Cooperation or confrontation in US-Japan trade? Some general equilibrium estimates

Using a detailed calibrated general equilibrium model, we evaluate the effe cts of greater cooperation or confrontation in bilateral trade relations be tween the U.S. and Japan. Our numerical results indicate that, if a trade w ar between the two were precipitated, the U.S. would eventually benefit fro m the mutual imposition of reciprocally optimal tariffs. While this result appears negative for those who advocate free trade, it provides the key to overcoming an important incentive problem of liberalization. Specifically, we find that Japan gains more from U.S. unilateral liberalization than from bilateral liberalization and thus has an incentive to limit its commitment to removing trade barriers. Since the U.S. has a credible threat of retali ation however, it can bargain with Japan to implement bilateral cooperation . In other words. the strategic environment is neither completely harmoniou s nor discordant. A credible threat of confrontation can secure the basis o f cooperation. (C) 1999 Academic Press.