Extradyadic Effects of Preferential Trade Agreements: Unintended Consequences of Exclusion

The conventional institutionalist view suggests that international institutions, the third leg of the Kantian tripod, facilitate international cooperation by reducing transaction costs, providing information, and encouraging issue linkage (Keohane 1984; Keohane and Martin 1995; Abbott and Snidal 1998; Martin and Simmons 1998; Koremenos, Lipson and Snidal 2001). Building on this body of literature, numerous studies demonstrate that international institutions play a significant role in reducing the likelihood of armed conflicts between nations (Oneal and Russett 1999; Boehmer, Gartzke and Nordstrom 2004; Dorussen and Ward 2008). In this respect, commercial institutions are no exception. Trade agreements are widely perceived as promoting peace. Mansfield and Pevehouse (2000) contend that members within the same trade community are less inclined to engage in conflict as they anticipate future economic benefits such as enhanced liberalization and reduced opportunism. Bearce and Omori (2005) find that preferential trade agreements (PTAs) that regularly bring together high-level state leaders tend to build mutual trust and promote peaceful relations. Recent studies employing network analysis provide robust evidence that nations belonging to the same trade communities are significantly less prone to conflict (Lupu and Traag 2013). Beardsley et al. (2020) argue that a greater degree of hierarchy within trade communities further restrains interstate conflict between members due to high switching costs. Because of their generally discriminatory nature, however, trade agreements include certain states at the expense of others. The heavy focus in trade-conflict studies is placed on the pacifying impact within trade communities. Although it is important to study the security benefits of PTAs for member states, it is equally important to examine how excluding other regional players can potentially exacerbate security concerns. The establishment of inclusive international institutions is of great importance to maintain world peace. Countries can intentionally or inadvertently trade the increased peace within commercial institutions for a higher prospect of conflict with outside members, who may become more suspicious of the strategic motives as they get excluded from regional trade agreements. In this paper, I argue that PTAs improve the security externalities of member states as their economy and military grow because of PTA-prompted trade gains, resulting in changing bargaining powers against nonmembers. I distinguish between two situations: one in which the excluded country only incurs economic costs via trade diversion and one in which the cooperating countries manage to convert the gains from trade into additional military capabilities. Therefore, strengthening trade ties with a third-party state may exacerbate security concerns between adversaries with existing commitment problems through adverse power shifts stemming from disproportional trade gains when at least one of the adversaries is excluded from a trade agreement. Theorizing on both mechanisms, I hypothesize that signing a PTA increases the prospect of conflict between member and nonmember states via intensifying economic competition and shifting their relative abilities to exploit trade gains. Utilizing innovative measurements of trade diversion, the security externalities of trade, and yearly intensity values from events data, I find supporting evidence that excluding certain actors from trade communities drives conflictual outcomes.