## TRADE COOPERATION IN AN AGE OF GEOPOLITICS

## Source details

**Canonical URL:** [TRADE COOPERATION IN AN AGE OF GEOPOLITICS](https://www.imf.org/-/media/files/publications/fandd/article/2026/06/mattoo.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/fandd/article/2026/06/mattoo.pdf.md)
- [Structured JSON version](/-/media/files/publications/fandd/article/2026/06/mattoo.pdf.json)

---

### The problem and context
- The multilateral trading system was established with the General Agreement on Tariffs and Trade (GATT) in 1947 and embedded in the World Trade Organization (WTO) in 1995, designed for a world where governments rarely used trade to achieve geopolitical goals.
- The United States and China now often refer to each other as geopolitical rivals and increasingly use trade policy to advance strategic objectives—limiting technology transfers, restricting exports of critical products, pursuing national security goals.
- Geopolitical rivalry changes governments’ objectives: policymakers care about absolute welfare and relative power, shifting trade policy incentives toward measures that damage rivals as well as affect domestic sectors.

### Economic logic and implications
- Standard models: uncoordinated tariff policy leads to inefficiently high protection and low welfare; trade agreements enable escape via coordinated tariff reductions.
- Geopolitics alters incentives:
  - Tariffs become attractive instruments of strategic competition because they can shrink rivals’ industries as well as build domestic ones.
  - A country might reject a highly beneficial trade deal if it would strengthen an adversary, or implement damaging measures if they harm an adversary more.
- Despite rivalry:
  - Economic efficiency still matters; if governments care at least somewhat about citizens’ welfare, they can still negotiate policies that make both countries better off—“enlightened self-interest” remains a viable foundation for cooperation.
  - However, rivalry raises noncooperative (Nash) equilibrium tariffs and reduces trade relative to a nonrivalry world.

### The adjustment problem and two paths
- The transition from a noncooperative to a cooperative equilibrium is difficult because the existing system’s key pillars—reciprocity and nondiscrimination—facilitated past transitions but may not accommodate geopolitical adjustment.
- Two possible adjustment paths to a new cooperative equilibrium (illustrated in the box):
  - War and redemption:
    - Path: B1 → N2 → B2.
    - Description: Allow the old agreement to collapse, tariffs rise to the new noncooperative level N2; eventually negotiate a new agreement through traditional reciprocal tariff reductions.
    - Features: Economically costly, lengthy negotiations, fits within existing multilateral framework.
  - Immediate transition (institutional innovation required):
    - Path: B1 → B2 directly.
    - Description: Negotiate an immediate transition along the efficiency frontier, avoiding economic disruption.
    - Feature: Requires nonreciprocal concessions—one rival may need to accept reduced welfare relative to the status quo to sustain cooperation—something the WTO’s reciprocity principle cannot accommodate.

### Multilateral complications
- Reciprocity and nondiscrimination limit feasible geopolitical adjustments:
  - Reciprocity cannot readily handle nonreciprocal transfers required when one rival must concede relative welfare to sustain cooperation.
  - Nondiscrimination requires that any trade benefit extended to one member be extended to all, complicating bilateral adjustments that exclude third countries.
- Example: The 2020 Phase One agreement between the United States and China:
  - Intended to ease trade tensions via Chinese commitments to buy specific quantities of US goods.
  - World Bank research at the time predicted both countries would have gained relative to continued escalation, but exporters in Europe, Latin America, and elsewhere would have been hurt if China redirected imports from those regions to the US.
  - The deal’s being struck outside multilateral rules highlights the current system’s inability to accommodate needed adjustments.

### Policy proposal: a geopolitical exemption
- Objective: Create space within the multilateral trading system for geopolitical adjustment while protecting third countries.
- Core design feature:
  - Allow strategic rivals to make discriminatory tariff adjustments under strict conditions.
  - Require that any discriminatory adjustments between rivals leave world prices between the rivals and third countries unchanged, thus limiting trade diversion.
- Precedent and limits:
  - The trading system already accommodates certain discrimination (preferential trade agreements, free trade areas) subject to strict conditions (e.g., they must cover “substantially all trade” among members and not raise barriers against nonmembers).
  - A geopolitical exemption would serve a different purpose—accommodating rivalry while minimizing damage to the broader multilateral system.
- Implementation challenges:
  - Technically complex to enforce the requirement that world prices between rivals and third countries remain unchanged.
  - Without such a mechanism, geopolitical adjustment will occur outside the multilateral framework or not at all, risking destructive trade conflicts and costs to neutral countries.

### Conclusions and policy implications
- The return of geopolitics does not eliminate the economic case for cooperation: negotiated agreements can still yield mutual gains even among strategic rivals.
- The trading system must adapt institutional rules to permit constructive geopolitical adjustment without undermining third parties or the system’s integrity.
- The proposed geopolitical exemption provides a mechanism for such adaptation by:
  - Allowing constrained discriminatory adjustments between rivals.
  - Establishing safeguards (price-preservation between rivals and third countries) to limit trade diversion and protect neutrals.
- Action required: Institutional innovation—analogous to past additions to the trading system—so the WTO framework can accommodate geopolitical realities while preserving core multilateral functions.

*Source: Aaditya Mattoo, Michele Ruta, and Robert W. Staiger, “Trade Cooperation in an Age of Geopolitics,” June 2026.*

---


_Source: https://www.imf.org/-/media/files/publications/fandd/article/2026/06/mattoo.pdf_