Game Theory in Trade Negotiations: The US-China Trade War
The US-China trade war has been ongoing since around 2017 to 2018. It began with the US setting tariffs and trade barriers on Chinese goods, intended to force China to change what the US claimed were longstanding unfair trade practices. China then responded with its own tariffs and trade barriers.
This back-and-forth battle continued until 2020 when the US and China reached a tense phase one agreement. Things haven’t settled yet, and many tariffs remain on both sides. The World Trade Organization stated that the new deal only slightly reduced US tariffs on China, from 17% to 16%. (wto.org, 2020) With the Trump administration re-entering office, there have been propositions to increase them in the coming years.
Game theory is a helpful way for us to analyze trade negotiations between countries. It applies mathematical models to better understand strategic choices that depend on the decisions of others. It includes principles like:
- Tit-for-tat strategies
- Nash equilibrium
- Bargaining strategies
We’ll cover each to show how these negotiations have progressed.
Tit-for-Tat Tariffs: A Sequential Game Analysis
Tit-for-tat in game theory occurs when opponents continuously match each other’s actions or try to one-up each other with similar actions. In the US-China trade war, this kind of back-and-forth occurred between 2018 and 2020, with each country trying to one-up the other with increasingly larger tariffs. Here’s a very brief analysis of how it progressed.
Round 1
The US started on January 22nd, 2018, putting a tariff on solar panels and washing machines worth $10.3 billion.
China followed that up on April 17th, 2018, placing a 178.6% tariff on sorghum.
Round 2
Between June 15th and August 23rd, 2018, the US and China exchanged tariffs of similar value.
On the US side, it included over $50 billion of tariffs on over 1,100 products, including steel and aluminum.
China then imposed over $50 billion in tariffs on products such as autos, aircraft, soybeans, and agriculture.
Round 3
On September 18th, 2018, the US and China both imposed another set of tariffs.
The US placed $200 billion worth of tariffs on consumer and intermediate goods.
China placed $60 billion in tariffs on intermediate inputs and capital equipment.
The Impact of This Tit-for-Tat Approach
Due to the billions of dollars of trade between the US and China each year, these tariffs severely impacted both countries. Namely, production costs go up because of this, which increases the cost of consumer goods. Some research estimates that two-thirds of taxable products increased in price during this time. (cepr.org, 2023)
Nash Equilibrium in the Trade Conflict
In game theory, the Nash Equilibrium is the most common explanation for opposing sides not cooperating. It essentially states that no player will gain by changing their strategy if the opposing side’s strategy remains the same. It can lead to both sides continuing their strategy indefinitely until an agreement is made.
During the US-China trade war, this situation occurred for a couple of years with the tit-for-tat of imposed tariffs. Since both sides seemed like they would continue placing tariffs even if the other stopped, it felt like neither would gain by shifting their strategy.
Therefore, they had to reach an agreement and make concessions on both sides to stop the process. That’s why they worked toward an agreement in 2020, although the situation remains tense, and it’s hard to say if it will hold in the future.
Bargaining Strategies
While forming an agreement in game theory, the concept of bargaining strategies comes into play. These are the strategies and approaches that each side uses to maximize their benefit while still coming to a mutual agreement. Bargaining strategies can include:
- Initial offers
- Counteroffers
- Making concessions
- Setting deadlines
- Strategic use of information
Here’s an overview of how this affected the agreement in the US-China trade war.
Bargaining While Forming an Agreement in the US-China Trade War
Initially, the range of tariffs set by both sides was used as leverage when beginning negotiations. Each side had something on the other, which meant concessions were made, and some tariffs were withdrawn, although many remained in place.
One of the big turning points was when China agreed to increase purchases of US goods by $200 billion over a two-year timeframe. China also agreed to implement policies that addressed ongoing concerns the US had about intellectual property rights and technology transfer when buying goods.
Lastly, both sides agreed on policies to enforce the agreement to ensure timelines and promises were met.
Conclusion
Game theory can be an effective concept for assessing international trade disputes. It can help take a step back and see why both sides are strategizing and reacting the way they are.
Given that there’s still tension between both sides, we’ll have to watch in the coming years to see if new disputes arise and how each country handles them.