Division of the Humanities and Social Sciences California Institute of Technology Pasadena, California 91125 Dynamic Tariffs with Asymmetric Information

Recent work in game theory has demonstrated how cooperative outcomes can be sustained when the game is played repeatedly, defectors are punished, but agents play non-cooperatively. This methodology is applied here to determine when two countries can sustain freer trade given that they determine trade policies non-cooperatively. We focus on the role of asynunetric information. Countries have private information about the extent of their own protection, but the overall level of protection can be thought of as private information. Therefore, any agreement to eliminate or reduce tariffs is limited by the fact that countries can cheat on the agreement by using non-observable forms of protection. Using import trigger strategies, cooperation (in the form of low tariffs) can be supported. There a.re periodic reversionary (high tariff) episodes which necessarily occur. They are not the result of mistakes, attempted manipulation, or misperception. Neither country cheats on the low tariff agreement, but reversions to high tariffs are triggered by the random variable. In section V we examine a slightly different trigger strategy. Countries' strategies are based on their observations of the terms of trade. This alteration changes the results and in this case cooperation does not occur.