Latest news with #Prisoner'sDilemma
Asia Times
16-04-2025
- Business
- Asia Times
US-China trade war stuck in a Prisoner's Dilemma
As the US and China escalate their trade war through tit-for-tat tariffs, it is tempting to view the situation as irrational brinkmanship. However, beneath the surface, the pattern follows a familiar structure in economics, specifically the 'Prisoner's Dilemma' in game theory — albeit one complicated by geopolitics, national pride and the realities of domestic the traditional Prisoner's Dilemma, two players (in this case, the US and China) each have two choices: cooperate (lower tariffs, open trade) or defect (raise tariffs, restrict trade). The payoffs are clear: If both cooperate, both benefit and no one 'loses face.' If one defects while the other cooperates, the defector wins big, gaining market share and strategic advantage, while the cooperator looks weak and loses economically and politically. If both defect, both suffer — but at least neither 'loses face' to the other. Graphic: Author supplied In purely economic terms, mutual cooperation would clearly be the most optimal outcome. Yet in this case, losing face carries heavier consequences. For Beijing, being perceived as capitulating to American pressure would not only undermine its international credibility but would also affect its political strength domestically. For Washington, especially under an administration defined by its transactional style, appearing 'tough on China' remains a major electoral asset. Two additional dynamics make this particular iteration of the Prisoner's Dilemma much more complex. First, trust is at an all-time low. President Trump's well-known capriciousness leaves counterparties understandably skeptical of any promises. Deals can be reversed, tariffs can be raised and imposed without warning and the political logic often shifts depending on domestic electoral swings and business lobby desires. Second, this is not a repeated game, at least from China's perspective. In game theory, repeated interactions encourage cooperation because each side knows it must live with the consequences over multiple rounds.
Forbes
02-04-2025
- Business
- Forbes
Games Countries Play: Tariffs, Threats And Tail Risks
As a market participant today, it is clear to most that the dominant driver of market performance, at least in the short term, is likely to be how the global game of tariffs and threats plays out. What is not clear is (1) What type of game it is (2) How much information participants have about each other's objectives (3) How much clarity each player has about the other players' actions and strategies (4) How many rounds of the game will be played, and (5) Are the players going to be time-consistent. In short, the list of things we know is much shorter than the list of things we don't know. In game theory, there are two types of canonical games. Simultaneous games are games where each player takes an action only maximizing their own payoff while acting at the same time. Sequential games are games where each player takes turns. circa 1956: A hen, a dog and a rabbit playing cards. (Photo by Evans/) The simplest and most familiar simultaneous game is the 'Prisoner's Dilemma'. Given the choices of the US to impose tariffs or not and the rest of the world (RoW) to retaliate by increasing or not increasing tariffs, traditional trade theory would recommend that both parties should, at least in the short term, leave the status quo as is to maximize short term gains; i.e. do nothing. But the Nash equilibrium solution to this game says that both parties will choose the solution where the US imposes tariffs and the RoW retaliates, reducing the gains to both. A race to the bottom, in other words, could happen, even if it is not the most profitable strategy collectively. As the payoffs change, this game may evolve into the classic game of chicken. Again, with two drivers heading on a collision course towards each other, the optimal game-theory solutions in this game are for one to swerve and the other not to swerve (the 'pure' strategies), along with a 'mixed' strategy where one swerves and the other does not. The strategy of both swerving in opposite directions, which would result in the least loss, is unfortunately not an equilibrium solution. Randomization of responses can be optimal. And randomness creates uncertainty. Pre-commitment that cannot be negotiated, i.e. one driver disabling their steering mechanism, can make things more predictable. But also more dangerous potentially. The players do not have to act at the same time, since most tariff games are sequential, and one can observe, even if imperfectly, how the other is acting or reacting. Some of these games have perfect information; i.e. each player knows what game the other player is playing. Most of them have imperfect information; i.e. one or more players does not know what game the other player is playing. Sometimes one player might have an advantage that they do not reveal until the other player uses a strategy that allows them to use this advantage. It might pay to hide all your cards. Again, having less information than more is volatility creating. FEATURED | Frase ByForbes™ Unscramble The Anagram To Reveal The Phrase Pinpoint By Linkedin Guess The Category Queens By Linkedin Crown Each Region Crossclimb By Linkedin Unlock A Trivia Ladder Using the technique of backward induction and assuming rationality of both sides (which one might argue is a lot to assume under current circumstances, but unfortunately we have to make this assumption to make any quantitative predictions), in many cases the optimal solution (known as the 'subgame perfect equilibrium', a mouthful indeed) can be found. To make things more complex, sometimes as the game evolves, participants can change their mind; i.e. being time-inconsistent, including making 180-degree pivots, making a previously optimal solution no longer optimal. When faced with the choice of letting a new entrant into a market, an incumbent might threaten a price war detrimental to both, but when faced with the entrant's decision to enter despite the threats, change to accommodating the new entrant. The initial threat, in this example may be seen as not credible and non-implementable in practice. Today's geopolitical and market environment shows characteristics of all these types of games and their nuances. While no one has the crystal ball to forecast what will happen in the future, but we can expect the following: Faced with these facts, investors are likely to find that they cannot rely on the traditional tools of diversification and mean-reversion which bets on stable relationships to build robust portfolios in such environments. While the market is still hoping that the current environment, like all others recently will nicely revert back into a traditional equilibrium, there is the tail risk that it does not. Once the collective sentiment changes, these opportunities, both on the left and the right side, might not exist anymore.
