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The Global Trade Game

History is less likely than game theory to provide useful insights into where the latest trade dispute between the US and China may be heading. The question, ultimately, is whether new tariffs will eventually lead to a more cooperative game, or to a competitive one in which everyone loses.

CAMBRIDGE – The trade confrontation between the United States and China is heating up. After firing an opening salvo of steep tariffs on steel and aluminum, the US administration has released a plan for a 25% tariff on 1,333 Chinese imports – worth about $50 billion last year – to punish China for what it views as decades of intellectual property theft. China has fired back with a plan to slap 25% levies on a range of US goods, also worth about $50 billion. In response to what he labels “unfair retaliation,” US President Donald Trump is now said to be considering yet another set of tariffs, covering another $100 billion worth of imports from China. Economists and market analysts are scrambling to figure out what will come next.

One might be tempted to rely on historical experience. But, given today’s economic, political, and social conditions, history is likely to be a poor guide. More useful insights come from game theory, which can help us to determine whether this exchange of tariffs will ultimately amount to strategic posturing that leads to a more “cooperative game” (freer and fairer trade), or develop into a wider “non-cooperative game” (an outright trade war). The answer will have significant consequences for the economic and policy outlook, and markets prospects.

The rapid expansion of trade in recent decades has given rise to a web of cross-border inter-dependencies in production and consumption. Supply chains now can have as many significant international links as domestic ones, and a substantial share of internal demand is being met by products partly or wholly produced abroad. As technological innovation further reduces entry barriers for both producers and consumers, the proliferation of these linkages becomes even easier, amplifying what already is essentially a spaghetti bowl of cross-border relationships and dependencies.

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