Tradeoffs, Tariffs, and Trade Wars
Like in many bilateral interactions, the classic prisoner’s dilemma underpins the approaches taken by countries in trading matters, especially regarding tariffs, or taxes on imported goods. However, investigating the Nash equilibrium for one round of tariffs may not entirely explain expected choices and outcomes between countries across a long trading relationship. When studying trade between countries, scholars of international relations often center analysis around two diametrically opposed approaches to global trade: protectionism, primarily characterized by the imposition of tariffs to protect domestic industries; and free trade, characterized by the absence of such restrictions. As noted by Dottle, Roeder, and Wolfe (2018), tariffs are the core vehicles by which trade wars are waged, and by imposing steep tariffs, protectionist states can depress the appeal of imports by making them more expensive, thus heightening the appeal of now comparatively cheaper domestic goods. With this conceptual overview, the following two-by-two table can be intuitively constructed. This table, which details the strategies of two countries, namely T (impose tariff) or NT (do not impose a tariff), reflects the four possible outcomes of a bilateral trade standoff. If no country imposes restrictions on the other’s trade, they enjoy free trade and will reap reasonably high rewards, and if both countries impose tariffs, they both suffer economically. Notably, however, if a country imposes tariffs and the other does not retaliate, then the aggressor enjoys considerably higher economic benefits and the tariff recipient suffers even more than if it had imposed restrictions of its own. Given these conditions, a tariff standoff mirrors the classic prisoner’s dilemma.
Similarly to how the dominant strategy for each player in the prisoner’s dilemma is to confess, the dominant strategy for each country in a tariff standoff is to impose tariffs, establishing a Nash equilibrium that results in less-than-ideal payoffs for the two combined. This theoretical approach to trade wars, therefore, explains why the imposition of tariffs is rarely without consequence—targeted countries frequently respond in kind, primarily to foment economic pain and thus coerce trade aggressors into dropping the aforementioned tariffs. Thus, with the information covered so far, it seems logical that countries will always impose tariffs, thus making trade wars seem inevitable and endless.
However, while the aforementioned table and framework inform the likely outcome of one round of a tariff standoff, a lengthy trade relationship involves many such rounds and therefore broader approaches to decision-making. In their article, Dottle, Roeder, and Wolfe (2018) contend that this approach only accounts for a brief snapshot—say, one exchange (or non-exchange) of tariffs—of a far longer bilateral trading relationship. When many more rounds of the dilemma are run, and when each participant (country) is aware of the previous rounds’ moves and outcomes, a participant can generously avoid imposing tariffs when the other participant avoids doing so in the previous round and retaliate if the participant restricts trade. Thus, this framework theoretically means that if the countries do not know the number of rounds that will occur, they might be inclined to work together and avoid tariffs—such an approach would be more beneficial than imposing tariffs forever, even if it might run contrary expectations based on the table’s Nash equilibrium. This concept, which Dottle, Roeder, and Wolfe (2018) call a “repeated prisoner’s dilemma,” adds to our understanding of countries’ potential choices regarding trade restrictions and informs why countries may eventually choose to avoid or leave a trade war, beyond the obvious external considerations of geopolitics, popular opinion, and other factors unique to the decision-making of states.
Website Links
- https://fivethirtyeight.com/features/how-to-win-a-trade-war/
- https://fivethirtyeight.com/features/we-let-our-readers-practice-international-trade-they-started-a-bunch-of-trade-wars/
Bibliography
Dottle, Rachael, Oliver Roeder, and Julia Wolfe. 2018. “How to Win a Trade War.” FiveThirtyEight. March 28, 2018. https://fivethirtyeight.com/features/how-to-win-a-trade-war/.
———. 2018b. “We Let Our Readers Practice International Trade. They Started a Bunch of Trade Wars.” FiveThirtyEight. April 3, 2018. https://fivethirtyeight.com/features/we-let-our-readers-practice-international-trade-they-started-a-bunch-of-trade-wars/.