Reciprocal tariffs as a tit-for-tat strategy in a repeated prisoners' dilemma

Trade policy can resemble a Prisoners' Dilemma game: free trade is the best outcome (no tariffs), but that is not a Nash Equilibrium because any country can do better by imposing tariffs on imports as it helps domestic producers.  The Nash equilibrium is for all countries to impose tariffs on imports.

One way out of this prisoners' dilemma is to play tit-for-tat (do whatever your rival did last period) because it gives foreign countries an incentive to keep their own tariffs low:  if foreign countries put a tariff on imports from the US, their exports to the US will be treated similarly.  

However, President Trump is computing reciprocal tariffs as (Trade Deficit with US)/(Exports to the US).  This measure is determined largely by foreign investment in the US, not foreign tariffs on US goods.  For example, China sells ￥to buy $ to invest in the US to buy US Treasuries.  Such an increase in demand for $ raises the price of a $ relative to the ￥.  The stronger $ makes Chinese exports look cheap to US consumers.  This is both a US Trade Deficit (the US buys more Chinese goods than China buys US goods), and a Chinese Investment Surplus (China invests more in the US than the US invests in China).

As a result of the policy, US tariffs on foreign goods are set to dramatically increase, which will likely lead to tit-for-tat responses from foreign countries which will result in less trade.  From Chapter One, we know that voluntary transactions create wealth, and with fewer of them, we are all poorer.  

It might make some sense to set reciprocal tariffs equal to actual tariffs on a country-by-country basis, i.e.,(reciprocal US tariffs on foreign goods) = (foreign tariffs on US goods). 

BOTTOM LINE: Reciprocal Tariffs, as calculated, would harm the US.  

CAVEAT:  The above analysis ignores: (i) the international nature of supply chains--domestic producers are also importers of foreign goods; and (ii) their harmful effect on consumers. 

HT:  Mike, Donna