Tuesday, August 13, 2019

Trade Wars and Game Theory: Who Wins, Who Loses?

Next week I will be in Colombia, and I am honored and delighted to be giving the opening keynote talk at the VI Congreso Internacional Industria, Organizaciones y Logıstica in Cartagena. The full program of this conference can be downloaded here.  The title of my keynote is: Tariffs and Quotas in Global Trade: What Networks, Game Theory, and Variational Inequalities Reveal.

And the day before my conference opening keynote, I will deliver a guest lecture at the Escuela Naval de Cadetes “Almirante Padilla.” The title of that lecture is: Networks to Save the World:
Operations Research in Action
. Having worked in technical consulting in Newport, Rhode Island, for the naval sector, I am very much looking forward to speaking at the naval academy as well!

I have been quite busy preparing both of these talks. This is my second trip to Colombia - I gave a keynote talk at this conference, back in 2015, which was in Bogota. The experience was truly magical, so I quickly accepted the invitation to speak in Colombia again. Plus, I have had several fabulous students from Colombia and we still stay in touch.

This blogpost is on what I believe is an extremely timely topic, continuing to dominate the news - that of trade wars, but with a game theory twist. Plus, tariffs and quotas are the theme of my keynote, and a topic that we have been researching very intensely. The latest research of ours has been conducted with one of my Isenberg School PhD students, Deniz Besik, and two alumnae (who were also my PhD students): Professor June Dong of SUNY Oswego and Professor Dong "Michelle" Li of Babson College, as well as the "other" Professor Nagurney - Ladimer S. Nagurney of the University of Hartford. In 2019, Deniz and I, with co-authors, published 3 papers on tariffs, quotas, and tariff-rate quotas, which are two-tiered tariffs and quite challenging to model.

Some Background

When it comes to war between nations, the weaponry is apparent - from flying missiles and bombs to stealth cyber weapons. The weapons of trade wars are, in contrast, economic, imposed by countries on products produced by other countries. Powerful trade war weapons used by governments include tariffs, quotas or combination thereof, known as tariff rate quotas. They impact not only the prices that you and I pay for our favorite foods such as avocados and cheeses, but even their quality!

Global Supply Chains

Global supply chains are the networks that enable fresh produce year round, smart phones at our fingertips, the latest fashions on demand, household appliances that we have come to depend on, and raw materials for crucial manufacturing processes. The resulting trade flows from origins to consumption are essential to the prosperity of nations and to the well-being of their citizenry.

Nevertheless, given today's economic climate and surrounding uncertainty, the International Monetary Fund expects the global GDP growth to slow from 3.6% in 2018 to 3.3% in 2019, before returning to 3.6% in 2020. Trade wars, notably, the ones between China and the US, are, in part, fueling the uncertainty.

Game Theory to the Rescue

Game theory allows us to quantify the effects of decisions of one adversary (or competitor) on others and has a long history of being applied by the military during war games; used by businesses to determine strategy, and now central to the understanding of  the effects of trade wars. Proper use of game theory can quantify a priori what the impacts of trade barriers will be on producers (both domestic and foreign), on consumers, and on governments. In addition, using game theory, embedded with algorithms, different scenarios and responses of governments, such as the tightening or loosening up of trade barriers, can be simulated. The need for such a framework is extremely relevant given the prevalence of tariffs and quotas in the news, with the coupled uncertainty. For example, the United States has imposed tariffs on steel, while the European Union has responded with quotas. Numerous tariffs were imposed by the US on products from China in 2018 including: food, toilet paper, hats, backpacks, beauty care products, sporting goods, home improvement items, and pet products, valued at $200 billion in Chinese imports. China then retaliated with their government imposing tariffs of 5% to 10% on $60 billion worth of US products. The combined tariffs apply to an amazing 5,207 items!

Producers Gain Under Protectionism and the Government May as Well

My research group has been researching trade policies and global trade for many years using game theory with applications to the dairy industry; see here and here; to fresh produce such as the very fashionable and nutritious avocados, as well as to a fundamental agricultural product - soybeans. Our studies have established that governments, by imposing a tariff or quota, may help firms in their own country garner enhanced profits. Moreover, although an appropriately calculated tariff can have the identical effect on the volume of trade flows and product prices as a quota, governments tend to favor tariffs since they then obtain additional revenue.

Our most recent study, published  in the journal, Transportation Research E,  has shown that producers, facing trade war weapons,  should expand the geographic dispersion of their production sites (which leads to new supply chain network structures) to avoid harmful tariffs and quotas. In addition, producers should actively expand and grow their demand markets in countries not under the trade policy restrictions, which can help them to achieve higher profits.

But Consumer Welfare Takes a Big Hit

Although producers in countries not under trade barriers generally benefit, that is not the case for consumers. Hence, governments imposing tariffs and quotas should beware.

Importantly, not only can trade barriers result in lower volumes of product imports, but also the quality of the product available to consumers may be negatively affected. Supply chain networks and product quality was the topic of one of our books.
And, in this book, we also analyzed a plethora of supply chain network topologies and even created a measure identifying the importance of different suppliers, components, to firms and their supply chain networks as well as to the supply chain network economy.

In our Transportation Research E study,  we constructed a measure of consumer welfare. This measure allows us to quantify the impact on consumers of trade barriers used in trade wars and includes the quality of the product being traded. We also conducted a case study, focusing on soybeans, assuming the trade war between China and the United States escalates, and the Chinese government, in retaliation, imposes a quota or equivalent tariff on the soybeans exported from the United States. Soybeans were discovered and domesticated in China over 3000 years ago; however, the United States is a leader in producing, consuming, and exporting soybeans globally.  In 2018, soybean production in the US reached 5.11 billion bushels with 40% of it exported. China, in turn, is the largest importer of soybeans due to its rapidly increasing population size. The consumption of soybeans in China, in 2017, was reported to be 112.18 million tons, but the domestic production volume was only about a tenth of that amount. Due to this huge gap, China has to rely heavily on soybeans imported from foreign countries, including the US, Brazil, and Argentina.

From the consumer's perspective, our results consistently and unanimously show that consumer welfare declines for consumers when their country imposes a strict quota or tariff on an imported product. This is the case regardless whether  China or the US imposes the trade barrier.

Governments must recognize that the imposition of tariffs or quotas always adversely affects consumers and, thus, they are not just instruments to protect producers. In war, as in peace, strategy matters and game theory is key to identifying winners and losers.