Economics Behind A Trade War

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Economics Behind A Trade War

By Anmoldeep Singh Karwal

 

 

The economic policies of United States President Donald Trump, often referred to as Trumponomics or MAGAnomics include trade protectionism, immigration reduction and individual and corporate tax reform.

In January 2018, President Donald Trump initiated trade protectionism via tariffs on imports of international goods from China, Mexico, Canada and the European Union, resulting in domestically produced goods more feasible for domestic consumption. [4]

TIT FOR TAT

In June 2018, President Trump said the U.S. would soon begin charging duties on $50 billion worth of Chinese imports in response to what he says are ‘decades of theft of American know-how’, and to reduce the $376 billion trade deficit with China.

China responded with equal intensity to tackle the tariffs which market the initiation of an upcoming trade war between the two largest economies on the planet.

In March 2017, the U.S. announced 25% tariffs on steel imports and 10% tariffs on aluminium imports from countries including China. China retaliated with 15%-20% import tariffs on 128 U.S. goods. [1]

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Figure 1: American and Chinese imports and exports [2]

 

GAME THEORY

Analyzing the current scenario, we can apply game theory under U.S. – CHINA trade war scenario and see what the outcomes are. Both economies have 2 strategies: to impose tariffs (T); and to maintain Free Trade (F).

The strategic form and the extensive form of the game are as follows:

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Normal form of a strategic interaction between US and CHINA

 

The numbers in the table represent the payoffs to the countries when the two strategies are played together.

The Nash Equilibrium in the above game is: T,T – from where neither of the countries have an incentive to deviate. The payoffs for both countries are the least when tariffs are imposed resulting in a trade war. If both the countries coordinate, then the payoffs would be much higher at 8.

The Nash equilibrium of T,T represents a classic “Prisoners’ Dilemma”, where both the players/countries choose to go against each other resulting in lower payoffs for both even though cooperation will lead to a better payoff. [3]

An economic implication of a trade war between the two largest economies of the world would lower economic profits and welfare as shown by an economic analysis of Game theory. But, the question posted in front of us is whether the trade war is Politics or Economic?

 

 

 

References:

  1. The Economist. (2018). A trade war between America and China takes shape. [online] Available at: https://www.economist.com/finance-and-economics/2018/04/07/a-trade-war-between-america-and-china-takes-shape [Accessed 26 Jun. 2018].
  2. com. (2018). The economic damage from a trade war | Financial Times. [online] Available at: https://www.ft.com/content/4bd6a57a-2874-11e8-b27e-cc62a39d57a0 [Accessed 26 Jun. 2018].
  1. Coy, P., Mayeda, A. and Horta e Costa, S. (2018). Using Game Theory to Explain the U.S.-China Spat. [online] Bloomberg Businessweek. Available at: https://www.bloomberg.com/news/articles/2018-06-21/game-theory-explains-why-the-u-s-china-trade-spat-is-worsening [Accessed 26 Jun. 2018].
  1. com. (2018). US-China trade tariffs in charts | Financial Times. [online] Available at: https://www.ft.com/content/e2848308-3804-11e8-8eee-e06bde01c544 [Accessed 26 Jun. 2018].