The Great Game: A Model of Geoeconomic Competition

We build a model of two hegemons that have valuable trading relationships with each other and at the same time compete in exerting geoeconomic power over countries in the rest of the world. When the hegemons trade with each other, their optimal policy is shaped both by classic economic considerations - the profitability of that specific trade - and by geoeconomic competition - how the trade affects the power of each hegemon vis-a-vis the rest of the world. We show that containment, a policy mix in which a hegemon limits sales of its inputs to the rival hegemon and uses its power to demand that the rest of the world shift away from sourcing from the rival, arises when the two hegemons offer relatively substitutable exports, are less interdependent with each other, and have more direct geopolitical rivalry. Countries in the rest of the world benefit, all else equal, from hegemons containing each other since they partially squander their power with offsetting demands. However, containment policy can also worsen the efficiency of global production, leaving the rest of the world worse off.