Trade Wars

This article presents a simplified model to compile and synthesize in a formal - and hopefully clear- way, some of the most important trade policy results of the literature, in what can be thought of as a Fundamental Theorem of Trade Policy. It shows that ceteris paribus, when other externalities and other distortions are not considered, optimal import tariffs and optimal taxes on exports are: positive for large countries; “beggar thy neighbor” and “beggar thy world” policies when applied by a large country; and examples of a dominant strategy for each large country, a Nash Equilibrium in trade policy and a Prisoner´s Dilemma, when applied simultaneously by several large countries. Import and export subsidies are shown to be “beggar thyself”, “benefit thy neighbor”, and “beggar thy world” policies. Optimal import tariffs and export taxes are zero for small countries. Consequently, retaliation by small countries when large countries use tariffs and/or export taxes exacerbates their own welfare losses. Enforceable and verifiable commitment technologies, through a multilateral institution such as a credible WTO, are required to avoid undesired outcomes.