Geopolitical incentives for economic policies
In this paper, Becko and O’Connor provide a framework for analyzing how countries can use peacetime economic policies to prepare for potential future geopolitical conflicts mediated through trade. They highlight the importance of considering how economic integration affects not just the level of trade, but also the sensitivity of prices to trade disruptions. The authors embed a simple geopolitical game into an otherwise standard neoclassical two-country, two-period model of international trade and geopolitics. The model includes a “peace” period and a “conflict” period, with countries making economic decisions in both periods and geopolitical decisions in the conflict period. Their results indicate some interesting patterns:
Capital Subsidies:
- When a country can credibly threaten any trade taxes in response to geopolitical actions, optimal capital subsidies are zero. This is because trade threats already balance economic costs against geopolitical benefits.
- If a country’s ability to threaten trade taxes is limited by credibility constraints, capital subsidies emerge as a second-best instrument. The optimal subsidies promote investments that make the country less vulnerable to its own sanctions. These capital subsidies tend to lean away from comparative advantage, promoting capacity in imported goods and discouraging capacity in exported goods.
- If a country faces non-discrimination constraints on trade threats (e.g. WTO rules), capital subsidies again become optimal but lean into comparative advantage.
Trade Policies:
- A country’s optimal peacetime trade policies aim to influence foreign capital investments in ways that make world prices more sensitive to trade during conflict.
- Surprisingly, the optimal trade policy does not simply target changes in foreign capital that increase foreign gains from trade. It ignores changes that only affect traded quantities and focuses on changes that make foreign net export demand more inelastic.
- For typical preferences, the optimal policy discourages foreign investment in all sectors, with a stronger focus on “core” goods with high prudence and goods with high trade openness.
- To discourage foreign investment, the optimal policy generally involves subsidizing exports and taxing imports of downstream goods, while taxing exports and subsidizing imports of upstream goods.
Strategic (Dis)Integration
Authors: John Sturm Becko, Daniel G. O’Connor
From: Princeton University, MIT
Geopolitical power and economic coercion
In this paper, Clayton et al. provide a different theoretical model than the one presented in Becko and O’Connor above on geopolitical power and economic coercion. In particular, they study how a global hegemon can mitigate contracting frictions with, extract rents from, and influence the behavior of international firms by coordinating threats among domestic and domestically supplied firms. Their framework introduces concepts of “pressure points” – sets of threats that, when consolidated, lead to increased production and profits for firms – and “extraction points” – firms from which the hegemon can extract positive side payments. The authors show that strategic industries tend to have certain characteristics: a) Goods with low transport costs and wide global use (e.g., finance, information technology) are more likely to generate pressure points; b) Industries used in both upstream and downstream production are more likely to generate extraction points. The paper provides insights into recent policy developments:
- China’s Belt and Road Initiative: Linking sovereign lending with trade decisions increases borrowing capacity for recipient countries. China can extract economic and political rents by consolidating threats across finance and trade.
- Efforts like the G7’s Partnership for Global Infrastructure and Investment aim to counter China’s growing influence.
- The EU’s Anti-Coercion Instrument can be understood as an attempt to raise countries’ outside options.
A Framework for Geoeconomics
Authors: Christopher Clayton, Matteo Maggiori, Jesse Schreger
From: Yale University, Harvard University, Columbia University
