I suspect many of you have seen and remember the 2001 movie, A Beautiful Mind, starring Russel Crowe as the American John Nash. Nash won a Nobel Prize  in Economics for his game theory – popularly known as the Nash Equilibrium. There are initial conditions for the “game” but that is probably only of interest to folks familiar with game theory. The Nash Equilibrium basically says, e.g. you have three players in the game – let’s say Canada, Mexico, and the United States. If each player has chosen a strategy – an action plan based on what has happened so far in the game – and no one can increase one’s own expected payoff by changing one’s strategy while the other players keep theirs unchanged, then the current set of strategy choices constitutes a Nash equilibrium.

Canada and Mexico are resource-rich countries with diversified economies. And they have a prosperous next-door neighbor who they’ve mostly been on good terms with. Over time their economies have become incredibly dependent on American trade. The United States receives 77 percent of Canada’s exports and those exports represent 20 percent of the entire Canadian economy by GDP. For Mexico, the US receives 79 percent of their exports and represents 26 percent of their GDP.  By comparison, no country in the world’s exports account for more than 2 percent of American GDP. 

The US institutes 25% tariffs. Retaliatory tariffs could cause plenty of pain for American consumers, but the situation is asymmetric. Tariffs by Mexico would put 26 percent of their economy at risk versus 2 percent of ours. The risks are asymmetrical for each country. In the extreme, completely pausing trade between the “player” countries might cause a recession in the United States, but it could trigger a depression in our neighbors. 

And so we – for the moment as Mexico and Canada capitulate – are in a Nash equilibrium. That is unless one of the player’s responses is other than rational from a game theory perspective. 

What could go wrong?

Source credit: Nate Silver, The game theory of Trump’s tariff threats | Image from Pexels