Business as Usual:Business as Usual: Economic Responses to Political Economic Responses to Political

TensionsTensions

Christina Davis and Sophie Christina Davis and Sophie MeunierMeunier

Princeton UniversityPrinceton University

The PuzzleThe Puzzle

France-US tensions over Iraq Sino-Japanese tensions over shrine

Worsening political relations and Deepening economic ties

Theoretical ApproachesTheoretical Approaches Alliances, security, and tradeAlliances, security, and trade

Security externalities encourage trade to follow the flag Security externalities encourage trade to follow the flag (e.g. Gowa and Mansfield)(e.g. Gowa and Mansfield)

Commercial peaceCommercial peace Economic interdependence encourages cooperative Economic interdependence encourages cooperative

political relations (e.g. Oneal and Russett)political relations (e.g. Oneal and Russett)

Linkages between political and economic Linkages between political and economic relationsrelations

Empirical evidence mostly examines Empirical evidence mostly examines patterns of trade and warpatterns of trade and war Questions about endogeneityQuestions about endogeneity Do causal mechanisms operate at lower threshold of Do causal mechanisms operate at lower threshold of

conflict?conflict?

HypothesesHypotheses

Politics firstPolitics first Political tensions reduce economic interactionsPolitical tensions reduce economic interactions

Economics firstEconomics first Risk of economic damage from political Risk of economic damage from political

tensions mobilizes lobbying for improved tensions mobilizes lobbying for improved relationsrelations

Separation of politics and economicsSeparation of politics and economics Political tensions have little effect on economic Political tensions have little effect on economic

interactions as private actors respond only to interactions as private actors respond only to economic informationeconomic information

The Franco-American The Franco-American RelationshipRelationship

Disagreement over Iraq warDisagreement over Iraq war Calls for boycotts on both sidesCalls for boycotts on both sides

No downturn in trade or investmentNo downturn in trade or investment McDonald’s posts best sales ever in McDonald’s posts best sales ever in

FranceFrance No effects on American imports of No effects on American imports of

French goods (except wine)French goods (except wine)

United State's Imports From France and U.K.

-

2,000.0

4,000.0

6,000.0

8,000.0

10,000.0

12,000.0

14,000.0

2000

: 1

2000

: 3

2001

: 1

2001

: 3

2002

: 1

2002

: 3

2003

: 1

2003

: 3

2004

: 1

2004

: 3

2005

: 1

2005

: 3

Mil

l U.S

. Dol

lars

200

0 P

rice

s

France

United Kingdom

US Outward FDI

-10000.0

0.0

10000.0

20000.0

30000.0

40000.0

50000.0

60000.0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Mil

l U

S D

oll

ars

2000

Pri

ces

France United Kingdom

Sino-Japanese RelationshipSino-Japanese Relationship

Political crisis over history issues and rivalryPolitical crisis over history issues and rivalry Demonstrations and boycott callsDemonstrations and boycott calls Suspension of high-level leader meetingsSuspension of high-level leader meetings

Trade and investment continues to growTrade and investment continues to grow Toyota enjoys rapidly growing sales in ChinaToyota enjoys rapidly growing sales in China Japanese firms plan to maintain or expand Japanese firms plan to maintain or expand

investmentinvestment ““Cold Politics, Hot Economics”Cold Politics, Hot Economics”

China/Hong Kong Share of Japanese Trade

0.00

0.05

0.10

0.15

0.20

0.25

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Perc

ent o

f to

tal t

rade

China's Imports From Japan and the United States

-

5,000.0

10,000.0

15,000.0

20,000.0

25,000.0

30,000.0

35,000.0

Mill

ion

U.S

. Dol

lars

200

0 Pr

ices

Japan

United States

Japanese Outward FDI

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Per

cen

t o

f to

tal

ou

twar

d F

DI

Rest of world

United States

China/Hong Kong

Explaining the ResultsExplaining the Results

Politics firstPolitics first Trade follows the flagTrade follows the flag Intensity of tensionsIntensity of tensions

Economics firstEconomics first Lobbying and feedback loopLobbying and feedback loop

Politics and economics as separate spheresPolitics and economics as separate spheres Economic interdependenceEconomic interdependence

Micro-Level ConditionsMicro-Level Conditions

TransnationaliTransnationalityty

SubstitutabilitSubstitutabilityy

Regulatory and procurement decisions

A Temporal ThresholdA Temporal Threshold

Duration of tensions and Duration of tensions and consumer boycottsconsumer boycotts

The “animosity model of foreign The “animosity model of foreign product purchase”: product purchase”: long-term impact of long-term impact of political tensions on brands and products (Klein political tensions on brands and products (Klein et al.)et al.)

Durable, long term impact on Durable, long term impact on brandsbrands

International Economic International Economic GovernanceGovernance

Negative effect on cooperationNegative effect on cooperation Spillover of political tensions on protectionismSpillover of political tensions on protectionism GrandstandingGrandstanding Cross-issue linkagesCross-issue linkages

Positive effect on cooperationPositive effect on cooperation Shelter from political tensionsShelter from political tensions Over-compensationOver-compensation More economic liberalizationMore economic liberalization

ConclusionConclusion

FindingsFindings Overall insulation between economics and politicsOverall insulation between economics and politics Firewall not impenetrableFirewall not impenetrable

ImplicationsImplications Questions how governments direct economic Questions how governments direct economic

flows under globalizationflows under globalization Shows linkage between politics and consumer Shows linkage between politics and consumer

behavior (for select markets and over long term)behavior (for select markets and over long term) Need further research to measure effects of Need further research to measure effects of

political tensions - more common than warspolitical tensions - more common than wars