International Politics and Import Diversification in the Second Wave of Globalization

We provide evidence that deterioration of relations between the United States and another country, measured by divergence in their UN General Assembly voting patterns, reduces US imports from that country during the second wave of globalization. Though statistically significant, such an effect of political distance on trade is small compared with the frictions imposed by other trade barriers. Indeed, using sector-level trade data, we show that except for petroleum and some chemical products, US imports are not affected by international politics. American firms, however, diversify their import of crude oil significantly away from the political opponents of the US, even after controlling for wars, sanctions, and tariffs. To explain the distinctive political impact on oil import diversification, we test the strategy commodity hypothesis over the hold-up risk hypothesis, because while oil is widely thought to be a strategic commodity, oil trade is also often associated with backward vertical FDI that is subject to the risks of hold-up and expropriation. Our results suggest both political and economic forces are at work. First, although the political limits on oil import are only significant when American firms import oil from dictators, the effect is even more pronounced when the exporting countries have high expropriation risk. Second, a similar import pattern is observed only for other major powers or countries with oil companies operating overseas. Finally, we show that while the US imports of a few strategic commodities, such as tin, are also discouraged by political distance, a similar political effect is also observed in the import of R&D intensive goods, in which case quasi-rents derived from backward FDI in R&D may be expropriated by a hostile government.