ALLIANCES, THE WTO, AND TRADE: THE ROLE OF RELATION-SPECIFIC INVESTMENT

Abstract

Recent developments in trade theory highlight the importance of the fixed costs firms must incur before exporting. The value of these fixed cost investments is often contingent upon the continuation of particular trading relationships. While substantial bodies of empirical literature examine the impact of alliances, the General Agreement on Tariffs and Trade (GATT), and the World Trade Organization (WTO) on trade, this research largely remains premised on the Heckscher-Ohlin model of trade and thus ignores the fixed costs of exporting. Accordingly, it is bereft of explanations of how these institutions relate to newer models of trade and emphasizes their capacity to stimulate trade through tariff liberalization. In this thesis, I argue that alliances and the GATT/WTO also promote trade by resolving the dynamic inconsistency problem that normally stifles relation-specific investment. Alliances’ capacity to address this dilemma further entails that they will reduce firms’ reliance on vertical integration, which firms typically employ to protect against contract renegotiation. My empirical results are mostly consistent with these arguments. Using data on bilateral trade flows between 1962 and 2001 and a gravity model of trade, I find that allies are more likely than other countries to trade in goods that involve relationspecific investments and that this impact is particularly strong when the allies are also members of the GATT/WTO. In contrast, I do not find reliable evidence that the GATT/WTO alone promotes this trade, but this puzzling result may reflect data limitation issues. Using data on the share of intra-firm imports in the United States in 2005, I further find that alliances reduce the incidence of vertical integration. These findings underscore the importance of considering the political context of international trade and suggest that scholars may have underestimated the capacity of alliances to induce economic welfare gains.