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Supply-Side Market Power

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1 Supply-Side Market Power: A Structural Argument for Peace through Interdependence Jaya Wen* Yale University ABSTRACT In economics, supply-side market concentration profoundly impacts the behavior and interests of firms within a market, and this dimension of economic interaction is applicable to the context of international relations. More specifically, supply-side market power changes the way trade influences the incidence of military conflict. To test this insight, I define and incorporate four new market power variables into the traditional model of military conflict. I find that high dyadic market power significantly decreases the likelihood that a state will initiate military conflict. This result is robust to a number of statistical checks and ultimately enriches our understanding of interstate conflict. * Author’s note: Special thanks to Bruce Russett, Michael Tomz, John Oneal, Jaroslav Tir, Jessica Weeks, Nathaniel Levine, and the entire MIDs team at Stanford University.2 I. Introduction The effect of trade on military conflict has been fiercely debated in modern conflict literature, though the concept arose centuries ago with liberal philosophers like Kant (1795). In an attempt to verify and refine the ideas behind peace through interdependence, contemporary scholars have tested the liberal argument empirically using data on military conflict and numerous explanatory variables. Current work predominantly suggests that trade inhibits military conflict (Russett and Oneal 2001; Oneal, Russett, and Berbaum 2003; Hegre, Oneal, and Russett 2010), although dissenting voices (Barbieri 1996, 2002; Beck 2003; Keshk, Pollins, and Reuveny 2004) contend that trade has an ambiguous or even inflammatory effect. However, these objections run contrary to a general consensus that the liberal peace exists, and there are already persuasive theoretical arguments regarding the mechanisms behind the pacifying effect of trade. There are two primary perspectives on the generation of peace through interdependence. The first view puts the mechanism in structural terms: trade promotes peace by increasing the opportunity cost of conflict (Angell 1913). In microeconomic theory, trade is a mutually beneficial exchange; it produces gains in efficiency by harnessing comparative advantages in production across parties (Mankiw 2008). Since military conflict leads to an interruption of trade, these gains from trade become an additional opportunity cost of conflict (Mansfield and Pollins 2001). Based on this idea, scholars have developed an expected utility model of conflict and interdependence and found encouraging results (Polachek 1980; Polachek, Chang, and Robst 1999). By reframing the cost of trade interruption as the gains from trade, scholars discovered a number of new approaches to structural theory. Since exchanges of goods offer varying gains in3 efficiency, the cost of trade interruption should also vary across specific factors, like the types of commodities exchanged and the nature of the dyad engaging in trade. Under the structural model, especially beneficial trades imply a higher cost of conflict than less lucrative exchanges (Polachek 1980) and thus create a stronger incentive against conflict. This segment of the literature also has implications for structural theory as a whole; it demonstrates that trade impacts conflict differently across markets and trading partners in ways intimately tied to microeconomic theory. The opportunity cost of conflict is also heavily dependent on a state‟s ability to substitute across trade partners (Hirschman 1980; Wagner 1988). When a state enters a conflict, it may sacrifice gains from a specific channel of trade, but it can potentially initiate an analogous exchange with the next best partner. If a state can switch trade partners at little or no extra cost, the pacific effect of peace will be quite small. While a significant portion of research in this field has relied on structural explanations, another major perspective holds that international trade offers a means to signal intentions (Gartzke 1998; Gartzke, Li, and Boehmer 2001; Morrow 1999). Trade policies, like embargos or tariffs, provide non-military opportunities for states to communicate how much they care about an issue. The level of a state‟s commitment to an issue determines the quantity and quality of resources a state will allocate to pursuing it, hence influencing the outcome of any potential conflicts that arise from it. Thus, revealing intentions through trade lowers the ex ante uncertainty of the conflict outcome and increases the likelihood that parties will come to a mutually beneficial settlement (Fearon 1995). Since trade behaves as a signal, this perspective is often referred to as the signaling argument. Proponents of the signaling argument often object to the structural stance, contending that4 opportunity costs are rarely large enough to prevent conflict and only impact on conflict at the margins (Gartzke, Li, and Boehmer 2001). The two sides of the debate have arranged themselves roughly along the lines of game theoretic approaches versus expected utility approaches, with most signaling models founded in game theory and most structural arguments based in expected utility. This difference in approach mirrors the essential difference between the structural and signaling arguments: the structural side believes that economic interests are directly responsible for the deterrent effect of trade, while the signaling side believes that trade is merely a method of decreasing ex ante uncertainty, a decrease which then provides the pacifying effect. In this article, I set out not to discredit the signaling perspective but rather to refine structural mechanisms so that they better demonstrate trade‟s direct role as a pacifying force. Signaling-based opponents to the opportunity cost argument tend to object to a blunt version of the developing theory without considering the more-than-marginal impact of interests under certain reasonable conditions, but many studies providing a more refined view of trade and its impact on conflict have already demonstrated that trade is not indiscriminately pacifying, as factor mobility (Hirschman 1980), elasticity of demand and supply (Reuveny 2003; Yarbrough and Yarbrough 1992), and the nature of the traded commodity (Dorussen 2006) all change the impact of trade on peace. The circumstantial nature of opportunity


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