Trade Embargoes
Carry a big stick but walk softly

Over the past four decades the United States and Western Europe have adopted very different policies towards East-West trade. Western Europe has recognized the linkages between trade and political relations but is reluctant to use trade policy explicitly as a political tool, while the United States has been willing to use trade embargoes for political ends.

In Discussion Paper No. 139, International Trade Programme Director Alasdair Smith contrasts two views of the connection between trade and political relations, the linkage and the leverage views. 'Linkage' focuses on the positive political effects of stronger economic ties: mutually beneficial trade gives each trading partner an incentive to avoid conflict. 'Leverage' refers to the use of economic pressures, such as threats of trade embargoes, for political objectives. The attractiveness of an embargo depends on the relative costs which it imposes on the parties involved. These costs are positively related to the share of a country's income derived from the embargoed trade. Perhaps even more important is the availability of substitutes for the embargoed good(s). The gains from trade (and the costs of the embargo) are negatively related to the price elasticity of the trade. The importance of substitution elasticities to the costs of the embargo means that an embargo is less likely to be successful the longer its duration; in the long run substitution elasticities increase. Moreover, the more countries join an embargo the greater will be the share of a country's trade which is embargoed and the greater the effect of the embargo. A more successful embargo, however, means higher profits from breaking it. Policing is therefore critical: embargoes on widely traded 'anonymous' goods such as grain and oil are less likely to be successful than those on supercomputers.

The issue of extraterritoriality often arises in discussions of the effectiveness of embargoes. The behaviour of foreign subsidiaries of US multinational corporations was highlighted by the 1981-2 pipeline dispute between the United States and Western Europe. Smith argues that this issue is merely one aspect of the more general question of how a multinational firm's investment decisions are affected by its expectations of government behaviour. Smith develops a formal model of multinational firms' decisions to enter new markets and to invest in productive capital, emphasizing the strategic and forward-looking nature of the investment decision and its consequences for policy. The multinational firm must decide whether to establish a foreign subsidiary in a market, to supply the market from exported home- country production, or to license technological knowledge to independent foreign producers. This choice will be influenced by its expectations of future embargoes. It may decide to establish a foreign subsidiary or to license technology to a foreign firm in order to reduce the power of the home government over its activities. Smith applies this model to the analysis of US and West European trade with Eastern Europe, assuming that the actions of foreign subsidiaries are beyond the reach of the multinational's home government. An embargo can therefore only be effective if the multinational has chosen to produce at home and then to export, highlighting the role of multinationality in reducing the effectiveness of embargoes.


East-West Trade, Embargoes and Expectations
Alasdair Smith

Discussion Paper No. 139, November 1986 (IT)