States Held Hostage: Political Hold-Up Problems and the Effects of International Institutions

This paper argues that the benefits of international institutions accrue disproportionately to pairs of states that find cooperation most difficult. It determines which states achieve the greatest gains from these institutions by identifying a central reason that states fail to cooperate in international relations: they fear being “held up” by other states for political concessions. Political hold-up problems occur when one state fails to undertake an otherwise productive investment due to the increased ability it would give another state to extract political concessions. Focusing on the World Trade Organization (WTO), I demonstrate that political hold-up problems are pervasive in international relations due to links between economic and political policies, but that international institutions can solve hold-up problems by helping to enforce agreements. I first formalize this argument and then empirically test the implications derived from the model, finding that the WTO increases trade most for politically dissimilar states by reducing states’ abilities to hold up their trading partners for foreign policy concessions. I provide evidence of the causal mechanism by showing that WTO membership increases trade in contract-intensive goods and boosts fixed capital investment. I conclude that by solving political hold-up problems, international institutions can normalize relations between politically asymmetric states that differ in terms of capabilities, regime types, and alliances.