State Control and the Effects of Foreign Relations on Bilateral Trade

Abstract

Can governments still use trade to reward and punish partner countries? While WTO rules and the pressures of globalization restrict states’ capacity to manipulate trade policies, politicization of trade is likely to occur where governments intervene in markets. We examine state ownership of firms as one tool of government control. Taking China and India as examples, we use new data on imports disaggregated by firm ownership type, as well as measures of political relations based on bilateral events and UN voting data to estimate the effect of political relations on import flows since the early 1990s. Our results support the hypothesis that imports controlled by state-owned enterprises (SOEs) are more responsive to political relations than imports controlled by private enterprises. This finding suggests that politicized trade will increase as countries with partially state-controlled economies gain strength in the global economy.

Keywords: International trade, Diplomatic tensions, State-owned enterprises, Firm ownership, Event data, UN voting, China, India

JEL Classification: D74, F13, P16, P26