Prisoners’ Dilemma in Trade War
https://www.ft.com/content/d288a98e-2e90-11e8-9b4b-bc4b9f08f381
Over the past years, the world’s two largest economies have imposed tariffs on billions of dollars on each other’s goods, and the rounds of escalation still continue. US President Donald Trump has long accused China of unfair trading practices and intellectual property theft, while China claims that the US is trying to curb its rise. Donald Trump and his administration believe that impose a high tariff on China would boost the United States’ economy and China would not retaliate, which is proven false both by reality and Prisoners’ Dilemma. In China’s perspective, more payoff can be attained if she imposes retaliatory measures taking account of economic costs and political benefits. Similarly, the US will also escalate tariff and refuse to set the tariff back to original magnitude. As a result, both countries impose tariffs successively.
This reminds me of the Game Theory and Prisoners’ Dilemma introduced in lectures. Suppose there are two players, China and the US. Each player has two strategies, either to increase their tariff or to remain constant. If the US continues to impose a high tariff, then China will be more beneficial also to impose tariff in respond. If the US does not increase tariff, then China will still attain more payoff to retaliate against the US. Therefore, the dominant strategy for both countries is to impose a tariff on each other. However, in this game, there are two Nash equilibria, one is at when both countries do not change their tariff and the other is at when both countries all increase tariffs. Apparently, one is good Nash equilibrium and the other is bad Nash equilibrium. Although both tend to achieve in good Nash equilibrium, this game, akin to a classic “Prisoners’ Dilemma”, the players gravitate towards a bad Nash Equilibrium. “Prisoners’ Dilemma” has strictly dominant strategies, which is imposed a tariff to other players in this case. Both, however, have the property that players can benefit if they cooperate, but risk suffering if they try cooperating while their partner does not.
Unlike the classic Prisoners’ Dilemma where two prisoners cannot communicate, cooperative behavior has a chance to lead to a good Nash equilibrium. Nevertheless, negotiations between the two countries are ongoing but have proven difficult. Two sides remain far apart on issues including how to roll back tariffs and enforce a deal. The good Nash equilibrium never happens. This trade war is hurting business and weighing on the global economy. According to this article, all countries lose in this game. Neither the US will win by starting a trade war with China, nor China will win by retaliating. When the US initially increased tariffs, IMF’s simulation on global economic model shows that there is an impact of 10% extra US tariff on all imports of goods from the rest of the world, which decreases US GDP by approximately 1% and global GDP by 0.3% in the long run. “Inevitably, the economic damage in China, the EU, and other countries would result in political pressure to retaliate by imposing tariffs on US exports”, which will hit US economy as well as global economies.
Given the fact that they did negotiate, we can see Prisoners’ Dilemma dominant the interpretation to real-world scenario. Under this analysis, successive rounds of retaliation are possible, leading to an even worse situation, which has turned into reality recently. US President Donald Trump raised tariff rates to 30% on Chinese goods in response to China’s retaliation. The article provides an assumption that if all countries impose a retaliatory 10 percent extra tariff on all imported goods from the US, then all global trade in goods would be subject to a rise of 10 percentage points in applied tariffs. Furthermore, according to the graph of OECD shown in the article, United States will undergo an approximately 15% decrease in export, 7% decrease in imports and 3% decrease in GDP, while China will suffer a drop in 12% in exports, 11% in import and 2% in GDP.
The increase of tariff started by the US will only lead to the worst situation due to the Prisoners’ Dilemma unless negotiation succeeds.