gss5-figures.pdfPage 1Page 2Page 3Page 4Page 5International Trade and Transnational Insecurity: HowComparative Advantage and Power are Jointly Determined†Michelle R. GarfinkelUniversity of California, IrvineStergios SkaperdasUniversity of California, IrvineConstantinos SyropoulosDrexel UniversityCurrent Version: May 21, 2009Abstract: We augment the canonical neoclassical model of trade to allow for interstatedisputes over land, oil, water, or other resources. The costs of such disputes in terms ofarming depend on the trade regime in place. Under either autarky or free trade, the largercountry (in terms of factor endowments) need not to be more powerful. Yet, under free trade,there is a stronger tendency for arming incentives to be equalized and thus for a “leveling ofthe playing field.” Depending on world prices, free trade can intensify arming incentives tosuch an extent that the additional security costs swamp the traditional gains from trade andthus render autarky more desirable for one or both rival states. Furthermore, contestation ofresources can reverse a country’s apparent comparative advantage relative to its comparativeadvantage in the absence of conflict. And, where such conflict is present, comparisons ofautarkic prices to world prices could be inaccurate predictors of trade patterns.JEL Classification: D30, D70, D72, D74, F2, F10.Keywords: trade openness, property rights, interstate disputes, conflict, security policies.†The authors wish to thank Michael McBride, Priya Ranjan and participants of the CEPR workshop onConflicts, Globalization and Development (November 2008), especially Ethan Kapstein, for helpful commentsand suggestions.1 IntroductionThinking about international trade and trade policy is typically based on models that as-sume perfectly and costlessly enforced property rights. Especially in transnational settings,however, where there is no ultimate authority to enforce property rights, countries expendresources on their defense and diplomacy in order to secure their borders and interestsor, to put it differently, to self-enforce their property rights. Moreover, sometimes coun-tries engage in wars that induce destruction and, at the same time, imply a diversion of(otherwise) productive resources, beyond that observed during peacetime. These costs areconsiderable by several measures1and therefore, one would suspect, they are of economicrelevance. Nevertheless, assessing the economic relevance of security costs is difficult, giventhe absence of such costs in models of international trade.2As an example of the problems and issues we seek to understand, consider the countriesalong the Nile river, as discussed in Klare (2001). The economy of Egypt critically dependson the Nile flowing at the rate that it has flowed for millennia, and given Egypt’s popula-tion growth that dependence is not likely to fall in the foreseeable future. The countrieslocated upstream—i.e., Burundi, Congo, Ethiopia, Kenya, Rwanda, Sudan, Tanzania, andUganda—are poorer than Egypt, and using the Nile for power-generation and irrigationwould be a key factor in their economic development. Of course, such use of the Nile bythese upstream countries would result in a reduced flow to Egypt and serious harm to itseconomy. When Ethiopia, with the help of the World Bank, was drawing plans to builddams in its territory, Egypt credibly threatened to destroy the dams using its air force.Debates over the usage of the Nile’s water remain largely unresolved, with significant impli-cations having both security and economic dimensions. The value of water to Egypt and theother up-stream countries depends on, among other factors, their degree of trade opennessand the prices of traded goods that use water as an input. For example, the internationalprice of Egyptian cotton, a good that uses water as a main input, also affects the value of1Military expenditures alone were about 2.6 percent of world GDP during 2004, varying from less than1 percent for a few countries to more than 10 percent for Saudi Arabia (SIPRI, 2005). As for the overallcosts of conflict (including civil war), Hess (2003) estimates a lower bound for the yearly cost of conflict of 8percent of steady state consumption for the 1960 to 1992 period. For high-income countries like the UnitedStates and France the cost was a bit over 3 percent of consumption, whereas for Iraq and Iran, largely as aresult of the war between then, it was 65 percent and 26 percent of their respective yearly consumptions.2Political scientists have long been interested in the linkages between international trade and conflict. (SeeBarbieri and Schneider (1999), who have surveyed much of the theoretical and empirical literatures on thesubject.) Economists, by contrast, have only begun to explore the relationship between security and trade.Examples include Anderson and Marcouiller (2005) and Anderton et al. (1999), who analyze Ricardianmodels in which traded commodities are insecure either because of the presence of pirates and bandits orbecause the contending sides influence the terms of trade through arming. Both approaches emphasize theimportant point that international trade can be hampered by the anarchic nature of international relations.Skaperdas and Syropoulos (2001, 2002) address some of the implications of insecure property in the contextof simple exchange models.the Nile’s water flow to Egypt.For this example of international contestation of resources and similar ones,3a numberof questions naturally arise. How does insecurity of productive resources affect militaryexpenditures and other related costs borne by the countries claiming ownership of suchresources? Do these security costs vary with the trade openness of the countries involved?Does insecurity significantly distort the allocation of resources within each country towardsdifferent productive uses compared with the absence of insecurity? And, of course, howdoes insecurity affect overall economic well-being?To tackle such questions, we take a micro-founded, economic approach that allows for theinterdependence of security and trade policies. To be more precise, we extend the canonicalneoclassical model of trade, with two factors of production and two consumption goods,in two substantive ways: First, we abandon the assumption that property rights on bothfactors are perfectly and costlessly enforced. Instead, at least part of the total endowmentof one factor is considered insecure and