Make concentrated trade not war?

• Published date: 01 May 2022
• Author: Pavel Yakovlev,Brandon Spleen
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/rode.12852

Rev Dev Econ. 2022;26:661–686. wileyonlinelibrary.com/journal/rode

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© 2022 John Wiley & Sons Ltd

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INTRODUCTION

In the real world of many sovereign states it will therefore be an elementary princi-

ple of the power policy of a state to direct its trade away from the large to the smaller

trading states. (Hirschman, 1945, p. 31)

According to the liberal peace theory, economic integration reduces international hostilities by

increasing the opportunity cost of militarized interstate disputes (MID). While this hypothesis

Received: 3 February 2021

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Revised: 8 October 2021

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Accepted: 14 December 2021

DOI: 10.1111/rode.12852

REGULAR ARTICLE

Make concentrated trade not war?

PavelYakovlev

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BrandonSpleen

Department of Economics and Finance,

A.J. Palumbo School of Business

Administration, Duquesne University,

Pittsburgh, Pennsylvania, USA

Correspondence

Pavel Yakovlev, Department of

Economics and Finance, A.J. Palumbo

School of Business Administration,

Duquesne University, 600 Forbes

Avenue, Pittsburgh, PA 15282, USA.

Email: yakovlevp@duq.edu

Abstract

In a seminal paper, Martin, Mayer, and Thoenig, The

Review of Economic Studies, 2008, 75(3), 865– 900, show

that bilateral trade decreases the probability of a mili-

tarized interstate dispute (MID), while multilateral

trade increases it by allowing countries to decrease the

opportunity cost of conflict through trade diversifica-

tion. Lee and Pyun (2016) challenge this assertion by

showing that both bilateral and multilateral trade flows

reduce the likelihood of MID. This study develops an

alternative measure of trade diversification based on

Hirschman's (National power and the structure of for-

eign trade, 1945, Berkley: University of California Press)

market concentration index and estimates its effect on

the probability of MID. We find that the estimated im-

pact of trade diversification on MID depends crucially

on the model's inclusion of the trade– distance interac-

tion terms.

KEYWORDS

conflict, diversification, globalization, peace, trade openness, war

JEL CLASSIFICATION

F1; F5

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YAKOVLEV and SPLEEN

has been gaining considerable empirical support, there might be an important nuance to this

story: much like asset diversification can lower financial risk, trade diversification can mitigate

bilateral trade losses and actually increase the probability of MID. As the world becomes more in-

tegrated, the tug- of- war between trade dependence and trade diversification can make the world

either more or less peaceful.

Martin etal.(2008) find robust evidence in support of this more nuanced view by showing that

bilateral and multilateral trade flows have opposite effects on the probability of MID. However,

a study by Lee and Pyun (2016) overturns their conclusion by showing that both bilateral and

multilateral trade flows reduce the likelihood of MID. A problem with both of these studies is

that they test the trade diversification hypothesis using multilateral trade to gross domestic prod-

uct (GDP) ratio, a measure more akin to overall trade dependence rather than diversification.

Furthermore, this measure creates ambiguities in deducing whether the estimated effect is due

to a change in the numerator or denominator of the variable (Robst etal.,2007). In other words,

a better measure of trade diversification is needed for the proper testing of this hypothesis.

In this paper, we investigate the reasons for diverging estimates by Martin et al. and Lee and

Pyun. More important, we develop a new measure of trade diversification and show its effect on

the probability of war in a simple theoretical model. We then estimate the impact of this new

measure on MID using, for benchmarking, the same dyadic data set as Martin et al. and Lee and

Pyun. Our trade diversification measure, called the trade concentration index (TCI), is inspired

by the seminal but often forgotten work by Albert Hirschman (1945). As can be gleaned from the

opening quote, Hirschman originally developed the now- famous Hirschman– Herfindahl market

concentration index for the explicit purpose of analyzing the interplay between international

trade and power relations. It is only fitting that Hirschman's measure of trade diversification is

finally being put to work as he originally intended.

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LITERATURE REVIEW

Although the scholarly literature on the war– trade nexus is both voluminous and multidisci-

plinary, we limit ourselves to a concise review of it here. The idea that commerce or economic

interdependence can promote international peace is not new. The philosophical roots of this ar-

gument, known as the liberal peace theory, can be traced back to Adam Smith, Immanuel Kant,

Joseph Schumpeter, Thomas Paine, and Frederic Bastiat. According to this theory, economic in-

terdependence promotes peace by increasing the opportunity cost of conflict in terms of forgone

international commerce or trade. In a related interpretation of this old idea, called the capitalist

peace theory (Schneider,2014; Weede,2003), its proponents argue that capitalism is what re-

ally reduces international hostilities by limiting disputes over natural resources (Gartzke,2007),

establishing contract- intensive economies (Mousseau,2009), and reducing the state's role in do-

mestic and international commerce (McDonald,2004, 2010).

While there is little doubt that wars do disrupt trade, the reverse claim that trade pro-

motes peace is still being debated in the literature today (Barbieri & Schneider, 1999;

Hirshleifer,2001; Kapstein, 2003). Among the critics of the liberal piece view are the de-

pendency theorists (Wallerstein,1974) and neo- Marxists (Emmanuel,1972), who argue that

asymmetric economic interdependence may increase interstate tensions and conflicts (Dos

Santos,1970) as evident from the history of conflicts that originated out of trade disputes.

Furthermore, Skaperdas and Syropoulos (2001) contend that countries, to protect their inter-

ests, may acquire more weapons through trade, which in turn may force their trading partners