The Influence of Economics and Politics on the Structure of World Trade and Investment Flows

Shiro Armstrong, Peter Drysdale
JEL codes: 
EABER Working Paper no. 61

The Asia Pacific region, and especially East Asia, has experienced rapid economic integration without the hard politics of legally binding economic and political treaties, unlike Europe where integration has been institutionled. The soft politics and marketled integration in East Asia set against a background of political tensions and rivalries in key relationships in the region. The paper measures trade and investment performance in the world economy. This allows comparison of bilateral and regional trade and investment flows. A measure of the effect of political distance on both trade and investment flows is also defined. The growth of ChinaJapan trade and investment, despite political distance between the two countries is discussed to highlight and elaborate on key findings. The analysis leads to five conclusions. Multilateral institutions are important in reducing economic and political distance between trading partners. While political relations do affect economic relations, their effect is not important across the vast majority of trading relationships. The important effects of political relations on economic relations come in todays world via international investment rather than through international trade. East Asian economies are leading trade and economic integration, measured in terms of their trade and investment performance and their impact on global trade and investment frontiers. Finally, of all the major regional groupings, APEC and ASEAN stand out as arrangements in which there has been no trade diversion, unlike the other formal regional groupings such as NAFTA and the EU in which trade diversion is measurable. The paper finds an APEC effect, explains how economics can dominate politics in international economic relations and recommends priority to strengthening regional and international investment regimes to help ameliorate the likely effects of politics on economic integration in the future.