National Bank of Georgia publishes working paper modelling international tariff rivalry and welfare outcomes

The National Bank of Georgia has released a working paper, “The Art of Trade War – A Stackelberg-Cournot Model of International Tariff Rivalry,” examining how large economies set tariffs strategically and what this implies for welfare and trade. Using scenarios calibrated to the US, China and the EU, the paper finds that a first mover in tariff setting can secure short-term welfare gains through tariff revenues and protection of domestic producers, despite higher local prices and lower consumer surplus, with these gains coming at the expense of trading partners and reducing global welfare and trade volumes. The paper develops a three-player Stackelberg-Cournot framework in which one country sets tariffs first and the other two respond simultaneously, before firms choose quantities supplied to destination markets. The model incorporates differences in market size, the distribution of tariff burdens between consumers and producers, bilateral trade preferences, and empirically estimated demand and cost parameters; it also shows that deviations from optimal tariffs can raise individual players’ gains even as global social welfare continues to fall, producing a Nash equilibrium with larger welfare losses and underscoring the role of cooperation given spillovers to small open economies indirectly exposed to trade conflicts. The working paper forms part of the National Bank of Georgia’s Working Paper Series, which is circulated to facilitate discussion and elicit feedback and is coordinated by the bank’s Macroeconomic Research Division.