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Threats Or Promises? A Built-In Mechanism Of Gradual Reciprocal Trade Liberalization

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  • TAIJI FURUSAWA
  • TAKASHI KAMIHIGASHI

Abstract

We analyze an infinitely repeated tariff-setting game played by two large countries with alternating moves. We focus on the subgame perfect equilibria in which each country chooses its tariff according to a stationary function of the other country's tariff. We show that there are many equilibria with two steady states, one with higher tariffs (but still lower than the static Nash tariffs), the other with lower tariffs. We also show that there is a special class of equilibria in which there exists a unique, globally stable steady state. In both types of equilibria, one country unilaterally reduces its tariff from the static Nash equilibrium, the other country reciprocates in response to the first country's implicit "promise" to lower its tariff even further, and this process continues forever, converging to a steady state with tariffs lower than the static Nash tariffs. Therefore, promises, rather than threats, induce countries to gradually reduce their tariffs.

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File URL: http://hdl.handle.net/10.1111/j.1468-5876.2012.00567.x
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Bibliographic Info

Article provided by Japanese Economic Association in its journal Japanese Economic Review.

Volume (Year): 63 (2012)
Issue (Month): 2 (06)
Pages: 259-279

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Handle: RePEc:bla:jecrev:v:63:y:2012:i:2:p:259-279

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  1. Eric W. Bond & Jee-Hyeong Park, 2002. "Gradualism in Trade Agreements with Asymmetric Countries," Review of Economic Studies, Oxford University Press, vol. 69(2), pages 379-406.
  2. Jagdish Bhagwati (ed.), 2002. "Going Alone: The Case for Relaxed Reciprocity in Freeing Trade," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025213, December.
  3. Takashi Kamihigashi & Taiji Furusawa, 2010. "Global Dynamics in Repeated Games with Additively Separable Payoffs," Discussion Paper Series DP2010-04, Research Institute for Economics & Business Administration, Kobe University, revised Jun 2010.
  4. Krishna, Pravin & Mitra, Devashish, 2005. "Reciprocated unilateralism in trade policy," Journal of International Economics, Elsevier, vol. 65(2), pages 461-487, March.
  5. Furusawa, Taiji & Lai, Edwin L. -C., 1999. "Adjustment costs and gradual trade liberalization," Journal of International Economics, Elsevier, vol. 49(2), pages 333-361, December.
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