The Relationship between Political Tensions, Trade and Capital Flows in ASEAN Plus Three

• Author: Thomas Gawarkiewicz,Yao Tang
• Published date: 01 September 2017
• DOI: http://doi.org/10.1111/twec.12478
• Date: 01 September 2017

The Relationship between Political

Tensions, Trade and Capital Flows in

ASEAN Plus Three

Thomas Gawarkiewicz

1

and Yao Tang

2,3

1

Cornerstone Research, Boston, MA,USA,

2

Department of Economics, Bowdoin College, Brunswick, ME,

USA and

3

Department of Applied Economics, Guanghua School of Management, Peking University,

Haidian District, Beijing, China

1. INTRODUCTION

THE relationship between international politics and international trade is often complex

with causality likely running both ways. As the episodes of large trade surpluses of Japan

and China against the United States have illustrated, significant trade imbalance can cause

political frictions. In the other direction, the most overt way political conflict can impact trade

flows is through government sanctions that limit trade with a rival. For example, the United

States and the European Union used sanctions on Russia in response to the Russian annexa-

tion of Crimea and fermenting unrest in eastern Ukraine (AP, 2015). Although the efficiency

of these sanctions, often used by large economies to coerce other countries into changing their

behaviour, is debatable, they are the clearest link between the bilateral political climate and

trade flows (Lindsay, 1986).

Even though political conflict often does not reach the threshold that incurs sanctions or

war, low-level tensions may impact trade through a number of channels. First, at the govern-

ment level, states, in an effort to enhance their own relative power and security, may avoid

trading with countries they deem as a potential threat. This may be particularly true in coun-

tries such as China and Vietnam where the government has more direct control of the econ-

omy and can thus use trade as a political tool. The bilateral climate also signals the likelihood

of future sanctions or war that would damage profits. Second, at the firm level companies

may cut trade ties due to pressure from the general public, or the risk of sanctions or war.

Periods of d

etente between the United States and Soviet Union during the Cold War brought

increased trade. Likewise, West Germany’s Ostpolitik strategy of warming political ties

between West Germany and the Eastern Bloc was followed by more trade (Pollins, 1989).

Similarly, lobby and interest groups, such as human rights organisations against South Afri-

ca’s apartheid regime, may influence trade and investment. Finally, political tensions may also

play out at the individual level where consumers choose to avoid trade with another country

because of personal dislike of their politics. American anger at France’s lack of suppor t for

the invasion of Iraq in 2003 resulted in anti-French boycotts, notably in the high-salience

industry of wine. This had noticeable effects on the volume of French wine sold, indicating

political conflict can influence consumer choice and, by extension, impact trade flows (Chavis

and Leslie, 2009).

We are grateful for the comments and suggestions of Matthew Botsch, Rachel Connelly, Deborah

DeGraff, John Fitzgerald, Ta Herrera, Stephen Meardon, Stephen Morris, Erik Nelson, Ke Pang and

Gonca Senel. The views expressed in this paper are solely those of the authors, who are responsible for

the content, and do not necessarily represent the views of Cornerstone Research. All errors are ours.

©2016 John Wiley & Sons Ltd

1958

The World Economy (2017)

doi: 10.1111/twec.12478

The World Economy

The empirical literature on low-level tensions has produced mixed results. Early work has

found that warmer political signalling results in higher bilateral trade (Pollins, 1989). This

result has especially held for countries where the government has a particularly powerful role

in the economy (Davis et al., 2014). The government, acting to ensure its security, tries to

achieve political goals through state-owned enterprises (SOEs), distorting the profit-maximis-

ing behaviour that encourages trade with all viable partners. However, recent work has found

no correlation between heightened political tensions and decreased trade levels when looking

at the trading partners of the United States and Japan, two countries with minimal government

involvement in the economy (Davis and Meunier, 2011). This insignificant result also holds

for foreign direct investment (FDI). Davis and Meunier (2011) argue this is due to the sunk

costs associated with international trade such as establishing intra-firm relations and marketing

in the partner country which increase the costs of shifting trade for political reasons. Recent

work has specifically explored one of Asia’s most prominent historical grievances, the 1937–

45 Japanese invasion of China. Che et al. (2015) find regions of China with more casualties

proportional to population trade less with Japan and receive less investment from Japan. The

authors hypothesise that the war fostered lasting distrust and anger between the countries that

still influences trade and investment.

In this paper, we aim to estimate the relationship between tensions and trade and capital

flows in East and South-East Asia specifically. The connection between politics and economic

relations is particularly important in East and South-East Asia where growing trade and capi-

tal flows face serious challenges in the form of rising tensions that have yet to cause sanctions

or war in recent decades. The data from the World Trade Organization (WTO) suggest that in

2013 Asia accounted for 34.4 per cent of the world’s merchandise exports and 34.4 per cent

of merchandise imports. This amounts to over $12 trillion in total trade. Asia also contains

the world’s second and third largest economies in the People’s Republic of China (PRC) and

Japan, with market exchange rate-evaluated GDPs of $9.5 trillion and $4.9 trillion in 2013,

respectively. The region is particularly bound by manufacturing trade ties as China deepens

its role as the hub (Economist, 2015a). The astounding growth of Asia has greatly shifted

economic power to the East.

However, territorial disputes, large contested energy reserves and the animosity from past

conflicts like World War II have all contributed to rising defence spending and tensions in

Asia, particularly in response to China’s growing clout. While no major conflict has broken

out in the region since the Sino-Vietnamese war of 1979, relations have been repeatedly

strained, concerning politicians and business leaders.

1

1

The threat of war was highlighted, and perhaps exaggerated, by Japanese Prime Minister Abe Shinzo’s

comments in January 2014, when he described Sino-Japanese relations as similar to Anglo-German rela-

tions before the outbreak of World War I. At the time, England and Germany were each the other’s lar-

gest trading partners, causing many experts, notably the English politician Norman Angell, to discount a

war as highly unlikely. Now China and Japan have significant economic ties, but also maintain fierce

distrust after Japan’s aggression in World War II and high-profile territorial disputes. Furthermore, Chi-

na’s aggressive assertion of sovereignty in the South China Sea, including the decision to move an oil

rig into disputed waters off of Vietnam’s coast in May 2014 and the rapid construction of facilities on

disputed islands, led to significant confrontation between China and the Philippines and Vietnam (Econo-

mist, 2015b). An important issue is thus what effect, if any, these tensions have on trade between the

countries of East and South-East Asia, notably China. If political tensions are decreasing trade, China’s

strong regional trade role in manufacturing may be undermined by its more bellicose stance.

©2016 John Wiley & Sons Ltd

TENSIONS, TRADE, AND CAPITAL FLOWS IN ASEAN+3 1959