Download Bilateral Trade as a Coordination Game

Bilateral Trade as a
Coordination Game
Nimarjit Singh
Introduction
O Interest in International Trade
O Increased Globalization has made the world
more integrated. A lot of rhetoric in Politics,
especially in this election on outsourcing.
O Global trade has grown during the last 60
years at an average rate of 6 percent per
year.
O As a result, annual world merchandise trade
has risen from $84 billion in 1953 to$15.7
trillion in 2008
Gains to Trade
O Economically it makes sense to Trade.
O Comparative Advantage and the Production
Possibility Frontier.
O Some countries can make goods with a lower
opportunity cost.
O If all the countries were to specialize and trade,
each country would enjoy the benefits of
consuming beyond the PPF
O The US can focus on making more Iphones,
while China can produce wheat, the resulting
trade would make them both better off!
The US and China
O China is the second largest trade partner of the US,
O
O
O
O
after Canada as of December 2011
China’s Strategy of Export led growth – undervalued
Currency, lower wages.
Many US manufacturers have set up shop in China
Since China entered the World Trade Organization in
2001, the U.S. trade deficit with China eliminated or
displaced more than 2.7 million U.S. jobs. Most of
them from the Manufacturing sector
The U.S. trade deficit with China has surged over the
past two decades, as U.S. imports from China have
grown much faster than U.S. exports to China.
The US and China
O Bone of contention – US policy makers say
China is not abiding by the rules.
O Tensions have risen over a number of Chinese
economic and trade policies that many U.S.
critics charge are protectionist, economically
distortive, and damaging to U.S. economic
interests.
O The U.S. trade deficit with China has surged over
the past two decades, as U.S. imports from
China have grown much faster than U.S. exports
to China.
Prisoner’s Dilemma Game
O The Nash Equilibrium
occurs at (Protection,
Protection), and both of
the players end up with
(1,1) which is the lowest
payoff.
O Suggests that even when
both countries would
clearly benefit from trade
liberalization, political
dynamics trap
governments in a
protectionist world
Repeated Play
O Concept of Discounting Future Gains/losses
O If the value of future cooperation is large,
and exceeds what can be gained in the
short term by defecting, then the long term
individual interests of the players can
automatically keep them from defecting.
General Model
• C : Cooperative Outcome; H: high payoff that goes to defector when other
player cooperates; D – Outcome where neither player Cooperates
• From the first table we saw that H>C>D>0
“Tit for Tat” Strategy
O In infinitely repeated games, players can adopt a "Tit for
O
O
O
O
Tat" trigger strategy,
Each player plays the strategy that the other player
played in the previous round of the game.
Therefore, trade liberalization by one player in one round
of play is met by trade liberalization from the other
player in the next round.
Should any player defect and play 'Protection' then it can
be 'punished' in the next round by the other player and
will end up with a lower payoff than before.
Such iterative play coupled with 'tit-for-tat' strategies
allows players to reward each other for cooperation and
punish each other for cheating
Discounting
O Is it worthwhile to defect against a rival
playing a tit for tat strategy?
O Depends upon the present value of the
losses and gains incurred over an infinite
horizon.
O The "discount factor" is δ = 1/1+r, and is
used to find the present value. Here, 'r' is a
rate of return, and is a positive number.
Discounting Gains and Losses
O Therefore, the value of all future cooperative
play gives a present value payoff of (C + δC
+ δ.δ.C+..) up to infinity.
O The sum of this infinite series is [C + δC/(1δ)].
O Similarly, the present value of future losses
from defection (including the immediate
short term gain) is [H + (δD)/(1- δ)]
Equilibrium
O This means that for cooperation between
the US and China to realize the Pareto
superior Nash Equilibrium, the following
equation must hold: [C + δC/(1- δ)] ≥ [H +
(δD)/(1- δ)]
O Rewrite as: [(C-D)*δ/(1-δ) ≥ (H-C)]
O In English: as long as the long term costs of
defecting are higher than short term gains,
there will be cooperation
The WTO
O In real life, the WTO ensures an enforcement
mechanism, as well as iteration.
O WTO member countries know that the
governments with which they negotiate
today will be the governments with which
they negotiate in the future.
The WTO
O The WTO collects and disseminates information
on its members' trade policies.
O WTO rules provide clear standards against which
governments' trade policies can be evaluated.
O The high quality information and transparency
provided by the WTO allows governments to
monitor the behavior of other WTO members.
O Therefore, I assume that governments (players)
have complete knowledge about their
opponent's history of play
Dispute Settlement
Mechanism
O The 'tit-for-tat' strategy can be used through the
WTO's 'dispute settlement mechanism'.
O Following an alleged violation of a trade
agreement, the WTO Dispute Settlement Body
(hereafter referred to as DSB) creates a formal
panel to investigate the incident.
O If it is found that some country did indeed
impose protection in an unfair manner, the WTO
allows the 'victim' country hurt by the tariff to
retaliate by imposing protection on the
'aggressor' country
International Relations
O China and the US are both members of the UN
Security Council.
O Strained economic relations between the two
countries have often translated to negotiation
problems within the UN.
O Both countries have the power to veto resolutions,
and the US has often had trouble convincing China to
support resolutions imposing tougher sanctions on
Iran to dismantle their efforts to build a nuclear
weapon.
O President Obama has said that China is both an
adversary, but also a potential partner in the
international community if it's following the rules.
All this means that….
O [(C-D)*δ/(1-δ) ≥ (H-C)] – Long term punishment
O
O
O
O
is larger than short term gains.
Costlier to defect – repercussions in
International Relations.
If China defects against the US, it will be widely
reported in the media, and if the WTO favors the
US it could be particularly embarrassing for
China.
It could affect it’s relationship with neighboring
countries and other partners.
Thus, I propose a change in pay offs
Coordination Game
O
It is now costlier for governments to
cheat on trade agreements.
O
It becomes a Coordination game
with 2 Nash Equilibria.
O
'Free Trade, Free Trade' emerges as
the pure strategy Pareto-superior
Nash Equilibrium, where both
players are better off with the payoff
(5,5)
O
Protection, Protection' emerges as
the pure strategy Pareto inferior
Nash Equilibrium, where the players
are 'stuck' with the lower payoff (1,1)
and have no incentive to change
their choices.