Trade war games reveal dire outcomes for US, China

The following article written by Paul Bracken, professor of management and political science at Yale University, appeared in The Hill on Feb. 4, 2019:

A key insight of game theorist Martin Shubik was that when a “tomorrow” exists, it profoundly reshapes competition. Individual moves in a game with “tomorrows” are radically different from one-shot games. 

Standing up to China is one thing, but working out an accommodation so that a series of individually sensible moves don’t explode into an escalation spiral that punishes both nations is more important. Let’s look at the trade war though this framework.

The U.S. slapped sanctions on two big Chinese companies, Huawei and ZTE, charging them with trading with an enemy (Iran) in violation of U.S. law and with intellectual property theft from western companies. 

Next, Huawei’s CFO, Meng Wangzhou, was arrested in Canada for violating U.S. law. Then, Washington demanded that American firms not buy computer chips and telecommunication products from Huawei and ZTE. 

Critically, Washington launched a global economic attack on Huawei and ZTE to destroy them in the U.K., Poland, the Netherlands and Germany.

The next move is China’s. U.S. multinationals IBM, GE, Facebook, Apple and others have invested an immense amount in the China market. For all practical purposes, these companies are now “hostages” in this trade war, as are China’s technology companies in the United States and Europe. 

If Washington continues its crackdown on Chinese businesses, these U.S. multinationals will be squeezed in China. They’ll lose contracts and connections. Their intellectual property will be stolen more than it already has. And their executives might be arrested on trumped up charges. 

The blowback on profits, stock prices and on communities in the United States will be considerable. Most importantly, they’ll be shut out of the opportunities in the China market.

This is all an utterly fascinating revelation about changing global economics. Where it goes will determine how future trade disputes of all kinds are handled. Forget about the World Trade Organization and international law.  This game is about power: using it to open up and defend markets. 

China has an immense home market. Beijing uses it as a lever to pry open new foreign markets just as China’s multinationals are about to go global.

Who’ll win this game? Who will compromise? The stakes are made higher by the industries in question. We aren’t talking about moving environmentally hazardous industries to the developing world or letting cheap textiles into the United States and Europe. 

The prize in this game is about something far more important: technology dominance. Technology is critical for global primacy in business and defense. The stakes couldn’t be higher, and this makes the prize all the more valuable. 

Add to this another critical element: techno-nationalism. Individually these are the two most powerful forces in the world today. When combined, they produce a combustible mixture of jobs, populism and chauvinism. 

Backing down in this game has large political consequences at home as technology is believed to be the path to future prosperity.

The immediate U.S. strategy is to teach Beijing a lesson that nothing good will come from its “Dracula strategy” of sucking the intellectual lifeblood from Western technology firms or from using this technology for espionage and disruption. 

We are in unknown territory here, as many have pointed out. But game theory offers useful ways to frame this problem. First, neither country can pressure the other into submission. They can inflict pain, but there’s no way either can force a surrender in the face of national wrath at home.

Second, the biggest danger in this game is that the escalation spirals out of control. Sanctions, penalties and arrests look like rational actions at the moment. They make sense and are needed to answer what the other side has already done, like China stealing Western technology. 

But over time a dystopian sequence can build up. Think of World War I. Politics, nationalism and sunk costs derailed logical attempts to stop the madness that destroyed Europe.

Escalation spirals swamp the rational calculation of gains and losses. They change the logic. That’s what happens repeatedly: in the Vietnam War, government shutdowns and in the irrational swings of the stock market. 

Finally, game theory says that every war must end. The trade war is no exception. Some new system will arise, just as one did after World War II when the liberal trading order we are all familiar with emerged. This insight doesn’t mean that every problem has a solution. It only means that every problem has an outcome. 

As Washington and Beijing plot their next moves, they must understand that things can really get out of control.  Winging it with moves that look sensible when they are made can result in a dynamic of their own, one that can destroy some great companies and harm millions of people. 

Paul Bracken is professor of management and political science at Yale University.