncertainty is produces increased stock volatility.

Stock volatility is costly. Stock is used as a currency in mergers and acquisitions and executive recruitment. Volatility makes it difficult for firms to raise money on corporate bond markets and increases the risk of insolvency.

Comparisons across sanctions episodes within and between firms over time show that returns for firms with commercial interests in targeted states are more volatile than returns for comparable firms that do not have commercial interests in targeted states. This suggests a need to revise strategic theories that treat sanctions threats as costless and highlights avenues for future research. Full article >>

IMF Lending and FDI Outflows: A Sectoral Perspective | March/April 2019

Michael Breen & Patrick J. W. Egan, The Catalytic Effect of IMF Lending: Evidence from Sectoral FDI DataInternational Interactions, 45:3 (2019). Read now >>

Country partnership with the International Monetary Fund (IMF) is ideally rare and short in duration. States turn to the IMF in times of economic crisis, which usually involve some combination of increasing national debt, balance of payments problems, and dwindling foreign reserves. The conditional loans provided by the IMF serve as a temporary solution to balance of payments issues, providing a capital influx in exchange for various policy shifts designed to bring about macroeconomic stabilization. The IMF has always viewed its loans as a stopgap measure; normally only a portion of the capital flows necessary to correct a deficit are lent to countries in crisis. The rest is expected to come from private capital markets. Indeed, the entire rationale for IMF lending rests on a conundrum: private capital is unwilling to finance a current account deficit, yet the IMF’s involvement is supposed to be a signal for private capital flows to resume. This ‘catalytic’ mission of the IMF is expressly stated as one of its three main goals, alongside adjustment to shocks and avoiding future crises.

IMF programs are supposed to function as seals of approval for various forms of investment to resume, but there is precious little evidence to support the catalytic ideal. What explains this gap between expectations and reality? This paper proposes that the potential for IMF catalysis depends in part on the characteristics of incoming investment in crisis-hit countries. We argue that the IMF is indeed sending multiple and potentially contradictory signals to private capital with the announcement of a rescue package. We consider the varieties of audiences receiving IMF signals. That is, the sectoral distributions of direct investment in countries before and after IMF agreements. We argue that IMF programs can have varied effects on different forms of investment, depending on the attitudes toward risk and other intrinsic characteristics of firms, which vary systematically across sectors. While the overall evidence linking IMF partnership with a resumption of capital flows in crisis-hit countries is underwhelming, there are important variations in the catalytic effect by industry. Certain sectors are likely less receptive to the catalytic signal of IMF programs (if it exists) than others.

Like previous studies, we find a reliable anti-catalytic effect of IMF programs on the overall stock of inward FDI. However, our central empirical finding is that this exodus is primarily driven by a select few sectors, including the financial industry and construction. We argue that the anti-catalytic effect of IMF lending depends crucially on two sector characteristics: dependence on external finance and fixed assets, which become sunk costs in host countries. We argue that when sectors couple high dependence on external finance with low sunk costs, firms are more likely to use an IMF agreement and attendant funds as an opportunity to deleverage or reduce risk exposure in crisis-hit countries. This results from moral hazard, but not for future investments. Rather, IMF liquidity provision encourages firms that have already taken on risk to exit. In contrast, we find no evidence of an anti-catalytic effect in sectors with high sunk costs. We argue that these sectors are less vulnerable to moral hazard, and instead interpret an IMF agreement as a signal that their assets are less likely to be expropriated. However, our results do not demonstrate a catalytic effect in these sectors, only an absence of exodus. Therefore, our results suggest that an IMF agreement is on balance unlikely to generate substantial broad-based inflows of any long-term capital. Instead, FDI flight may be severe depending on the type of investments prominent in the country at the time of crisis.

IMF programs are associated with a substantively large and negative effect on investment in financial and construction-related FDI, two sectors that exhibit a high degree of external capital dependence and low sunk costs. The prospect of austerity measures, limited growth, and structural adjustment likely combine with these sectors’ relatively leveraged positions at the time of crisis to prompt exit. The funds provided by the IMF also likely allow these firms to recoup some losses before leaving. IMF support may allow risk-imbued actors to survive and either exit or prevent new entrants from entering the market. In either case, the IMF program does not prompt a new wave of investment but instead signals the fulfillment of moral hazard dynamics for firms already in country. In contrast, FDI in high sunk cost, low external dependence sectors do not experience similar exodus after IMF programs. Where investors are tied and perhaps risk-averse, the information provided by partnership with the IMF may serve as a critical signal regarding the returns on future investment, diminished likelihood of expropriation, and/or the possibility of future bailouts.

One implication of our findings is that the failure of IMF programs to generate sustained inflows of international capital may have less to do with the IMF itself and more to do with the changing nature of international investment. Since the 1990s, FDI has diversified greatly in developing countries. Natural resource FDI has declined as a proportion of overall FDI flows in these countries, and service sector investments have increased substantially. As investment patterns change, large outflows of investments after crises and IMF interventions perhaps become more understandable.

Our findings also have implications for host country governments and international organizations. Greater attention should be paid to the specific types of investments entering developing countries before and after economic crises. If mobile firms with high external dependence do indeed anticipate crises and subsequent bailouts, it would suggest that these types of investments do not represent sustainable vehicles for industrial upgrading in fragile economies. High acceptance of risk and financial hedging against crises may produce outflows of investment. At minimum, analysts and policymakers alike should consider the types of investment common in crisis-hit countries and how these investors are likely to respond to an IMF agreement. Full article >>

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