How credible are China’s threats of economic retaliation in the context of bilateral disputes?

Andreas Fuchs, Nils-Hendrik Klann

This year’s Nobel Peace Prize was awarded to Liu Xiaobo, the human rights activist who is currently a prisoner in China. Beijing has condemned the decision, saying it will harm relations with Norway. This column argues this threat should be taken seriously. It shows that receiving the Dalai Lama, who is perceived as a threat by the Chinese, can decrease exports to China by as much as 8.1%.

Even before the announcement of this year’s Nobel Peace Prize laureate, a spokesperson for the Chinese Foreign Ministry warned that the selection of Liu Xiaobo would “damage China-Norway relations.”1 Shortly after the decision, China cancelled a meeting with Norway’s Fisheries Minister Lisbeth Berg-Hansen. She was originally scheduled to visit Norway’s representation at the Shanghai Expo, where the country also promotes its fishery products. Not meeting the Norwegian minister on her visit to China is perceived as a first sign of worsening bilateral relations between the two countries.

Is political compliance a precondition for sound trade relations with China?

As in the case of Liu Xiaobo, the Dalai Lama, in his position as leader of the Tibetan community, is seen as a threat to the integrity of the Chinese nation and the rule of the Communist Party. When the Dalai Lama was awarded the Nobel Peace Prize in 1989, China threatened to cut economic ties with Norway should the Norwegian king or government attend the ceremony. Since the Chinese government seeks to contain the expression of opinions that challenge the status quo of Tibet, receptions of the Dalai Lama are a constant source of bilateral diplomatic tensions with China. Figure 1 shows a map indicating where and how many times such receptions by a government official occurred between 1991 and 2008.

Figure 1. Geographic allocation of Dalai Lama receptions by government official (1991-2008)

Source: Fuchs and Klann (2010)

In response to potential meetings with foreign dignitaries, China’s administration threatens with a deterioration of bilateral trade relations with nations not abiding by its political will. The government’s decisiveness on this matter is reflected in instances such as the prominent case of France, where the country was crossed off the travel agenda of two Chinese trade delegations in 2009 in retaliation to a meeting between French president Nicolas Sarkozy and the Dalai Lama. In an interview conducted in 2007, the Dalai Lama himself acknowledged the unwillingness of state officials to receive him, so as not to jeopardise the intense economic ties that their countries have established with China.

Previous research has shown that the bilateral political climate plays an important role in trade relationships (e.g., Pollins 1989, Morrow et al.1998). Also, diplomatic exchanges between trading partners foster bilateral trade through diplomatic representations (Rose 2007) and state visits (Nitsch 2007). The state of political relations between autocratic China and its trading partners is likely to be an even more important determinant of bilateral trade than for free market economies. This idea is supported in a Vox column by Toke Aidt and Martin Gassebner from December 2008, wherein the authors argue that governments of autocracies exert more influence on trade flows than democratic administrations. This greater ability for direct influence can be explained by a lack of political accountability faced by the executive of an autocratic regime (see also Mansfield et al. 2000, Aidt and Gassebner 2010). Since China is neither a democracy, nor a free market economy, its administration has greater capacity to impact on trading decisions than democratic governments. Given the importance Beijing’s government attaches to the containment of its political opposition, it appears that China’s administration uses its extensive influence in the economy to exploit trade flows as a foreign policy tool. However, such an economic punishment mechanism will only prevail as long as the expected political gains from stabilising the regime outweigh the losses from trade diversion.

Is there a “Dalai Lama Effect” on international trade?

In our most recent paper (Fuchs and Klann 2010), we analyse to what extent bilateral tensions affect trade with autocratic China. In particular, we investigate empirically whether China responds to foreign officials’ meetings with the Tibetan leader with policies that result in a significant reduction of exports from these Dalai Lama-receiving countries. We run an augmented gravity model of exports to China from 159 partner countries between 1991 and 2008. Information on the travel pattern of the Buddhist leader is obtained from the Office of His Holiness the 14th Dalai Lama. Empirical results confirm the existence of a negative effect of Dalai Lama receptions on exports to China for the Hu Jintao era (2002-2008).

We find that meetings of a political leader with the Dalai Lama decrease exports to China by 8.1% or 16.9% on average, depending on the estimation technique used. These baseline results are robust to the restriction of the sample to the more homogeneous group of European countries, as well as the inclusion of data on partner countries’ export orientation, bilateral tariffs and the degree of voting alignment in the United Nations General Assembly, a commonly used measure of bilateral political friendship. The results also hold when controlling for the potential endogeneity of Dalai Lama meetings in our trade equation. For this purpose, the number of Tibet Support Groups in a country and the travel pattern of the Buddhist leader are used as instruments for receptions of the Dalai Lama at the highest political level.

We also investigate whether the scope of the so-called “Dalai Lama Effect” depends on the political importance of the dignitary that receives the Tibetan leader. Classifying all Dalai Lama receptions by the rank of the foreign dignitary met, empirical results show that the trade-deteriorating effect is greatest for encounters between the Dalai Lama and heads of state or government. Smaller, but still significant, effects are found when the definition of our variable of interest is extended to include government members, all national officials and, finally, all dignitaries listed by the Office of the Dalai Lama. Moreover, we find that the “Dalai Lama Effect” is mainly driven by reduced exports of machinery and transport equipment and that it disappears two years after a meeting took place.

Final remarks

In summary, our results confirm that countries officially receiving the Dalai Lama at the highest political level are punished through a reduction of their exports to China. However, this “Dalai Lama Effect” is only observed for the Hu Jintao era and not for earlier periods. This result is in line with the increased political and economic power China acquired in the world in recent years. Our results underline the importance of sound bilateral relations for trade with China. Chinese trade relations are not free of political biases and the country seems to exploit trade ties as a foreign policy tool to achieve political compliance by its trading partners. At first glance, it may seem odd that China would be willing to forgo the gains that arise from trade under efficient importing decisions in order to punish trading partners for political reasons. However, China’s political leadership may be willing to bear the economic and political costs that arise from diverting trade away from Dalai Lama-receiving countries if such “punishment” increases the likelihood of its political survival.

While political leaders should be aware of potential export losses when receiving the Dalai Lama, not meeting with him is not necessarily the conclusion to be drawn from our findings. Instead, state leaders can harness the relation between Dalai Lama receptions and trade deteriorations as a means to manifest their stance on human rights and democracy. Therefore, the willingness to bear the costs of trade reductions in conjunction with bilateral disagreements lends credible resolve to the political position of such a country (see also Morrow 2003; Gartzke et al. 2001).

Beyond that, internationally coordinated receptions of the Dalai Lama by political leaders or even joint meetings are a possibility to reconcile commercial interests with the demands to receive the Tibetan leader. Such a strategy may reduce China’s scope to play one trading partner off against another. Similarly, in the case of Liu Xiaobo, if country leaders welcome this year’s Nobel Peace Prize despite China’s protest, they should do so jointly to reduce their vulnerability towards potential Chinese retaliation.

Nonetheless, with the increasing economic power of China and other (autocratic) emerging countries, the use – or abuse – of trade ties as a foreign policy tool is likely to gain in importance.

References

Aidt, TS and M Gassebner (2008), “Political regimes and international trade”, VoxEU.org, 16 December.

Aidt, TS and M Gassebner (2010), “Do Autocratic States Trade Less?”, World Bank Economic Review, 24(1):38-76.

Fuchs, A and NH Klann (2010), “Paying a Visit: The Dalai Lama Effect on International Trade,” cege Discussion Paper 113, University of Goettingen.

Gartzke, E, Q Li and C Boehmer (2001), “Investing in the Peace: Economic Interdependence and International Conflict”, International Organizations, 55(2):391-438.

Mansfield, E, H Milner, and P Rosendorff (2000), “Free to Trade: Democracies, Autocracies, and International Trade”, American Political Science Review, 94(2):305–322.

Morrow, JD, RM Siverson, and T Tabares (1998), “The Political Determinants of International Trade: The Major Powers, 1907–1990”, American Political Science Review, 92(4):649–661.

Morrow, JD (2003), “Assessing the Role of Trade as a Source of Costly Signals”, in Edward D Mansfield and Brian M Pollins (eds.), Economic Interdependence and International Conflict: New Perspectives on an Enduring Debate, University of Michigan Press.

Nitsch, V (2007), “State Visits and International Trade”, World Economy, 30(12):1797-1816.

Pollins, BM (1989), “Does Trade Still Follow the Flag?”, American Political Science Review, 83(2):465-480.

Rose, A (2007), “The Foreign Service and Foreign Trade: Embassies as Export Promotion”, World Economy, 30(1):22-38.

This statement was given in a press briefing by Foreign Ministry Spokesperson Ma Zhaoxu.