Trump Wants to Win at Trade. He's Missing the Point.

The ultimatum game, the double thank-you, and the politics of global commerce

Donald Trump is screwing up the ultimatum game.

The classic psychology experiment works like this: One player is given some amount of money, say $20, and told to divide it between herself and another player however she pleases. The second player can accept or reject the offer. If he agrees, both players keep the money. If he declines, both players walk away empty-handed. In theory, the second player should accept any offer. After all, something is better than nothing.

But that's not what people do. When offered less than 30 percent of the total, peeved second players consistently turn it down. Tweaking the terms can change the outcome on the margins, but not the underlying fact that even when people are getting something for nothing, they're willing to sabotage their own material gain to make sure the person who offered them a bad deal loses too. This is, alas, the secret to understanding international trade policy.

In July, President Trump laid out his plan to renegotiate the North American Free Trade Agreement (NAFTA), a set of rules governing commerce between the U.S., Canada, and Mexico that he has called "the worst trade deal maybe ever." The tariff- and bureaucracy-reducing arrangement, which was negotiated by President George H.W. Bush and signed into law by President Bill Clinton, has been a political ping pong ball ever since. White House hopefuls like to talk smack about it during their now-mandatory factory-floor campaign speeches, which generally demean the quality of goods manufactured abroad, lament the loss of certain blue-collar jobs, and bemoan the existence of trade deficits—where imports outweigh exports—as the root of these evils.

More than 20 years after its implementation, NAFTA has tripled the United States' cross-border trade with Canada and Mexico, an increase that significantly outpaces the growth in U.S. trade with the rest of the world. But the U.S. did have a $63 billion trade deficit with Mexico last year, compared with a $1.7 billion surplus in 1993. Is that a sign that America got a bad deal? Donald Trump thinks so.

The same sentiment was on display in his recent partial reversal of President Barack Obama's opening up of relations with Cuba. "Effective immediately, I am canceling the last administration's completely one-sided deal with Cuba," the president said in June. (For more on that, flip to "Whiplash and Backlash in the Republic of Cuba" on page 28.)

Donald Trump isn't anti-trade, unlike some of his unlikely lefty bedfellows. He's pumped, for instance, about the prospect of helping Make Britain Great Again with a "big and exciting" trade deal. But for Trump, the presence of trade deficits—especially with China, but with Japan and Germany as well—are a dead giveaway that something is rotten.

As a side note, the president seems a little unclear on the distinction between trade deficits and budget deficits: In a June meeting with South Korean President Moon Jae-in, he said: "The United States has trade deficits…with South Korea right now, but we cannot allow that to continue. This is really a statement that I make about all trade: For many, many years the United States has suffered through massive trade deficits; that's why we have $20 trillion in debt."

In an August interview with The Wall Street Journal, Trump justified his plans to further limit imports from Europe by describing the E.U. as "very, very protectionist" and "very unfair."

His way of talking about trade, as a series of good deals or bad deals, misses the genius of the idea of swapping stuff in a market. The other guy being happy—smug, even—after a commercial transaction is not a sign that something went wrong for you. When I sold my 8-year-old television on Craigslist after it started spontaneously turning itself off, the guy who bought it definitely thought I was an idiot for not knowing how to fix this technical glitch, and I thought he was a sucker to have paid me for the privilege of hauling away my garbage.

American-style capitalism is built on the double thank-you. When you trade with someone, you thank each other at the end of the transaction, because you've both gotten something you wanted. Trump, meanwhile, is the second player in the psychology experiment, willing to throw free money back in the face of people who don't treat America fairly.

At the end of July, Foxconn, the Taiwan-based company that assembles iPhones in Chinese factories, announced plans to open a new production facility in Wisconsin. Given that Steve Jobs was openly contemptuous of the idea that his products would ever be made in America, this is indeed a surprise. In fact, it's a response to a combination of threats and bribery: The plant is a boondoggle, designed to suck $3 billion in cash and favors out of taxpayers. But more vitally, it's insurance against the great political risk introduced by a president who thinks nothing of making policy on Twitter, and who holds as one of his core tenets that buying too much stuff made in other countries is a sign of weakness.

In August, the president signed the House- and Senate-passed Countering America's Adversaries Through Sanctions Act, which will dramatically curtail trade with Iran, North Korea, and Russia. His formal signing statement closed with a particularly confusing threat/brag: "I built a truly great company worth many billions of dollars. That is a big part of the reason I was elected. As President, I can make far better deals with foreign countries than Congress."

The ultimatum game is a hoary classic in experimental psych by now. Many versions of it have been tried. People demand and receive more balanced offers from people they perceive to be a part of their tribe or in-group, for instance. Increasing players' empathy—by having them imagine themselves in the position of the other player, or simply by pumping them full of oxytocin—also boosts the chance that an offer will be accepted. When chimps play the game with other chimps, they behave similarly to human beings, but will accept even low offers when they are tendered by a machine. When people play the game for higher stakes—two weeks' salary in Indonesia; nearly a year's salary in India—they are more likely to accept inequitable offers.

That last bit may be good news for America's trade policy. Even if Trump offers a trading partner a deal that tips strongly in the United States' favor, the other country might take it because the stakes are so incredibly high.

Donald Trump is far from alone in his disgust for bad deals. This deeply embedded trait is the reason we have the World Trade Organization (WTO), to help settle disputes and to nudge nations toward actually doing a deal in the first place instead of walking away.

More to the point, this impulse is the reason we have trade agreements at all. We're so afraid of getting screwed that we're constantly leaving money on the table, so we tangle ourselves up in formalities to minimize the temptation to give in to our base instincts.

But the rational reaction is the right one: Any deal is a good deal. Engagement is better than non-engagement. Opening up trade sometimes means accepting the one-penny offer from a $20 country. That's a tough sell for politicians with a zero-sum mindset, because it doesn't feel like winning. But it's one of the most unambiguously powerful ways to make America more prosperous. If the rest of the world gets richer too, that doesn't mean we got a bad deal.