Tariff games: Cooperation with random variation in political regimes

Abstract

This paper analyzes consequences of diverse political parties in the context of international tariff policy. We consider a noncooperative infinitely repeated tariff game between two countries and derive conditions under which free international trade can be sustained as an equilibrium of the game when the governments of the participating nations are subject to random variation in their type. It is shown that the uncertain future can create an incentive for trade agreements: since payoffs of all players are subject to political changes, trade agreements that limit policy variations can provide long-run gains. It is shown, however, that maintenance of free trade may not be feasible if an international trade agreement does not pay attention to the distribution of gains within countries. If compensating side payments between political interest groups are feasible, then it may be possible to maintain free trade indefinitely, given that political conditions of the nations satisfy certain restrictions. Generally, maintenance of permanent free trade requires higher probabilities of protectionist governments in both countries. But, we argue that even when trade cooperation is feasible, such cooperation will be very susceptible to small variations in the countries' political climates.