Political alliances and trade: Europe in a polarized world

This study investigates how political alliances influence trade and welfare in Europe and major global economies amidst escalating geopolitical tensions. Utilizing a panel data approach, we assess the impact of military alliances on trade through structural gravity and staggered difference-in-difference methodologies. We further simulate the potential trade and welfare effects of the strengthening and disintegration of political alliances within blocs. Results reveal significant trade and welfare consequences stemming from the expansion or disintegration of the North Atlantic Treaty Organization (NATO) and the establishment of a military alliance under the Shanghai Cooperation Organization (SCO). From a European point of view, our results suggest that the accession of new NATO members will bring economic benefits, while the US leaving NATO, or the deepening of the SCO, will bring negative trade and welfare effects. If a US exit from NATO triggers a disintegration of the alliance and the SCO creates a military alliance, this would lead to severe negative consequences for the EU. Notably, the study finds that the benefits of collective security provided by NATO substantially outweigh the costs associated with its 2% defence spending requirement.