How do Firms Respond to Long-term Political Tensions? Evidence from Chinese Food Importers

Abstract

<p>Political and economic tensions, which often jeopardize trade, are rising among the world’s major powers, and countries like China are more frequently using food-related trade actions to deal with deteriorating political relations. Previous literature largely focuses on how brief, short-lived political tensions affect bilateral trade; however, little is known about firm-level trade responses to long-termpolitical tensions. This paper investigates how importers respond to long-term political tensions by examining the six-year Norway-China political tensions that ended in 2016. In particular, we use an event study approach to examine China’s seafood importers’ responses to China’s 2010 sanction on Norwegian fresh salmon imports after Norway awarded Liu Xiaobo, a Chinese political dissident, a Nobel Peace Prize. Our results reveal firm-level responses at both the extensive and intensive margins. At the intensive margin, firms that imported Norwegian fresh salmon before the sanction saw a 20% persistent decline in their fresh salmon import value and an 80% decrease in import share of Norwegian fresh salmon products over our study period. At the extensive margin, we not only find a trade diversion effect on firms importing from other countries and less firms importing fresh salmon from Norway, but also a permanent "political hedging" effect with a 20% decline in the maximum import share from any particular country, even if not Norway. We also provide evidence of persistent sanction effects even after China-Norway relations unfroze. Our findings emphasize the need to consider the long-term sanction consequences in foreign policy using food-related trade sanctions.</p>