University Park, Pa. -- Countries that maintain in-depth financial and economic ties with each other are less likely to engage in military conflict, according to a Penn State study.
"Political analysts have observed for several centuries that international trade inhibits interstate war between countries by raising the cost of military violence," says Dr. Quan Li, assistant professor of political science. "Recent studies by John Oneal, Bruce Russett and several others evolve along this liberal reasoning. Our study, however, shows mathematically that it is not the prospective loss of trade, but the costly signaling of resolve by manipulating economic ties that render exchanges of violence unnecessary. Furthermore, we show statistically that compared with trade ties, capital market and monetary policy linkages are more effective in inhibiting conflict behaviors. In short, monetary ties allows countries to fight with money, rather than with bullets. "Financial interdependence incorporates portfolio investment of funds in foreign companies; loaning and borrowing between banks in different countries; and direct investment, an example of which would be an American company opening a factory in China," Li says.
Li, Dr. Erik Gartzke, assistant professor of political science at Columbia University, and Charles Boehmer, Penn State doctoral candidate in political science, published their findings in "Investing in the Peace: Economic Interdependence and International Conflict" recently in the journal, International Organization.
The researchers constructed a game theoretic model to compare the opportunity cost and costly signaling arguments. The model shows that the benefits of interdependence have no discernable effect on the probability of conflict, but a country's willingness to signal costly resolve by manipulating the interdependent ties decreases the probability of fighting. The authors also argue for a notion of interdependence that covers not just trade ties, but also capital market and monetary policy linkages.
The researchers examine their claims statistically over a sample of political relevant dyads from 1951 to 1985. The dependent variable is the onset of Militarized Interstate Disputes -- meaning threats, displays or uses of military force. Political relevant dyads are defined as pairs of countries that are either neighbors or involve one of the five major post-World War II powers:
A country on the verge of hostilities with another country already knows the monetary value of its trade with that other country. Therefore, the researchers say, the risk factor in terms of trade is not an unknown. However, what each country doesn't know is how strongly the other country is willing to fight over some other issue beside trade: a slice of territory coveted by both countries, a military build-up perceived as a threat, the exposure of a spy network or the mistreatment of an ethnic or religious minority, they note.
"Interdependent countries are in a better position to test the resolve of economic partners because they can more effectively exert non-violent (i.e. economic) pressure, and then observe the consequences," Li notes. "By taking commercial measures that represent both a clear and credible threat, a state can signal to economic partners that it is prepared to make considerable sacrifices. If, however, these sacrifices are too critical, the country could lose bargaining power in future conflicts.
"In the event of a serious dispute, countries that are autarkic or economically isolated are most at risk of war, because they have no financial bargaining chips. All they can do is fall back on bluff and `cheap talk.' Should that fail, their only option is to fight," says Li.
The Suez crisis of 1956 is an example of how economic interdependence allows countries to compete financially rather than through force. On July 26 of that year, Egyptian President Gamal Abdel Nasser nationalized the Suez Canal, prompting protests from Great Britain and France. When negotiations failed to resolve the crisis, British and French forces invaded Egypt on Oct. 31. Despite a U.N. General Assembly resolution ordering a cease-fire and vocal opposition from the United States, Britain and France persisted in their attempts to occupy the canal and overthrow Nasser.
On Nov. 5, the United States, which then represented 45 percent of the world economy, decided to take action against its traditional allies, Britain and France. Rather than employing military force, the U.S. government started selling off its supply of British pounds sterling, compelling the central bankers in Britain either to buy pounds on the market or face a devaluation of their currency relative to the dollar, the international benchmark at that time. This caused British reserves to fall 15 percent within a month.
"U.S. Treasury Secretary George Humphrey informed Britain that, unless it obeyed the U.N. resolution and withdrew from Suez, the United States would continue to sell pounds and block British access to International Monetary Fund reserves," Li notes. "The United States, by far the biggest contributor to the IMF in those days, could block loans from the IMF by simply refusing to lend it the money. U.S. control of the IMF assured that Britain remained in an economic predicament that the United States had created. This strategy had the desired effect. On Nov. 6, Britain ordered a cease-fire, in effect forcing the French to end military operations as well."
The increasing economic openness of China might have just helped in preventing a military contest between China, Taiwan and the United States during the wake of Taiwan's 2000 presidential election. The admission of China to the World Trade Organization will foreseeably generate the positive political externality of promoting peace, the researchers say. In contrast, the economically isolated Afghanistan appears to serve as an example of the effect of economic autarky.
"Our findings provide new evidence supporting a new theory why liberal economics may be at least as vital to peace as liberal politics," Li adds.
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