GAME THEORY ANALYSIS OF THE SMOOT-HAWLEY TARIFF ACT

 By J André Faust  (Jan 19, 2025)

Below is a game theory analysis of the Smoot-Hawley Tariff Act (Tariff Act of 1930) and its repercussions. While this historical event predates the formalization of many game-theoretic concepts, we can nonetheless interpret the behaviour of the United States and its trading partners in strategic, game-theoretic terms.

President Trump informed Alberta Premier Danielle Smith, following their meeting at his Mar-a-Lago resort, that he plans to move forward with a 25% tariff on Canadian goods. This statement implies he is not bluffing. Examining the situation through the lens of the Smoot-Hawley Tariff Act, game theory suggests that other nations (or “players”) would likely respond in a similar manner. While this does not necessarily mean we would be plunged into another depression, it suggests we might see outcomes reminiscent of those experienced during the Smoot-Hawley era.

1. Setting the Stage: Players and Strategies

Players:

• The United States, aiming to protect domestic industries and farmers.

• Major U.S. trading partners (e.g., Canada, France), seeking continued access to U.S. markets and to safeguard their own industries.

Strategies:

1. Impose High Tariffs (Protectionist): Unilaterally raise or maintain high import duties to shield domestic producers from foreign competition.

2. Maintain or Lower Tariffs (Cooperative): Keep tariffs low or reduce them to foster international trade, despite short-term pressure from domestic industries.

In the Smoot-Hawley context, the United States chose Protectionist (raising tariffs), while its trading partners could respond by either accepting the tariffs or retaliating with tariffs of their own.

2. Game Structure: A Multi-Player “Trade War” Scenario

Game theory often models trade interactions as a variant of the Prisoner’s Dilemma:

• Short-Term Gain: If one player imposes high tariffs while others do not retaliate, that player can enjoy short-term benefits (domestic industry protection, potential political support).
• Retaliation Risk: However, if the other players also impose high tariffs, overall trade suffers—everyone is worse off.

When the U.S. raised tariffs drastically under Smoot-Hawley, it essentially made a unilateral “defection” move. This spurred other nations to retaliate with their own tariffs, dragging all parties into a non-cooperative equilibrium where trade volumes declined significantly.

3. Payoffs and Outcomes

• U.S. Short-Term Payoff: Protection for certain domestic industries and a political narrative of “protecting jobs.”
• U.S. Long-Term Payoff: Retaliatory tariffs severely reduced exports, contributing to a deeper economic downturn. Industries relying on international sales were particularly harmed.
• Trading Partners’ Payoff: They faced higher barriers to exporting goods to the U.S. Imposing retaliatory tariffs helped them politically at home but shrank global trade overall.
• Collective Outcome: The strategy profile where everyone imposes high tariffs is Pareto-inferior. No single country benefits enough to offset the overall loss in global trade, contributing to worsening conditions during the Great Depression.

4. Retaliation and Repeated Games

In a single-shot game, one might gain by imposing high tariffs while others keep them low. However, global trade is typically a repeated game, with ongoing interactions over time. Retaliation (tit-for-tat) is common:

• Tit-for-Tat: After Smoot-Hawley, countries like Canada immediately raised tariffs on U.S. goods, mirroring U.S. action.
• Persistent Non-Cooperation: Once both sides enacted protectionist stances, reversing course required significant policy shifts (which did not occur until the mid-1930s with reciprocal trade agreements).

5. Information and Expectations

Over 1,000 economists opposed Smoot-Hawley, indicating a strong belief it would backfire. In game theory terms, this reflects:

• Incomplete Information: U.S. policymakers underestimated other nations’ willingness to retaliate.
• Overoptimistic Beliefs: Officials presumed other countries might not retaliate or that domestic gains would outweigh any global drawbacks.

6. Lessons Through a Game Theoretic Lens

• Mutual Gains Through Cooperation: International trade is often more beneficial if nations lower tariffs collectively.
• Danger of Defection: One nation’s decision to raise tariffs can trigger a chain reaction, leading to a “trade war” that hurts all players.
• Importance of Repeated Interactions: Over time, trust and stable agreements (like GATT and the WTO) serve to prevent destructive cycles of retaliatory tariffs.

From a game theory perspective, Smoot-Hawley exemplifies how short-term political gains can lead to non-cooperative equilibria with long-term collective losses.

Conclusion

The Smoot-Hawley Tariff Act represents a classic case of defection in an iterated trade game. By dramatically raising tariffs, the U.S. encouraged other nations to do the same, resulting in economic isolation and a deeper global crisis. The severe consequences of this non-cooperative strategy helped pave the way for more cooperative, rules-based global trade policies in the decades that followed, which may be how the Trump game will end.

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