The Bargaining Mechanism in International Trade during Economic Crisis

Author: Ana MIHEI, PhD. Student, Alexandru Ioan Cuza University, Romania

Abstract:

The current economic crisis hits directly at what is referred to as the “engine on economic growth”, that is international trade. For the year 2009, the first contraction of trade since 1982 is announced. World Trade Organization says trade would fall by 9% this year, whereas the Organization for Economic Co-operation and Developments stresses on 13%. This step back is due to the diminishing demand for goods and the break down of production. And the situation could go worse as a consequence of the adoption of protectionist measures by a great number of states.

Herein we intend to highlight the macroeconomic game played by the states in order to combat the perverse effects of international trade's fall. For the clarity of the exposure, we make recourse to the simplification of the context and reduce the game to two players: the developed countries and the developing markets. Both players are characterized by distinct behaviors: the developed countries comply with the “hedgehog syndrome” as they tend to concentrate their productive capital into the national territory, and the developing countries act under the impact of panic produced the the flee of foreign capital and the sudden decline in production. In both situations, the impulse is to play a non-cooperative game in which each player takes individual decisions that do not take into account the long run effects and, especially, the consequences over the others' economies. And the decision is to impose protection to trade.

In the first part of the analysis we make recourse to a theoretical game model that fixes the gains and losses for both players for the two possible decisions: impose protection and not impose protection. The game is a non-transferable utility cooperative one and has its core solution for maximum of gain and minimum of loss for each part.

The second part of the analysis corroborates the theoretical model with the real economy. Taking into account the incomplete rationality of players and well as information, in the real world the strategies adopted are ventured and do not fold exactly over the model. Moreover, the lack of confidence in the partner's word as well as the temptation of avoiding a supplementary loss over the short run to the partner's favor lead to a partially non-cooperative game.

Resuming, even though the best solution for both developed and developing countries would be to halt further protectionism and fight together to bypass the crisis, when trade will recover due to global supply chains as fast as it fell, both players tend to retreat into their national territory and close the gates. More rationality and effort are needed not to diverge too much from the optimal solution of the game, otherwise there would be major negative repercussions on the long run.

Keywords:international trade, economic crisis, protectionism, macroeconomic bargaining, cooperative game, non-cooperative game,

JEL Classification: P45, G01, C78, F51, C71, C72

Negocierea în comerţul internaţional pe timp de criză economică

Autor: Drd. Ana MIHEI, Universitatea “Alexandru Ioan Cuza” din Iaşi, România

Rezumat:

Criza economică loveşte direct în ceea ce numim „motorul creşterii economice”, şi anume în comerţul internaţional. Pentru anul 2009 se anunţă prima contracţie a comerţului mondial după şocul din 1982, Organizaţia Mondială a Comerţului semnalând o scădere cu 9% a fluxurilor comerciale, iar Organizaţia pentru Cooperare şi Dezvoltare Economică, cu 13%. Acest pas înapoi se datorează scăderii cererii mondiale pentru bunuri şi colapsului producţiei. Mai grav este că situaţia se poate înrăutăţi ca efect al impunerii protecţionismului la nivelul naţiunilor participante la schimbul internaţional.

În lucrarea de faţă ne propunem să ilustrăm jocul macroeconomic jucat de state în combaterea căderii fluxurilor economice internaţionale. Pentru claritatea expunerii, recurgem la simplificarea contextului şi reducerea la doi jucători: ţările dezvoltate şi economiile în curs dedezvoltare. Ambii jucători sunt caracterizaţi de comportamente distincte: ţările dezvoltate se supun „sindromului ariciului”, recurgând la concentrarea capitalului productiv pe teritoriul naţional, iar economiile în dezvoltare acţionează sub impactul panicii generate de fuga capitalurilor străine şi scăderea bruscă a producţiei. În ambele situaţii, impulsul este de a recurge la un joc economic non-cooperativ de tipul deciziilor individuale, ce nu ţine cont de urmările te termen lung şi nici de impactul deciziilor proprii asupra economiilor statelor partenere în schimbul internaţional. Iar decizia este protecţionismul, sub forme şi în grade distincte.

În prima parte a analizei facem apel la un model teoretic de joc construit pentru a stabili care sunt câştigurile şi pierderile ambelor părţi pentru cele două decizii posibile: a impune măsuri protecţioniste şi a nu impune măsuri protecţioniste. Jocul este de tip cooperativ cu utilitate non-transferabilă şi se finalizează pe poziţie de echilibru pentru un profituri maxime şi pierderi minime pentru ambii jucători.

A doua parte a analizei vizează coroborarea modelului cu situaţia economică reală. Ţinând cont de raţionalitatea incompletă şi de imperfecţiunea imformaţiei, jucătorii adoptă în lumea reală strategii hazardate, ce nu se pliază perfect pe modelul de joc strategic. În plus, neîncrederea în cuvântul partenerului de joc şi tenataţia evitării unei pierderi suplimentare pe termen scurt în favoarea oponentului conduc la un joc parţialmente non-cooperativ.

În concluzie, deşi cea mai bună opţiune atât a ţărilor în curs de dezvoltare cât şi a celor dezvoltate este să nu adopte măsuri protecţioniste şi să lupte împreună pentru depăşirea crizei, când comerţul va lua avânt pe baza lanţurilor de achiziţii mondializate la fel de repede cum a sucombat, ambii agenţi în ansamblul lor tind să se retragă pe teritoriul naţional şi să închidă porţile. Un plus de raţiune şi efort se impune pentru a nu devia prea mult de la optimum jocului, fapt ce ar avea repercusiuni negative majore pe termen lung.

Cuvinte cheie: comerţ internaţional, criză economică, protecţionism, negociere macroeconomică, joc cooperativ, joc non-cooperativ.

Clasificare JEL: P45, G01, C78, F51, C71, C72

1. INTRODUCTION

Accordingly to the latest WTO report, the economic situation for all the WTO members has seriously deteriorated.

The economic crisis, though it burst from the financial sector, has eventually affected the real economy, were we to ignore the pure panic. It translated into shrinking global demand which, along with the shortfall of trade financing (or its high cost, where available), has determined the diminishing of trade flows all around the world.

As a fact, the WTO points out the sharp decline of world trade (both imports and exports, on average) since November 2008. The estimates show that world trade fell gradually and deep, by 5 per cent in November, 7 per cent in December 2008 and in January 2009 there was seen a 7 per cent month-on-month and a 17 per cent year-on-year decline. (see Chart 1)

After these data, the forecast for world trade flows is not optimistic. We are to see the most severe contraction of trade since the shock of 1982. The WTO has announced that “the volume of trade is projected now to contract sharply in 2009 by as much as 9 per cent”[1], whereas the OECD predicted a contraction of 13 per cent.

Chart 1


As bad as the picture may look, it can get worse, as an economic crisis leads to protectionism or at least to the halt of liberalization[2]. Indeed, as stated above, an economic crisis, may it have been generated in the financial sector, ultimately touches real economy and hits on the everyday worker. Therefore, at national level, each country being envisaged, there is great social pressure towards governments to keep feeding the people, that is to maintain jobs for national citizens and keep each industry and each mass employer on their feet. Of course, the intensity of such a pressure from the overall population differs from state to state, indirectly proportional to its population that benefits from activities of subsistence.

However, the above mentioned is much of a cliché situation, which is generally not escaped from. Automatically, it calls for the imposing of protectionist measures. The popular thought is that protectionism protects. In reality, history has shown different. Subsequently, protectionism would rather theatrically be considered at economic level as a “pact with the devil”, on the long run.

The lesson from history on protectionism during crisis is that “raising trade barriers (…) risks pushing the economy into prolonged contraction”[3] Should we first take the case of the 1930's crisis, what came with the economic shock was an alarming decline in trade, as global demand imploded and prices fell sharply. The governments reacted to the worsening economic situation by initializing a “destructive, protectionist spiral of higher tariffs and retaliation”. The outcome was not beneficial for the states' economies and it is considered that protectionism has prolonged the effects of the crisis. Moreover, a useful lesson was that “once trade barriers come up, they take years of negotiations to dismantle”[4].

A representative example of the benefits of liberalization compared to the rise of protectionism was the Asian crisis, when the states involved went on further liberalizing trade rather than closing the borders to the foreign merchandise. The outlook was a more rapid restoration of Asian economies.

History teaches lessons. But, each crisis is different as circumstances differ and it needs distinct approaches. Though the current crisis has largely been compared to the one of the 1930's, at least from the point of view of world trade and protectionism, there are significant differences. First of all, economy has changes due to globalization. We are not confronted anymore to the economies of Ricardo's theory. Countries no longer specialize in the production of a certain good, but in a certain activity of the production cycle. Economies are much more interdependent now. We talk currently about global supply chains. It is them that fasten the fall of trade if one part of the chain is damaged and it is still them that will support the revival of trade and economy were the leaders not to impede commercial flows through protectionism.

Summarizing, the current real image is that : “as global demand contracts, trade is slumping and protectionism rising”[5] and “a further rise in protectionism risks choking off what should be the engine of recovery for the world economy”[6].

Also having in mind the power of global supply chains of moving the wheels of economy, at this point of the equation the question to be asked is: What should world leaders do to save the globalized trade?

2. A model of state's behavior in international trade during economic crisis

In order to answer the above-put questions, we have to remember that trade policies have not determined the crisis and nor will they cure it.

But, the way governments play the game of international trade will have an impact on the length and intensity of the crisis, as well as on the crisis' aftermath picture as concerns international trade relations and flows and the speed of recovery.

We make appeal, at this point, at the theory of game, in order to discover the optimal positions states should take for global trade to suffer the least during the crisis and after it.

The reason to have invoked theory of game is that this science gives the methods to illustrate the gains and losses of a conflict situation between rational agents. Indeed, we aim at identifying the benefits for the states as rational players were they to impose or not protectionist measures during the current economic crisis.

The game we propose has two parts: the descriptive model and the solution.

2.1.Descriptive model

A bargaining game, seen as a mathematical problem, needs a set of elements and hypothesis as a starting point in order to get to a solution. All these are to be presented in the following paragraphs.

General hypothesis

The theory of games considers that the players are perfectly rational and they compete for a certain set of gains. Moreover, each player seeks to maximize its gains. A priori, considering history, we believe that in international trade players should better cooperate, that is they are able to communicate and coordinate their actions. As a consequence, we take the perspective of a cooperating game with non-transferable utility, and with complete information (that is each player knows at every point of the game which are the possible moves of the other party and the motivations).

Players

For the international trade arena, we have considered as strategic players the group of countries comprised by the Group of Twenty Finance Ministers and Central Bank Governors (G20) and forum of Asia-Pacific Economic Cooperation (APEC). The justification for this selection is that all together, these countries account for 86.6 per cent of world exports (after WTO – International Trade Statistics 2008) and 82.3 per cent of world imports.

The total number of countries (excluding the few superpositions of G20 and APEC) is 54[7].A 54 – agent game would be difficult at this time as there are distinct variables that characterize the each country. Therefore, in order to build a more precise and synthetic model, we are to divide the 54 – group of countries in two categories: developed and developing nations[8], further referred to as D, respectively d.

D stands for the 31[9] developed nations of the two political groups: G20 and APEC, and d stands for the 23 developing nations of the groups.

Both D and d are to be seen as single players (though represented by a group of countries), each one characterized by an individual set of strategies.

Possible actions – pure strategies

In the context described in the introduction of this paper, what we are interested in is what do national governments do as concerns the adoption of protectionist measures in international trade during economic crisis.

Ergo, the there are two possible moves for each player: to adopt protectionism (P) and not to adopt protectionist measures (NP). Thus, we consider J1 the set of the two strategies of D and J2 the two-strategy set of d, where J1 = {P, NP} and J2 = {P, NP}.

We note that nowadays, protectionism is varied. Accordingly to the WTO, the developed nations mostly subsidize, whereas developing countries adopt an extended array of protectionist measures.

Gains of the game

D and d fight to divide the international market for the set of products each specializes in. The general gains that can hypothetically be obtained by the countries are of the form: Gkij – gain of D when D plays strategy i and d plays strategy j, where k = {D,d} and i = j = {P, NP}.

2.2.Solution of the game

A solution or a “bargaining set” focuses on the utility that the players obtain[10].

In playing the international trade game, both countries are interested in selling their overproduction on the international market, and the game that is presented as follows:

Specific hypothesis

  • we have two countries: D (developed country) and d (developing country);
  • both D and d produce two products: A and B;
  • the production of both A and B is preset;
  • in situation of economic crisis, as demand contracts, both D and d are in the situation of overproduction. D has an overproduction of A and d has an overproduction of B;
  • the strategies applied are J1 = {P, NP} for D and J2 = {P, NP} for d.

Synthetic game model

We consider that the states play a sequential game, the decision of one country following and being determined by the decision of the other one. Moreover, it is a dynamic game, as it can continue beyond a single action for each player, according to the situation, as seen in the graph.

For the sequential game, we adopt the graph method to illustrate the confrontation of the pure strategies.

Order of moves: D acts first, having two possibilities – P and NP. Second will go d, with the same two possibilities of action for each strategy of D.


The above model stresses upon the fact that were one country to adopt protectionism, the other one would react by a symmetric action. The final result is a cease of international trade flows, each countries having a zero gain.

Were the countries to maintain free trade, they will both have a gain from trade, as they will share the market. However, a < x and b < z.

Game situations

At this point, we have a 4-situation game. Each of them can be identified as a sub-game of the above – illustrated model.

1st situation: D has an overproduction of A and sufficient quantity of B; d has overproduction of B and sufficient quantity of A.

In this situation, both countries are interested to export and none to import.

In order to sell its surplus of A, D chooses to adopt a beggar-thy-neighbour strategy and subsidize its A industry. D has now cheaper A product, more attractive for the consumers from d than their national production. As a consequence, to protect its A industry, considering that it also has a surplus in B, d will raise its import taxes. The result is no trade and a (0,0) set of gains. Were D not to interfere in the competition of the market, buyers from d might choose to buy some A from D and some buyers from D might choose to buy some B from d. This way, each country would lose in one industry and win in the other. Globally, the trade mechanism would not be stopped.

2nd situation: D has an overproduction of A and sufficient quantity of B; d has overproduction of B and insufficient quantity of A.

d needs more A, but would buy if it could sell its overproduction of B. D, however, is only interested to sell A and would not buy B as it has enough.

Here, the first to make a move is d, who will restrict access for D on A – industry market. In reaction, were B from d more attractive that B from D, the latter country would restrict the access on the market for B from d. Again, the result is no trade and a set of gains of (0,0). Had the countries not impose restrictions, d would have bought A from D and D would have bought some B from d. That is, the gains are not equal to zero if trade is not halted.

3rd situation: D has overproduction of A and insufficient quantity of B; d has overproduction of B and sufficient quantity of A.

d only wants to sell B, but D, although is in shortage of B, would only buy it if d bought its overproduction of A.

This is a similar game as situation 2, but seen in reverse.

4th situation: D has overproduction of A and insufficient quantity of B; d has overproduction of B and insufficient quantity of A.

In this 4th situation both countries are interested to buy one from another: D buys B and sells A, whereas d buys A and sells B. Free trade functions until one of the countries has fulfilled its need for the product it had shortage in. Considering that none of the countries has escaped its overproduction, we are now either in one of the situations 2 or 3 (which are similar but in a mirror perspective for D and d), or in situation 1.

The conclusion is that, were countries to impose restrictions, the gains from trade would be null. If trade is free, however, countries support each-other and gain by trade by reducing their total overproduction of goods and services. Hence, the optimal solution of the game is the strategy (NP, NP) with the gains (a,b) that account for maximum of profit with minimum of loss (x>a>-w and z>b>-y).