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

tit-for-tat in the New Congress

In a repeated prisoners' dilemma, [play coauthor Mike Shor's online game against 5 different players], the best strategies exhibit the following characteristics: 

• Be nice--no first strikes 
• Be provokable--retailiate immediately if your rival cheats 
• Be forgiving--don't punish cheating too much 
• Be clear--make sure your rival can interpret your moves 
• Dont be envious--focus on only your slice of the profit pie

Tit-for-tat is the winning strategy (examples)

The WSJ reports that new Republican House Speaker is doing exactly what the previous Democratic House Speaker did, in order to deter future abuses of power:

Republicans believe that if they don’t play tit-for-tat like this, Democrats will feel empowered to keep escalating. Maybe if Democrats get the same ill treatment, the GOP thinks, Democrats will revert to better form the next time they’re in the majority.

Of course, this works only in an evenly divided Congress. If one party gains the majority for a long time, it need not fear retaliation.

How can a country increase exports?

Countries with strong currencies, face reduced demand for their exports:

“I would not want to be in machine tools in Germany at the moment,” said Adam Posen, president of the Peterson Institute for International Economics and a former Bank of England official. “I would not want to be in ship building in South Korea.”

The feeble recovery is tempting countries to weaken their currencies (by printing money):

European Central Bank President Mario Draghi has praised the euro’s decline, an indication to investors that a weaker currency is a key ECB policy objective. Bank of Japan governor Haruhiko Kuroda made similar remarks about the yen’s value. South Korea and China have come under fire for keeping their currencies lower than levels many economists say would reflect fair market values.

But this works only if you are the only country doing it.  If rivals also weaken their currencies, the net effect is zero, a type of prisoners' dilemma.

Top finance officials trying to talk down the value of their exchange rates have resurrected warnings of a global currency war. Such tit-for-tat devaluations tend to create short-term growth at other countries’ expense.

The best tariff threat is one you do not have to use

Following up on an earlier post, Reciprocal tariffs as a tit-for-tat strategy in a repeated prisoners' dilemma 

From NY Times:

Trump imposed, quickly withdrew and then threatened to bring back huge tariffs on dozens of countries. Immediately, they began calling and asking what they could do to stop him. “More than 100 countries have already come to the table looking to offer more favorable terms for America and our people,” Karoline Leavitt, the White House press secretary, said at a briefing with Treasury Secretary Scott Bessent on Tuesday. “There has never been a president who has created his own leverage like this president.”

What can Trump get? For starters, some countries are offering to lower their own tariffs on American exports and cut red tape that keeps U.S. businesses out. India said it might lower its tariffs on U.S. farm goods, while Europeans may drop them on cars and machinery if Washington agrees to do the same.

BOTTOM LINE: It looks as though President Trump's Tariff threats are working.

China plays optimally in a repeated prisoners' dilemma

We have blogged before about how trade policy can resemble a repeated prisoners' dilemma. Now it looks as if China looks as if it is playing optimally:

If Trump acts on his threats to impose a 45% tariff on Chinese imports and officially list China as a currency manipulator, China will take a "tit-for-tat approach," the newspaper, Global Times, said. 

The airline industry was singled out in the list of countermeasures — specifically that China would replace a batch of orders for US-owned Boeing airplanes with French-owned Airbus ones. 

It also said US soybean and maize imports would be halted and China could limit the number of Chinese students studying in the US.

Negative campaigning as a repeated prisoners' dillemma

Negative campaigning works well against an opponent in the primaries, but if the Democratic primary turns nasty, which by some accounts it already has, anything the Democrats say against each other will be used against them in the general election. So while negative campaigning will help win the primary, it will also reduce the probability of winning in the general election, setting up a game with the same logical structure as a prisoners' dillemma.

Later in the call, the Clinton team was asked whether the not-qualified-to-be-commander-in-chief criticism of Obama was going too far, given that it would be used by Republicans against Obama if Obama is the Democratic nominee against John McCain. "We don't believe that he is the one who will face John McCain," Clinton spokesman Howard Wolfson said. "This is a legitimate question that Sen. Obama would face if he were the nominee, and it is a question that he is facing as a result of criticism from Sen. McCain now, so I think it's perfectly appropriate."

Senator Obama's best response to negative campaigning comes right out of an economics textbook:

1. Be nice (no first strikes)
2. Be provokable (attack immediately if attacked)
3. Be forgiving (stop if she stops).
4. Be clear (make it very clear that you will attack every time she attacks.)

Winning strategy is probably tit-for-tat, do whatever she did yesterday.

Canada returns fire

After we took the first shots with the protectionist measures in the stimulus bill, Canadians are firing back:

Ordered by Congress to "buy American" when spending money from the $787 billion stimulus package, the town of Peru, Ind., stunned its Canadian supplier by rejecting sewage pumps made outside of Toronto. After a Navy official spotted Canadian pipe fittings in a construction project at Camp Pendleton, Calif., they were hauled out of the ground and replaced with American versions. In recent weeks, other Canadian manufacturers doing business with U.S. state and local governments say they have been besieged with requests to sign affidavits pledging that they will only supply materials made in the USA.

...This week, the Canadians fired back. A number of Ontario towns, with a collective population of nearly 500,000, retaliated with measures effectively barring U.S. companies from their municipal contracts -- the first shot in a larger campaign that could shut U.S. companies out of billions of dollars worth of Canadian projects.

This is not your father's trade war, a tit-for-tat over champagne or cheese. With countries worldwide desperately trying to keep and create jobs in the midst of a global recession, the spat between the United States and its normally friendly northern neighbor underscores what is emerging as the biggest threat to open commerce during the economic crisis.