In 1976 the United States and Mexico discussed the construction of a natural gas pipeline that had the potential to improve both countries’ welfare through gains from trade. However, Mexico expressed concerns that once the pipeline was built, the United States could violate the agreement's terms to extract political concessions from Mexico (Grayson 1981, 37–49). For example, the United States might threaten to curb imports or even seize the pipeline unless Mexico met its demands. The two states therefore failed to reach an agreement at the time.

Such political hold-up problems pervade relations between many states in the absence of international institutions. When states trust each other not to use trade for coercion, economic cooperation can occur. However, when they worry that their partner will use the cooperative arrangement to exercise coercive diplomacy, as Mexico feared the United States would, they avoid engaging in bilateral trade and investment.

These suspicions exist between two types of states in particular: those with dissimilar capabilities and those with dissimilar policy preferences. Consider the impact of asymmetric power on bilateral trade and investment. When one country possesses much stronger capabilities than another, it is typically much more difficult to coerce than the weaker state because it relies on cooperation with the weaker state much less than the weaker state depends on cooperation with it. For example, if a weak state invests in trade relations with a strong state, it may incur a large cost from the investment but reap little reward, because the strong state can then use the cooperative arrangement to coerce the weak state to make concessions. By contrast, the weak state is generally unable to hold up the strong state, because the strong state places a lower value on the bilateral arrangement. Because weak states anticipate powerful states’ attempts to use agreements for coercive diplomacy, they frequently fail to undertake investments whose profitability requires cooperation with their stronger partners.

Now consider the effect of dissimilar policy preferences on the prevalence of hold-up problems. Asymmetric foreign policy interests indicate that states are more likely to espouse views and prefer actions contrary to their partners’ wishes.