Trade and conflicts: Do preferential trade agreements matter? Arslan Tariq RANA* Abstract A long debate continues whether international trade institutions (specifically preferential trade agreements, (PTAs)) affect security relations between states. Contradicting theories and empirical claims are put forward by realists and liberals. The former posit that the institutions are epiphenomenal and possess no power to constrain state behavior whereas the latter claim that the institutions are likely to promote cooperation by supplying forums for consultation, arbitration and adjudication, thus reducing the risk of war between states. This study identifies an important channel through which the legal dimension of trade agreements (hence Dispute Settlement Mechanisms in PTAs) may have pacifying effects on the outbreaks of war. Dispute Settlement Mechanisms of PTAs do have strong implications for MIDs, although not directly, but through low-level of foreign policy disputes, such as economic sanctions. If economic sanctions are believed to escalate to violent conflict, PTA DSMs may reduce the probability of war by mitigating the escalation of economic sanctions. However, the level of legalism differs among DSMs in PTAs. The present study first confirms empirically that sanction disputes escalate to militarized disputes and further, addresses the selection issue by using bivariate probit model. I find a sizeable impact of medium level of legalism reducing the sanctions escalation into war whereas high level of legalism, in which the state sovereignty is limited, do reduce the probability of sanctions but have no impact on war probability. Further, the interstate political cooperation proves to be a strong determinant for highly legalistic PTAs but not in the case of medium level of legalism. JEL classification: D74, F15, F51 Keywords: international relations, trade, dispute settlement mechanisms, war * Laboratoire d’Economie d’Orléans (LEO) UMR 7322 - CNRS, Faculté de Droit, d’Economie et de Gestion Rue de Blois – BP 26739, 45067, Orléans Cedex 2, France. Cell # 33(0) 6 26 55 39 30. Email: [email protected] 1 1. Introduction In 1945 A.O. Hirschman launched a timely debate on the role of international trade as a major factor influencing conflicts and even wars between states. This was also the time when the international community had to be reconstructed through complex cooperation mechanisms with the view to build on lessons of past errors. Two centuries before, the German philosopher I. Kant, trying to devise a scheme for perpetual peace, had seen in international trade a powerful mean to consolidate peaceful relationship between states, thus praising sweet trade. There is no contest on the fact that trade is central in antagonistic or cooperative relationships of nations pursuing legitimately their own interests. Still the ways through which trade institutions, trading arrangements and more recently the ever growing various types of free trade agreements, orientate states towards resolution of conflicts or stalemate, has to be revisited. Specifically, the legal dimension of trade institutions (hence Preferential Trade Agreements) plays an important role for the preservation of peace. Also it is important to identify the ways through which the institutional (legal) dimension in PTAs (Duina and Morano-Foadi, 2011) may or may not have a profound effect on peace. The aim of this chapter is to identify statistically the contribution of various form of institutionalization of trade relationship on conflict outbreaks of varying intensities (including wars), to identify also the channels through which these institutions mitigate or eventually exacerbate latent conflicts. The literature in international relations identifies three pillar, based on so-called Kantian tripod, through which peace can be preserved (Russett and Oneal, 2001) which are democracy, economic (trade) interdependence and international institutionalization. Indeed, realists believe that trade induces conflict (Hirschman, 1945) or have no impact on the establishment of peace (Keshk et al, 2010) due to the existence of asymmetries in trade relationship whereas for the liberals, trade increases the opportunity cost of war and thus promotes peace (Hegre et al., 2010; Martin et al., 2008). Obviously, it is not possible 2 to claim that all military conflicts originate in confrontation of trading interest. But trade would nonetheless play a central part in the set up of latent or developing conflicts. For this reason, the effects of trade interdependence on military conflict have become a widely discussed issue in economic and political literature. Furthermore, the role of institutions devised to organize trading relations, to set up rules to solve conflicts and to provide a legal framework to commercial exchanges, was viewed as central in these processes of cooperation and confrontation among nations. After 1945, institutions developed predominantly as multilateral organizations, but more recently, regional organizations and even bilateral preferential trade agreements began to occupy the front stage (e.g. Mansfield and Pevehouse, 2000). Consequently, the legal dimension of PTAs became essential to contain possible conflicts (Russett and Oneal, 1998). Indeed, Robert Schuman accentuated the idea of a governing body, during the creation of European Steel and Coal Community, a predecessor to today’s European Union. In his words: “By pooling basic production and by instituting a new High Authority, whose decisions will bind France, Germany and other member countries; this proposal will lead to the realization of the first concrete foundation of a European federation indispensable to the preservation of peace.” The Schuman Declaration – 9 May 19501. The basis of this High Authority, as well as in other trade agreements, lies in the creation of Dispute Settlement Mechanisms (DSMs) that perform numerous functions reducing transaction costs through restraining norm-breakers, mediating among the conflicting parties, arbitrating and adjudicating. 1 http://europa.eu/about-eu/basic-information/symbols/europe-day/schuman-declaration/index_en.htm 3 Preferential Trade Agreements, however, differ greatly in terms of legalization. Low level of legalism leaves to political/diplomatic negotiation the responsibility to resolve disputes, whereas medium level of legalism organizes the establishment of ad hoc panels (third party), whose arbitration is legally binding. These institutions are referred as quasi-judicial (Chase et al., 2013). Finally, the highly legalistic mechanisms allow for standing tribunals and courts. These represent the highest form of institutionalization. This chapter will provide an empirical analysis of the impact of various types of dispute settlement mechanisms in PTAs on militarized disputes. A two-stage approach is proposed, where the link between DSMs and sanctions is combined with the link between sanctions and militarized disputes. First, the effects of threat and imposition of economic sanctions are analyzed using a simple probit model. Then, the selection issue is addressed in order to analyze the escalation of lower-level of disputes (economic sanctions) to the higher level of disputes (militarized interstate disputes) across country pairs using a bivariate probit model covering the period 1950-2001. Correlates of War (COW) database is used for the information on Militarized Interstate Disputes at country-pair level2. The data on economic sanctions is extracted from Threats and Imposition of Sanctions (TIES) database. The paper proceeds as follows. The next section offers a broad review on the relationship between different aspects of international institutions (notably Preferential Trade Agreements) and militarized interstate disputes. Section 3 presents the analysis of the effects of sanctions on militarized conflicts. Section 4 presents the analysis on the impact of institutionalization of PTAs on war probabilities through sanctions, section 5 analyses the determinants of institutionalization of PTAs whereas section 6 concludes. 2 Currently the Correlates of War (COW) database offers the data till 2001, however, it will be updated till 2010 in the near future. It will then be possible to extend the analysis, to include the important wave of PTAs post 2001. 4 2. Trade institutions and interstate conflict The literature in international relations on economic interdependence has recently renewed its attention on the relationship between international trade institutions and agreements and interstate conflict, introducing econometric methods. Like in the old debate, a controversy exists between realists and liberals, who theorize contradictory effects of trade institutions on violent conflict. The so-called realist school of thought considers international institutions to have little impact on the propensity of states to engage in conflicts. In the presence of powerful nations and international anarchy, organizations have little importance and reflect the interests of powerful states. The realists note that customary international law is very weak, so is the regulatory power of supranational institutions to protect the rights of states in the international system. This is the reason why these institutions could not play a vital role in reducing international conflict. Even in the context of European Union (which in the most advanced stage towards political union), Mearsheimer (1990) casts doubt on the belief that EU, as an institution, has played a major role