Critically Important: The Heterogeneous Effect of Politics on Trade
28 Pages Posted: 20 Dec 2018
Date Written: December 2018
There is strong empirical evidence showing that political relations have an impact on aggregate bilateral trade flows. In this paper, we show that the impact is heterogeneous across products, depending on product characteristics. Specifically, imported products used as intermediate inputs intensively may be more sensitive to adverse shocks. This is particularly relevant in the current context of increased international input linkages. We sketch a simple theoretical framework and test the mechanism in reduced-form. We implement a difference-in-differences approach with monthly trade flows and a novel dataset of diplomatic incidents. We find that a negative shock to political relations leads to a general decrease in trade flows, and that the response is larger for products in markets with low price gaps to alternative sourcing partners and high direct and indirect imported input use.
Keywords: Trade frictions, political relations, dependence, input sourcing
JEL Classification: F14, F15, F51, F52
Suggested Citation: Suggested Citation