Threats or Promises?: A Simple Explanation of Gradual Trade Liberalization

Taiji Furusawa and Takashi Kamihigashi

No DP2010-34, Discussion Paper Series from Research Institute for Economics & Business Administration, Kobe University

Abstract: We analyze a infinitely repeated tariff-setting game by two large countries with alternating moves. We focus on the subgame perfect equilibria in which each country chooses its tariff according to a stationary function of the other country's tariff. We show that there are many equilibria with two steady states, one with higher tariffs (but still lower than the static Nash tariffs), the other with lower tariffs. We also show that there is a special class of equilibria in which there exists a unique, globally stable steady state. In both types of equilibria, one country unilaterally reduces its tariff from the static Nash equilibrium, the other country reciprocates in response to the first country's implicit "promise" to lower its tariff even further, and this process continues forever, converging to a steady state with tariffs lower than the static Nash tariffs. Therefore it is promises, rather than threats, that induce the countries to gradually reduce their tariffs.

JEL-codes: C73 F13 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2010-11
New Economics Papers: this item is included in nep-mic
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