Traditional economic theories tell us that free trade is great for everyone. "Everyone produces what they're best at, and everyone wins." Sounds simple and logical, right?
But when we look at the real world, we see tariff wars, massive government subsidies, and races to capture market share. This is where classical theories fall short, and Game Theory enters the stage.
Game theory sees international trade not as a market with "perfect competition," but as a strategic arena where a few powerful players (countries or giant corporations) watch each other's moves.
Here are the two most famous acts of this game:
This perfectly explains why countries fall into the trap of protectionism, which is obviously "bad."
The Game: There are two large countries (Let's say A and B).
The Moves: They can either choose "Free Trade" or impose "Protectionist Tariffs."
The Dilemma:
If B chooses free trade, the most profitable move for A is to impose a tariff, protecting its own market while accessing B's.
If B imposes a tariff, the most "rational" move for A (to avoid being a "sucker") is to retaliate, meaning, impose a tariff again.
The Outcome (Nash Equilibrium): Both countries, regardless of what the other does, choose the most logical move for themselves individually (protectionism). Thus, they both end up in a tariff war and both lose. However, if they had both chosen free trade, they would have been collectively much better off.
This is why institutions like the World Trade Organization (WTO) exist: to save countries from this "bad equilibrium" trap and enforce cooperation.
This explains sectors with huge R&D costs, where only a few giant firms (an oligopoly) can exist, like aircraft (Airbus vs. Boeing) or semiconductors.
The Game: Imagine a global market where only one firm can fit (or be profitable). There are two firms: one European (Airbus) and one American (Boeing).
The Moves: "Enter" the market or "Stay Out."
The Dilemma: If both enter, both go bankrupt. If only one enters, it makes massive profits.
The Government's Move: Right here, the European government joins the game. It gives Airbus a massive "subsidy" (incentive).
The New Outcome: Now, for Airbus, it is profitable to enter the market even if Boeing also enters (thanks to the subsidy). Knowing this, Boeing understands that Airbus will "enter no matter what" and backs out of the game. The result? Thanks to the subsidy, Airbus captures the market.
Game theory shows us that international trade isn't just a matter of "who produces it cheaper" (efficiency). Trade is also a game of strategy, power, and timing.
