Why Did Trump Impose Liberation Day Tariffs: A Short Game Theory Explanation

Sarvesh Kilariaar

London, UK

On April 2, 2025, President Trump declared “Liberation Day” tariffs, marking the implementation of the most extensive U.S. tariff hikes since the infamous Smoot-Hawley Tariff Act of 1930. It was a bold response to decades of perceived unfair trade practices, imposing a sweeping 10 percent tariff on all imported goods, as well as specific tariffs on countries calculated using their trade balance with the US in the following formula, a higher xi - mi (trade surplus with the US) results in higher tariffs:

Or, in simple terms, tariff rate = trade deficit with the US/imports to the US x 2, and then multiplied by 100 to make it a percentage. 

Officially, the administration justifies these tariffs as a necessary correction to longstanding ‘unfairness’ in global trade; President Trump describes the US’s trade partners, such as the EU, as “ripping them off”. He aims, through the implementation of reciprocal tarriffs, to reclaim domestic manufacturing and to reduce the persistent U.S. trade deficit. There is also a strategic fiscal motive: it is his belief that tariffs would generate revenue for the government as a sort of tax on imports from foreign countries, which would then allow the government to cut taxes for domestic consumers. While these dual objectives may appear to be complementary, higher tariffs risk dampening trade volumes and, consequently, tariff revenues; that is to say, if tarriffs on imports are too high companies will reduce how much they import into the US, and therefore total revenue from tarriffs will fall.

Trade has long been a key driver of economic growth. Ricardo’s theory of comparative advantage shows that when countries specialise in producing goods with the lowest relative marginal cost, both trading partners benefit. Trade as a means of mutual benefit has historically defined US-China trade, by contributing to mutual welfare gains from 1995-2011 (Table 1, Caliendo & Parro 2022)

Game theory is the study of decision-making; it analyses how one player's strategy affects the other player(s) strategies, under the assumption of rationality. We can model China and the United States as players and their two strategies, ‘Free-Trade’ (F) and ‘Tariffs’ (T), to model the reality before the trade war.

Game theory helps model this mutual benefit in the following payoff matrix, which is called the Stag-Hunt model. The cells represent the payoffs for China and America, given the respective pair of decisions made by each country.

	F	T (China)
F	a,A	b,B
T (US)	c,C	d,D

Where A>C=D>B; a>b=d>c. For clarity, I will replace A, B, C, D… with numerical payoffs in the traditional Stag-Hunt Game.

	F	T (China)
F	5,5	1,3
T (US)	3,1	2,2

At (FF), both players have no incentive to change strategy, regardless of what the other player does. We define this as the Nash equilibrium (underlined) - an outcome where no player can improve their payoff by unilaterally changing their strategy. Hence, both players have an incentive to engage in Free Trade. This was the reality before the trade war between China and the US.

Despite the universal benefits of free trade - and (F, F) being a rational equilibrium - the US still imposed trade restrictions to i) protect domestic manufacturing and ii) improve trade balance. The rise in Chinese exports contributed to a 16% decline in US manufacturing employment and caused the US trade deficit to hit a record high of $130.7 billion in January 2025. This shifted the strategic political scenario to a prisoner's dilemma model in the short term. We can represent this in the following matrix.

	F	T (China)
F	3,3	0,5
T (US)	5,0	1,1

Due to the Prisoner’s dilemma shift, (TT) is the new Nash equilibrium, and the US and China ‘play tariffs’.

Even though free trade would benefit both sides, fear of being undercut keeps them stuck in this outcome. This goes beyond economics; if China, for example, were to be the first to move back to free trade, despite the US continuing to impose tarriffs, it would be perceived as weak, which would further empower the US. Without trust or cooperation, both countries continue to raise barriers to avoid the political perception of weakness, as well as the economic penalty incurred by being the ‘first to blink’, showing how individual rational choices can still lead to a worse result for everyone. This also emphasises the crucial role of international cooperation, such as through the WTO, in sustaining global free trade and preventing trade wars and destructive tariffs, whose damaging effects on the U.S. economy are likely to become increasingly evident over time.