International trade is not always just a race for efficiency (i.e., "who produces cheapest"). When powerful countries or dominant corporations (oligopolies) are involved, it quickly becomes a strategic game. Game theory provides a framework for analyzing how these actors consider their rivals' decisions and how their own moves will affect those rivals.
Two primary approaches stand out in this field:
Tariff Dilemmas (The Prisoner's Dilemma): This model explains why countries get dragged into tariff wars, which are demonstrably welfare-reducing. Consider two large countries. For each, the most "rational" individual move (the dominant strategy) is to impose tariffs to protect its market, regardless of what the rival does. The problem is that when both sides follow this individual logic, they end up in a Nash Equilibrium known as a trade war, where both sides lose (ending up worse off than under free trade). International agreements and institutions like the World Trade Organization (WTO) are designed as commitment mechanisms to help countries escape this "bad equilibrium" trap and enforce cooperation (free trade).
Strategic Trade Policy (Brander-Spencer Model): This approach examines why governments intervene in specific (usually oligopolistic) industries. In markets with massive R&D costs, like aircraft or semiconductors, entry is extremely risky, and perhaps only one firm can be profitable. At this point, a government can change the game by giving its home firm (e.g., Airbus) a large subsidy. This subsidy makes the firm's threat to "enter the market no matter what" credible. The rival firm (e.g., Boeing), knowing the subsidized firm will enter and stay even if it's not immediately profitable, is deterred from entering. The subsidy thus becomes a strategic weapon used to capture market share.
In summary, game theory demonstrates that international trade is as much about strategic interdependence, timing, and credibility as it is about simple efficiency.
