As the US and China escalate their trade war through tit-for-tat tariffs, it is tempting to view the situation as irrational brinkmanship.
However, beneath the surface, the pattern follows a familiar structure in economics, specifically the “Prisoner’s Dilemma” in game theory — albeit one complicated by geopolitics, national pride and the realities of domestic politics.
In the traditional Prisoner’s Dilemma, two players (in this case, the US and China) each have two choices: cooperate (lower tariffs, open trade) or defect (raise tariffs, restrict trade). The payoffs are clear:
- If both cooperate, both benefit and no one “loses face.”
- If one defects while the other cooperates, the defector wins big, gaining market share and strategic advantage, while the cooperator looks weak and loses economically and politically.
- If both defect, both suffer — but at least neither “loses face” to the other.
In purely economic terms, mutual cooperation would clearly be the most optimal outcome. Yet in this case, losing face carries heavier consequences.
For Beijing, being perceived as capitulating to American pressure would not only undermine its international credibility but would also affect its political strength domestically.
For Washington, especially under an administration defined by its transactional style, appearing “tough on China” remains a major electoral asset.
Trust, time and Trump
Two additional dynamics make this particular iteration of the Prisoner’s Dilemma much more complex.
First, trust is at an all-time low. President Trump’s well-known capriciousness leaves counterparties understandably skeptical of any promises.
Deals can be reversed, tariffs can be raised and imposed without warning and the political logic often shifts depending on domestic electoral swings and business lobby desires.
Second, this is not a repeated game, at least from China’s perspective. In game theory, repeated interactions encourage cooperation because each side knows it must live with the consequences over multiple rounds.
Here, China knows it might only need to weather one term or possibly just another year of Trump’s administration. With US midterms on the horizon, there is little incentive for Trump to make serious concessions now.
When the game is short-term, the safest move becomes defecting, regardless of the broader economic cost. Vietnam offers a sobering illustration of what happens when a player tries to cooperate too early.
When Vietnam floated a plan to eliminate tariffs on US goods in the hope of reciprocal treatment from the Trump administration, rather than rewarding the offer, US officials flatly rejected it, criticizing Vietnam’s trade surplus and accusing it of “dumping” cheap products such as shrimp into the American market.
The lesson for China was obvious – caving early does not guarantee leniency. Indeed, it may simply invite more demands.
More than just trade
The consequences of the mutual defection extend far beyond the tariffs themselves. Global supply chains continue to shift – companies are accelerating efforts to diversify away from US-centric or China-centric models.
Instead, they are investing across Southeast Asia, Latin America and even Africa, viewing them as potential final demand destinations and not just as offshore manufacturing bases. Intra-Asian trade is strengthening as countries seek alternatives in a polarized global order.
Meanwhile, the political framing, particularly in the US, has become increasingly zero-sum: if China benefits, America must be losing. This leaves little room for the nuance and compromise that international trade agreements typically require.
As a result, the tariff war is no longer just an economic dispute. It is a contest over narrative, pride and geopolitical influence.
No easy exit
In an ideal world, both sides would recognize the mutual damage and seek a face-saving solution.
But with trust eroded, incentives misaligned and the political cost of losing face ever so high, mutual defection has become the Nash Equilibrium. Neither side wants to back down and both would rather lose economically than appear weak.
The real tragedy isn’t just in the tariffs themselves. It is in how deeply trust has broken down, making cooperation harder not only today, but well into the future. Still, two broad paths remain for breaking the destructive cycle – changing the payoffs and finding a face-saving exit.
The first is if defection becomes much more painful than cooperation. This could happen if the domestic costs of the tariff war – slower growth, inflation, declining exports and a louder backlash from affected industries – begin to outweigh the political gains of “looking tough.”
The second path is more psychological but no less important. Given the strongman personas of both Trump and Xi, neither is likely to back down unless there is a narrative that allows them to do so without losing face.
This might come in the form of a temporary truce framed as “strategic recalibration” or even cooperation on a larger crisis that redirects attention and justifies de-escalation.
In short, what’s needed is not just a better deal, but a better story – one that allows both sides to retreat gracefully without looking like they’ve surrendered.
