Trade Wars, Trade Negotiations and Applied Game Theory

Abstract

What is the value of trade negotiations? Quantitative measures of the value of trade liberalisation generally ignore the strategic aspects of protection policy. The traditional approach is to compare welfare levels under the existing structure of protection with welfare levels under some alternative structure of protection, such as unilateral or multilateral free trade. We add two additional questions. First, in a non-cooperative context, are either of these points of comparison consistent with countries adopting 'best response' policies given the policies of other countries? Second, in the context of a cooperative negotiation, are either of these points of comparison consistent with the outcome that meets certain plausible criteria for a bargaining process? If the answer to either of these questions is 'no' then the traditional approach provides at best an incomplete answer to the original question, and could provide a misleading answer. A simple example illustrates our basic point. Consider the game in Table i. This is a non-cooperative game between the United States and EC, in which each agent has just two pure strategies: to do nothing and Keep (K) the existing structure of protection in place, or to Abolish (A) trade barriers (on imports from the other agent only). The payoffs shown are the annual welfare impact relative to the status quo, as measured by the Equivalent Variation (EV) in income in billions of I973 U.S. dollars. The values shown are taken from the simulation results of Brown and Whalley (I980; Table I 4, p. 864). What is the best response of the United States in this context? If the EC decides to Keep its protection structure the United States does better by also Keeping its protection structure intact. In other words, given that the EC plays K, it is a best response for the United States to also play K. Thus the traditional approach would imply that the United States gains from protection in this case. However, what is the best response of the United States if the EC decides to Abolish its protection structure? In this instance the United States does best by also Abolishing its protection structure. The point here is simply that the welfare cost of protection to the United States depends on what the EC does. Without saying something about what the EC will do, one cannot answer our question vis-'a-vis the United States. As it happens, in this particular game we