Using Game Theory to Explain the U.S.-China Spat

Picking a fight with a trading partner seems like a bad idea, but it’s not necessarily irrational. Probing a partner’s weaknesses can be an effective way to get a better trade deal, according to game theory, the branch of mathematics that deals with strategy. It sometimes makes sense for countries to “test each other’s resolve,” says Ethan Harris, head of global economics at Bank of America Merrill Lynch. “The act of putting on tariffs teaches you something about the other side,” in particular its willingness to retaliate, Harris says. It worked for the U.S. when it threatened South Korea with steel and aluminum tariffs; the Koreans quickly made concessions to escape the tariffs.

The problem with tit for tat is not irrationality, but miscalculation. If each country keeps escalating in the mistaken expectation that the other side will eventually back down, the result will be high tariff barriers and a reduction in cross-border commerce that leaves both sides worse off. That’s the risk the U.S. and China are courting.