Trading around geopolitics

Abstract

Geopolitical fragmentation triggers complex dynamics in international trade. Sanctions forcing existing (large) exporters to discontinue or reduce their sales in target countries create profit opportunities in these countries. But firms responding to these opportunities face (i) risk of nonpayment, (ii) reputational risks and the threat of punitive measures, if their trading with unfriendly countries is exposed, and (iii) higher costs of established trading practice, such as making payments in international currencies through international circuits. This paper builds a stylized model accounting for these factors and provides empirical evidence exploiting developments in Türkiye’s international trade in the aftermath of Russia’s invasion of Ukraine and the subsequent introduction of Western sanctions on Russia. Our results show that Turkish exports to Russia have risen sharply and particularly so in sanctioned products, with Turkish firms charging higher markups and prices. These developments were accompanied by an increase in the share of cash-in-advance transactions and the share of Turkish firms invoicing in Turkish liras instead of dollars. Overall, the paper provides evidence of strong trade diversion, particularly for products for which the pre-war market share of European exporters was high. However, exports of firms with significant Western ties via ownership and trade have dropped or remained un-changed.