East-West trade involves numerous forms of contract that vary in the extent to which they bind the parties, from spot transactions through tying contracts (countertrade) to common ownership (joint ventures). Before 1989, some 60% of East-West trade took the form of spot import transactions and some 40% was countertrade. This was generally attributed to the shortage of foreign exchange and the low quality of East European goods.

In Discussion Paper No. 673, Research Fellow Dalia Marin attributes these economies' countertrade instead to their desire to mitigate the contractual hazards arising in risk-sharing, marketing and technology trade. This allowed the centrally planned economies (CPEs) to sell forward the products they planned to produce for export to guarantee their foreign exchange earnings and also required the OECD firms to invest up front in distribution and marketing. Tying exposed them to the ex post contractual risk that the CPEs might produce goods of poor quality, while exposing the CPEs to the risk that OECD firms would not provide the after-sales service and upgrades that are essential to successful technology transfer. By increasing their mutual dependence, both parties credibly committed the reliability of their future conduct.

By signing a tying contract ex ante, the parties deter potential ex post exploitation: tying acts as a commitment device against renegotiation during the contract's execution. The consequent reallocation of power in ex post bargaining reflects the importance of the each party's ex ante investment. A low compensation ratio (the degree of tying) gives the OECD firms a high punishment potential: the value of the technology an OECD firm sells to a CPE is larger than the value of the goods the CPE is selling to the OECD firm, which locks the CPE into the relationship more strongly than the OECD firm.

Marin maintains that the tying contract also raises the ex post incentives of the OECD firms as technology suppliers to provide upgrades and not to overstate the quality of their technology. Countertrade thereby acts as an efficient governance structure, securing technology spillovers from OECD countries to CPEs. She uses a sample of 230 countertrade contracts signed between OECD firms and CPEs during 1984-8 to estimate the extent of tying as a function of their ex ante investments, the risk the OECD firms absorb, and reputation in repeated contracting. She reports that these data are consistent with the view that the CPEs used countertrade to secure technology spillovers from OECD countries and as a means of securing efficient marketing of their exports that substitutes for a perfect risk market.

Tying, Risk-Sharing, and `Lock-in': An Investigation of Countertrade Contracts
Dalia Marin