The economics of targeted sabotage
The paper by Jin Liu, Martin Rotemberg, and Sharon Traiberman uses a two-country Ricardian trade model where one country can strategically reduce the other country’s productivity as a form of industrial policy. The authors extend this framework to account for imperfect substitutability between domestic and foreign products, trade costs, and varying spending patterns across sectors. The core contribution of this paper is deriving sufficient statistics that make welfare effects quantifiable using readily available data: trade elasticities, import shares, production shares, and within-sector elasticities of substitution.
Findings:
The analysis uncovers a striking non-monotonic paradox in how sabotage affects national welfare:
- Partial sabotage hurts the saboteur: Destroying only some of a foreign country’s production capacity raises prices without bringing production home, making consumers worse off and eliminating the terms-of-trade benefits needed for positive gains.
- Comprehensive sabotage can help: When sabotage is extensive enough to shift production entirely to the home country, it generates favorable terms-of-trade changes that outweigh the efficiency losses from higher prices, potentially raising national real income.
- Semiconductor paradox: For the US targeting Chinese semiconductor production, the findings are stark: partial restrictions would reduce American real income, while comprehensive sanctions could increase it—though the magnitude of gains depends on how substitutable foreign and domestic chips are.
- Where sabotage works best: The policy is most effective when targeting goods where comparative advantages between countries are small, allowing production relocation without massive efficiency costs.
- Export controls as sabotage: The CHIPS Act and similar semiconductor export restrictions function as “soft” comprehensive sabotage, but their benefits are partially offset by foregone export revenues on the restricted inputs themselves.
Sabotage as Industrial Policy
Authors: Jin Liu, Martin Rotemberg, Sharon Traiberman
From: UPenn, NYU
Geopolitical fragmentation and defensive innovation
Joel P. Flynn, Antoine Levy, Jacob Moscona, and Mai Wo, in this paper, examine how foreign political risk drives domestic technological innovation and reshapes international trade patterns. The authors develop a two-country endogenous growth model where firms can produce using either domestic labor or imported inputs, and can invest in innovation to increase productivity. Political shocks create uncertainty around the cost and availability of foreign inputs, generating incentives for defensive innovation.
The empirical analysis exploits multiple data sources: US patents from PatentsView linked to industries, political risk measures from the International Country Risk Guide (ICRG), trade data from UN Comtrade, and geopolitical alliance information from the Correlates of War project and UN voting patterns. The key identification strategy relies on sector-level exposure to foreign political risk, which is constructed by weighting country-level political risk by a sector’s baseline import dependence on each country. This approach isolates the effect of exogenous foreign political shocks rather than domestic trends.
Findings
- Political risk drives innovation: Sectors with higher exposure to foreign political risk exhibit significantly greater innovative activity. A one standard deviation increase in political risk exposure raises patenting by approximately 22% annually, with effects roughly 50% larger when measured over decades, indicating that innovation responds more strongly to persistent changes in risk.
- Geopolitical alliances matter: The innovation response is substantially stronger for political risk emanating from geopolitical adversaries than from allies. Government-related sources of political risk (such as democratic backsliding or military involvement in politics) drive this differentiation, as firms anticipate that governments are more likely to impose trade restrictions between geopolitical foes. Direct evidence shows that following political risk shocks, countries impose trade-restricting policies disproportionately on non-allies.
- Asymmetric economic consequences: While directed innovation reduces countries’ reliance on risky foreign markets, this protective mechanism is available only to innovation-intensive countries. Less innovative countries cannot weather political shocks through technology development. Critically, when domestic political turmoil occurs in countries experiencing rising political risk, their exports decline disproportionately to markets that are most innovation-intensive—markets that have “innovated away” their need for imports. This exacerbates export losses for politically turbulent countries.
- Firm-level response heterogeneity: The aggregate innovation response operates through both extensive and intensive margins: new firms enter innovation activity while existing innovators expand. The analysis identifies three firm types: “laggards” that continue importing despite rising risk, “insurance innovators” that develop defensive capabilities, and “classical innovators” driven by general equilibrium price effects.
Foreign Political Risk and Technological Change
Authors: Joel P. Flynn, Antoine Levy, Jacob Moscona, Mai Wo
From: Yale, Berkeley, MIT
