When is a trade war, not a trade war? When it’s a boss game
In our latest article, Ed Margot FEI’s Investment Strategist, contemplates the power struggle that raging between the world’s two largest superpowers: China and the USA. All, it appears, is not as it seems on the surface…
In war, there are winners and the winner takes all. In war, there are losers and the loser walks away losing out. With the US and China trading blows, it seems like a competition, or a war, or as game theorist call it: a “zero sum game.” Whilst it may appear that way superficially, there is more to the games that nation states play.
One premise of game theory with two sides in competition is the zero sum game. We use this terminology because someone wins (+1) and someone loses (-1): they add up to 0.
There are two more facets to game theory than a winner and a loser scenario. There are “non-zero sum” games; games that do not add up to zero. There can be a positive sum game and a negative sum game.
Positive sum games typify the win-win scenario. Both sides co-operate to their mutual benefit where one side wins +1 and the other side wins +1. This adds up to make 2.
Negative sums are the opposite of positive sum games. One side loses -1 and the other side loses -1. These are also called “wars of attrition” where both sides lose, exchanging blows with no potential upside. They are short lived as the endgame does not justify the means and both parties realise there is nothing to be gained.
In a positive sum game, two sides voluntarily come to an agreement and work together for their mutual benefit. The pre-Brexit Europe-UK relationship is a prime example. The countries of Europe came together, bringing people, the countries and resources for their benefit. Their relationship lasted decades with peace, prosperity and economic growth.
The Brexit vote indicated that a fundamental element of the win-win game needed to change: within every positive sum game there is a boss game: someone always has the upper hand. The Referendum was the electorate changing the balance of power: the electorate felt that the European Union had the upper hand in their relationship and that leaving Europe would control the UK’s destiny.
In America, Donald Trump has decided on a change. He wants to change the US-Sino relationship. A large swathe of electorate who voted him into power suffer from the growth of the Chinese economy. China also allows questionable behaviour within its economy, allowing companies to use intellectual property to benefit Chinese companies. Ideas, technology and knowhow are pillaged for the benefit of the People of China. The balance of power needed to change and for Trump, it was an easy move for the US to make.
So, is a trade war a zero sum game or a positive sum game; they both exchange blows? In a war, one side takes something the other side possesses. Is the US taking something China possesses, or vice versa? No: regardless of the tariffs imposed by both sides, trade is still made between the nations. Both sides still benefit, although the trade game is less advantageous. They both win in the positive sum game.
This leaves us in a position whereby each side incrementally reduced the value of the positive sum game. Both sides will still trade with each other. Tariffs may rise and volume of trade may change. Industries reorganise, supply chains and adjust their product lines. Nonetheless, they both trade and both benefit from their relationship.
You may argue that they are still “fighting” and trading blows. You are correct but the devil is in the detail. Within each win-win game there is another game. There is a battle raging and the US wants to rebalance the “boss game.” The boss game is different from a win-lose, zero sum game. In the boss game you want to win, but you do not want the other party to walk away, you want them to keep playing for your mutual benefit. This differentiates it from the zero sum game.
The strategy angle should be explored. In the context of a game the risks are high, while the trade war is win-win, it’s a proxy for a wider conflict that is zero sum. China is on track to become the world’s largest economy; the boss game is about who becomes the most important global actor.
Losing the game will be humiliating for China and possibly fatal to Trump given the election next November. There are two unsatisfactory outcomes, that the trade war game continues without reaching equilibrium until it becomes lose-lose, or that the conflict is not confined to trade as the losing party will need to regain honour/popularity by starting and winning a second game. Possibly by invading someone.
To find out more about how our model portfolio service can help to manage risk in uncertain times, please join our free webinar hosted by Ed Margot, Investment Strategist.