Alliances, imperfect markets, and major-power trade

The "new" trade theory and standard trade theory make different predictions about the composition and distribution of trade flows. Empirical evidence suggests that an increasing share of international trade consists of differentiated products, a consequence of increasing returns to scale. Nonetheless, the existing political science literature typically assumes that the conditions of standard theory hold. As such, the literature ignores the dynamic-inconsistency problem that imperfect markets can create. In doing so, it also ignores the fact that imperfect markets can shift the political prerequisites of open international markets. In this article we examine these shifts. We argue that alliances can support an optimal level of trade when scale economies rather than differences in relative factor endowments motivate it. Our empirical results support this argument, indicating that alliances exert a stronger influence on trade in goods produced under conditions of increasing rather than constant returns to scale.