Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
=Transcript of the talk, from the video's captions. Auto-generated: speaker names in particular are unreliable.
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# A Framework for Geoeconomics

Authors: Matteo Maggiori (Stanford GSB), presenting joint work with Christopher Clayton (Yale SOM) and Jesse Schreger (Columbia) — Hoover Institution economics seminar, Stanford, 10 Jan 2024 (chair: John Taylor; Schreger on Zoom)  
Discussant: None  
Video: https://www.youtube.com/watch?v=uCM_Abl-CJI&t=3s


## Talk (00:00:03 – 01:27:49)

[00:00:03] but they're welcome to the start of the new year. It's really exciting to get going.  
[00:00:08] But we're very pleased to have Matteo Maggiori speak to us today. The title is hard to pronounce.  
[00:00:15] A framework for geo-economics. Is that correct? Yes. Okay. Which is joint with Christopher Clayton and Jesse Jesse Schreger's on? Yes, Jesse I think is on Zoom. Okay.  
[00:00:25] Anyway, so take it away. We're anxious to hear this novel way to think about the world. Fantastic. Well, thank you for coming and um happy New Year. Uh this actually is the first seminar I gave when I joined Stanford in January  
[00:00:38] 2020 and George Shultz was still alive and it was pretty impressive to meet him. But it's good to be back and the paper today as John mentioned is with Christopher Clayton is at Yale and Jesse Schreger is at Columbia. He's online so if you have  
[00:00:52] any tough questions, he'll he'll handle them.  
[00:00:55] Um So first what's the topic? So at some level it's a very old topic.  
[00:01:01] It's the idea that governments use their country's economic strength that comes from existing trade and financial relationships to achieve some geopolitical goals or economic goals uh towards other countries.  
[00:01:14] Uh sometimes it's easier to think of the topic as a set of questions. Uh so first is is this a thing? Like does it even exist? Uh if this power does exist and in which dimension does it operate? What are its origins? How does it get  
[00:01:27] wielded? Uh there is a lot of informal talking about this topic. But once you try to dig deep on where does it come from and what exactly do you mean, the answers aren't so obvious.  
[00:01:38] Uh similarly, whenever you talk about particularly geopolitics, there's a tendency to think of it as a zero-sum game.  
[00:01:45] Uh I get something out of another country and you know, I'm better off, they're worse off.  
[00:01:51] Uh but is it potentially, you know, a positive sum game? For example, having a country like the US exert global power, are are there positive aspects from that? Um Fundamentally, another question that is  
[00:02:04] related is what sectors are strategic? Now, strategic is one of the most loaded words because governments tend to abuse them in all sorts of fashions to, you know, start justify protection and subsidy, nationalism, you know,  
[00:02:18] Khrushchev used to say you can make button strategic because soldiers need buttons cuz otherwise they need to hold their pants so they can't fight. Uh so you can make almost anything strategic without a theory. And so the the point today is to provide a theory and some  
[00:02:33] set of definitions that you might agree or disagree with, uh but they hopefully, you know, push us to confront these questions from a more uh formal perspective.  
[00:02:42] Uh the ingredients I'm going to use are pretty standard coming from economic theory. Uh so a lot of the contribution of the paper is trying to weave them together into a framework to answer this question. So I'm going to have a collection of countries.  
[00:02:55] I'm going to have global production networks. So think of it as input-output matrices. Well, some something that I produce gets used as an input somewhere else. That creates linkages across industries and countries.  
[00:03:07] Um and I'm going to have limited enforceability. So why do I have it? I want to position the paper and geoeconomics in general between two extremes. At one end is the very blunt threat of going to war.  
[00:03:19] You don't do what I what I want, I'll invade you. At the other end of the spectrum is complete contracts where we can agree on fully enforceable contracts on all possible contingencies. This power operates somewhere in the middle  
[00:03:33] where the threats are not war, they're commercial threats. Uh but very often what I try to achieve is either not enforceable or um I don't want to write it down. For example, I might want to  
[00:03:46] have a political concession. Uh I don't want I'm China, I I want another country to recognize the Dalai Lama, I'm going to pressure them commercially, but I don't want to write this down in a contract.  
[00:03:58] Uh, so the main mechanism we're going to have is that the power arises from the ability to do joint threats. From the ability to use a number of activities that might look rather unrelated. Uh, exporting and manufacturing and  
[00:04:12] financing or government aid. Uh, and join them together to exert pressure on other entities.  
[00:04:19] Uh, but also because I'm a large country, I'm going to ask you, once I have power over you, I'm going to ask you to take some costly actions.  
[00:04:27] Uh, but the reason why I'm going to ask you for those actions is I'm trying to manipulate the world equilibrium in my favor. So, costly actions are typical things like tariffs, uh, sanctions, uh, export bonds. I'm asking Nvidia not to  
[00:04:41] export chips to China. Okay, it's a privately costly action for Nvidia.  
[00:04:47] I'm doing it, uh, because I would like China not to develop a particular technology. So, for a matter of reason, okay?  
[00:04:54] So, that's that's sort of the broad framework. Let me try to position it in the literature. This is kind of interesting. Uh, this is my own very partial reading of what happened through the history of thought, but uh, um, we're building very heavily on two books  
[00:05:08] from Hirschman in '45 and '59 who was thinking about national power and trade.  
[00:05:15] So, this was a very big topic immediately after the war.  
[00:05:18] And then my own partial reading is that when formal mathematics came in with Chicago and and MIT uh, pushing the frontier, it was very difficult to to deal with these concepts.  
[00:05:30] Uh, and some people reacted badly and went into the wilderness of all the mathematical enterprise is useless because it can't quite give me what I want yet. Uh, and the topic kind of went out of fashion.  
[00:05:42] And I'm going to argue that today what we're going to try to do is bring it back into fashion.  
[00:05:48] Particularly because you know, over time we've developed substantially more sophisticated theoretical methods and we're going to borrow heavily from the theory literature to in some sense show that there are tools that we have developed over 50 years that actually  
[00:06:02] make these concepts very easy to analyze or at least possible to analyze. So what I have in mind, well first I'm going to use threats.  
[00:06:10] So the way to exert power here is going to be threats. Now 50 years ago threats were difficult concept. Today we have meaningful concept like off the equilibrium threats to induce good behavior.  
[00:06:20] Um I'm going to think about the idea of using multiple industries or multiple activities as being very connected with the work on why having multiple points of contact and provide high power  
[00:06:34] incentives. Okay, some of that work is here is done here at Stanford. Similarly, when I think about costly actions because I'm trying to distort the equilibrium, I'm going to build very heavily on the market literature that has developed  
[00:06:49] plenty of tools in public finance and in macro where we want to apply some, you know, wedges in first order conditions to to affect prices or aggregate quantities. Okay, so that those are the tools I'm going to use. Now let's get started and the way I'm going  
[00:07:03] to run the talk is first, please do feel free to jump in. This is not a paper where I can do 45 minutes of talking and then you ask me a question at the end because I trust me this will be unclear because I'm not good enough at presenting it. So please stop me.  
[00:07:16] But really point one, two, and three, there's a lot of model set up. Okay, you need to bear with me for a while because I need to define the environments.  
[00:07:24] Then the paper really comes alive in point four when we start thinking about there's a big country and it can make these threats and it can manipulate things and let's see what it does. What is his optimal contract and then trying to go through applications. Okay? But as I go  
[00:07:38] through the setup, please stop me if anything is unclear. I heard Peter Navarro talk about economic warfare all the time.  
[00:07:47] Is what you're trying to capture? Uh yes, coercion welfare. I'm not sure I'm going to talk about it in the same way, but um It's something like that.  
[00:07:57] Yeah, I mean there's two I hear this sort of stuff all the time as well. Um one motivation is we need to win the actual affair, you know, don't don't give them parts that they can use  
[00:08:10] to fly planes with. And the other part what I hear all the time is we need to win the strategic economic competition, which God knows what that means. So are are you after your economic economy as a source of military power or just somehow we need  
[00:08:24] to This is going to be There is going to be no no military actions. It's going to be entirely on the economic side or political connections.  
[00:08:33] Um And I think I I share your sentiment of I For a long time I was interested in this topic. Get it all the time.  
[00:08:41] I couldn't make heads or tails of that was me. So this is my attempt to move past words that you and I will quickly disagree on what they mean into a questions that you and I will still disagree on, but at at least we know  
[00:08:53] what they mean. Um so I have an infinite horizon model.  
[00:08:58] Um I have N countries. And there is productive sectors in each of the countries, okay? So here a productive sector uh think of it as Russian oil and US oil are two different sectors, okay? So sector here isn't an industry. It's a  
[00:09:13] sector in a country. Okay? And I have some local factors.  
[00:09:17] Think of it as labor or, you know, local endowments.  
[00:09:21] Um I have a unit mass in each sector of producers. What they're doing is they're buying inputs from other sectors.  
[00:09:29] They're using some local factors and they're producing some output.  
[00:09:33] And that output may end up being consumed or may end up being an input into somebody's health production, okay?  
[00:09:40] To make it simple in each country, I'm going to have a representative consumer.  
[00:09:43] So, here the focus is really going to be on the sectors of production.  
[00:09:47] And then the first thing I'm going to do, which goes to trying to put content on what John was mentioning, is I'm going to have a vector of aggregates that are I'm going to use to track externalities. So, what am I really doing? If you're familiar with  
[00:10:01] Rothschild Stiglitz, I'm just borrowing that one entirely.  
[00:10:04] So, there's a bunch of aggregates that might affect me. Uh you can think of it as climate, you can think of it as national security, and I take them as given as an agent, but our collective actions affect these aggregates, okay?  
[00:10:17] So, it's a very simple reduced form way to capture all sorts of externalities uh that we're going to use. And you'll see exactly what it does. It's a repeated game, so I have a discount factor beta.  
[00:10:28] Good. So, this is the easy part, the consumer. He has pretty standard preferences over a consumption of all the goods that exist in the world. And you can see the first appearance of the Rothschild Stiglitz term. Uh I have a  
[00:10:42] utility component that Which Rothschild Stiglitz paper are you talking about? Uh '86. No, no, no. Not the adverse selection. No, no, no. This is like pure pure externalities. How to track externalities. So, you can see there I'm  
[00:10:55] putting a a vector of aggregates into the utility function. So, simplest crude interpretation is as a consumer, I'm afraid if I see the military sector in China being big.  
[00:11:07] Okay? Uh it's been mostly used in economics to say um there are some aggregates that I don't like. Um that's all it does, okay? I'm not going to use it a lot, but it's there.  
[00:11:19] What is the budget constraint? It's pretty straightforward. Per period, I have money that I spend on consumption of the goods on the left-hand side, you can see it here.  
[00:11:28] I have the profits from my domestic sectors. Here I'm going to assume that you own your domestic sectors. There is nothing difficult in this paper if I assume that you arbitrarily own some foreign industry, but I'm not going to solve for endogenous ownership. So, I'm  
[00:11:42] going to assume that you own the domestic firms, and of course you get the revenues from the factors. Okay?  
[00:11:49] Please. Matteo, you you've already assumed away one thing which I would thought was important in this context, and that's the distinction between a regime and the populace.  
[00:12:00] So, sometimes geo-economic threats are exercised with the intent of undermining the regime rather than harming or helping a populace.  
[00:12:10] That seems to be off the table. So, no. Let me tell you So, there's one part that is definitely off the table cuz it requires a real model of that, and there's one part that is not. So, in a lot of the literature you have in mind, for example, these aggregates here  
[00:12:23] can be used to be political concessions. I don't want you to take an action, and I don't like your government being blue.  
[00:12:30] I like it being red. If you switch to red, I'm happy. Now, it's cheap, so I wouldn't call it a model of that.  
[00:12:37] But when you don't want to provide a full model making that one the the real thing, this is a cheap way, for example, in trade to track it. So, I have it to that extent. I certainly am not going to have good models of lobbying or elections at all.  
[00:12:51] We decided intentionally not to do it, but you're totally right.  
[00:12:54] Okay, out of these all all I get off to keep track is a typical Marshallian demand that prices. I have my wealth.  
[00:13:02] I I decide my optimal consumption. I have my indirect utility of the stage game, okay? So, the consumer here does very little.  
[00:13:09] Now, here's the interesting part. Is my suppliers versus clients game. So, this is the production side. So, I'm going to set it up as a stage game, and then I'm going to build an a repeated equilibrium with threats.  
[00:13:21] Okay? So, I'm going to do the stage game informally in the slides just to get a sense of how it works.  
[00:13:28] So, I'm thinking of a firm I playing against a set of suppliers J.  
[00:13:34] Okay? So, these are two links in the input-output.  
[00:13:37] I'm buying an input an intermediate input from them, they're selling to me.  
[00:13:40] At the beginning, what do I do? I place an order. I say, "I'm firm I, I'm ordering X I J from from the suppliers in J." They can accept or reject this order.  
[00:13:51] Okay, if they reject, nothing happens. If they accept, I'm I get the delivery of this order. So, I get the goods or I get the capital if it's a loan.  
[00:14:00] And then I have a choice. I can pay the suppliers or I can steal from them.  
[00:14:05] And I'm going to assume symmetric strategies. So, I This is a a game between a single firm and an entire sector. If I pay, I pay all suppliers equally in that sector. If I steal, I steal from all of them.  
[00:14:17] Okay, that's That's essentially the first part. Now, what happens if I pay?  
[00:14:23] Well, if I pay, they will trust me next period.  
[00:14:26] Okay? So, I'm going to define an a strategy that is a trigger strategy that is based on whether I trust you or not. If I trust you, I think it's possible that you're not going to steal from me.  
[00:14:37] If I don't trust you, I think that with probability one, you'll steal from me.  
[00:14:41] Okay, those are my beliefs at the beginning of the period. So, the updating is if last period you paid me, I will trust you next period.  
[00:14:48] If last period you stole from me, I will not trust you next period. And And since it's self-fulfilling, I'm not going to trust you ever again. So, is this stealing or not meant to be Uh good. See, for breaking any rule between firms  
[00:15:03] I mean, but I'm stealing intellectual property. That's a very different Like, I have it forever. I mean, I mean, you have a work for things like that? Yeah, this I mean, we are at the end of a long school of thought on this.  
[00:15:17] But, these are are pretty general. They're essentially just repeated relationship where you give me something. You We sign a contract and if I deviate, you punish me from in the future thinking that I'm not going to I'm always going to screw you. Yeah, so  
[00:15:31] it's pretty general in terms of doing anything that we decide to do. It could be a loan, it could be you provide me inputs. What we are excluding to be clear is paying up front.  
[00:15:43] So this doesn't work very well for small transactions that can be entirely collateralized. This has to be in a space where there's that isn't to that you need to trust me a little bit at the beginning. Okay? What about what about larger  
[00:15:58] ramifications just having some of your one period output stolen?  
[00:16:04] What about the threat of ruin annihilation?  
[00:16:07] Or As I mentioned at the beginning, I'm going to intentionally avoid those cuz that's I want to think of it as almost a different topic.  
[00:16:15] Here I wanted to sort of try to focus the model on that intermediate area where the US is pressuring other countries commercially. Not you know invading is a pretty expensive proposition. Not selling you some goods.  
[00:16:28] Like think of Russia right now. Nukes are off the table, thank god.  
[00:16:33] Commercial sanctions are what we're doing. Well, I'm not going to get into that.  
[00:16:37] I know you people have opinions. They do. So the part I can talk about Or it's not government. So we're not even talking For for now these are sectors.  
[00:16:45] Governments are going to be a sort of an entity that is going to correlate with respect Let's say private armies. That's not what we're talking about anyway.  
[00:16:52] That's exactly what I mean.  
[00:16:54] but in this supplier relationship, do you allow for say you know I mean I delivered this type of good and you're going to handle in this way so  
[00:17:08] you're not going to steal intellectual property or you're going to use it or you're not going to put anything you know think about the Huawei uh case uh in Europe, right? You know, at one point they were all buying uh  
[00:17:22] that, but then there was a threat that uh Huawei would, you know, Give me a few slides and we'll get into exactly that. Um but for now I need to do some some more setup. Okay. So, how does this work out? So, it's pretty  
[00:17:35] straightforward. Uh if I behave as a firm, I get my per period profits.  
[00:17:42] I I'm using these inputs, I'm producing, and then I get a continuation value that for now is exogenous. The next period you're still going to trust me.  
[00:17:50] Okay? If I'm a supplier, and this is important, I'm assuming that the firm is small, so the suppliers could always sell to somebody else. Okay? So, the cost of opportunity of selling to the firm is very small. I'm I'm essentially  
[00:18:04] rigging the model to make the threats cheap, which is an intentional decision.  
[00:18:08] I'll show you what it I'll tell you later where it shows up in equilibrium.  
[00:18:12] Now, if I go down, what happens? Well, I get a bumping profits because clearly I stole this period. I'm going to assume genetically that they can they can repossess a fraction theta of the inputs. That's like think of it as some rule of law. Yeah, there's some  
[00:18:26] baseline that I can't steal. Um but then, what is the cost is that next period you're not going to trust me.  
[00:18:32] So, next period, and this is important, you'll see, I can't use you as an input.  
[00:18:37] I can still re-optimize among everybody else who still trusts me. So, that's going to allow potentially for a low substitutability to kick in in equilibrium. But you're not going to trust me, so I'm losing access to your input. Okay?  
[00:18:51] Now, if I'm the supplier, clearly I make a loss cuz you stole from me.  
[00:18:55] So, if you do backward induction, it's pretty straightforward that the suppliers only accept contracts that are not going to be stolen on.  
[00:19:02] So, that leads you to an incentive condition that trades off the little bump I get from stealing, that's my short-run profits, versus this gap here, which is my loss in continuation value from the fact that I'm not going to be able to use you again as an input  
[00:19:16] provider. Now, if you I will make it more, you know, more examples in a second, but you can immediately see here that this threat is only valuable to the extent that you cannot substitute away from me easily. Okay? Threatening you with  
[00:19:31] something that you can easily buy somewhere else from somebody else just isn't valuable in equilibrium. But you can you can immediately see it.  
[00:19:38] Okay. Yeah. There's your your reference to J is confusing me because you say that the supplier's J, like there's multiple suppliers in individual J. But now when  
[00:19:53] you talk in J, but now when you're talking about the incentive compatibility constraint, is is that mean that's true for all J?  
[00:20:02] No, very good. Very good. So, this is important. That's why at the beginning I tried to be careful about the game here that I'm studying is between a firm in a downstream sector. So, firm I is a specific firm.  
[00:20:15] And a sector of suppliers of which there is a unit measure. Okay?  
[00:20:19] Now, in equilibrium and only have symmetric strategies and representative firms, so in some sense the representative firm is the sector. But for the for the off-path analysis it's important to think about when the deviation is a  
[00:20:33] single firm in the sector versus the whole sector together. So, here J is a set of suppliers. They all have the same beliefs about me and I treat them symmetrically. So, the the updating is at the sector level versus an individual  
[00:20:47] firm. Okay? Well, the other thing is what's X sub I J? Is that the quantity from one firm or from the whole sector?  
[00:20:54] It's the quantity that the entire supplying sector J supply to firm I. If I steal, I'm stealing from all of them at the same time.  
[00:21:02] Okay. So, I treat them always symmetrically. That's a but that's an important subtle thing in this. Okay.  
[00:21:08] And the continuation value if you deviate and do this, this is individual firm by firm or I would think of this like a coalition. I kick them out of Swift and they No, this is individual firm by firm and I'm going to build an SPE. So for now  
[00:21:23] I'm taking them as exogenous. And then I'm going to endogenize them by building the entire SPE for it. For now I'm thinking about I take the continuation values as exogenous a firm.  
[00:21:33] This is my action. In a second I'm going to need to build where continuation values come from.  
[00:21:38] But that's exactly right. Um Okay, so the the one-shot game for the firm is it takes these continuation values as given. It's trying to maximize profit subject to incentive constraints, okay?  
[00:21:51] Some notation. BI is the set of sectors that trust me as a firm I.  
[00:21:56] Uh if I steal a subset of S of them, this is the set next period that is left trusting me.  
[00:22:04] And this is going to be the incentive is potentially has lots and lots of combinations. I could steal one good, three goods, six goods, all together. So let me give you like a concrete example to make it somewhat easier. So let's  
[00:22:18] assume that I have two sectors that are supplying J and K and I'm looking at firm I, okay?  
[00:22:25] So let's start from a combination where both sectors that trust me, okay?  
[00:22:31] So the set of possible stealing decisions are I steal J, I steal K, I steal both of them.  
[00:22:38] Okay? Those stealing decisions then define a set of incentive constraints that if I only steal from J, next time only K trusts me. If I only steal from K, next time only J trusts me. If I steal from both, next time all I have is  
[00:22:53] zero. I can't produce anymore. I lost all my inputs. So J cannot observe when you are stealing from K. Like you know, they They can. All actions here are observable. Observable. And the set of trust the set B of all trust is common  
[00:23:07] knowledge. Okay? Everybody knows everybody's type.  
[00:23:10] Yeah. Everybody knows everybody's type. So, this belief that if you cheated on me, I don't trust you anymore. But I can see that you cheated on Doug, but I still trust you and I don't Uh that's going to be exactly what I'm going to play around with. My source of joint trust are going to be exactly those  
[00:23:24] triggers. I could in principle say, um look, my beliefs update that if you stole on anybody, you're going to steal on me. Or my beliefs update where if you steal from me, that's the only time uh that I'm going to update. I'm going to  
[00:23:37] use those to form joint triggers in a second.  
[00:23:41] Okay. Now, this is what uh Doug was asking me, the value function. So, how do I build it? Here I'm It's literally a a straight from a bio Pearson Stacchetti, okay? So, if it looks like a magical construction, uh it is. It's a beautiful paper. We're not adding  
[00:23:56] anything at all. Uh we're using it. Their paper was with black so things not observed. Yeah, yeah. You know, we're using very simple versions 30 years later. following Fudenberg and Tirole's formulation. I'm good with  
[00:24:10] that. What I want to say is we didn't invent this. We're using No, no, I know. That's all.  
[00:24:15] Okay, so let me start, okay? Just to make it simple. The construction is a typical recursive one. You start with nobody trust you. Value is zero. I can produce anything. Now, I go up one notch.  
[00:24:28] There's one sector that trusts me. I can use the previous built one as my continuation value. If only one sector trusts me and I steal, I go to zero.  
[00:24:37] I build my new value function. Then I go one step up. What if two sectors trust trust me? Well, if I steal any one of them, the previous value functions are the continuation values from where I am.  
[00:24:50] Okay? And I'm going to keep going until I get to the set where everybody trusts me.  
[00:24:56] Okay? So, that's how we build it.  
[00:24:59] Now, that's a lot.  
[00:25:01] See, you're using sort of single agent decision-making version of dynamic programming to talk about a game.  
[00:25:10] And and the thing is that um the Bellman principle doesn't apply to games.  
[00:25:16] This this business of uh you know iterating backwards in the value functions because uh there might be multiple fixed points or multiplicities. So, I I'm certainly not So, your story about  
[00:25:30] building whereas what the another the intuitive way to build is to assume that everybody trusts you. But, then you find out conditions under which incentives don't  
[00:25:44] work and then you shrink down to the building building You're talking like building interior and what that there's no theory that says that that's going to  
[00:25:56] get you the full set of equilibria. I You start with everybody trusting everybody and then chopping off. Hold on one second. Let me get John and then I'll go back to this.  
[00:26:06] So, mine mine's very simple. If you could take 30 seconds to read that equation to those of us who have forgotten what all the letters I will do both.  
[00:26:14] Let me start from one and then go to the other. So, so what am I doing?  
[00:26:18] Um I am maximizing profits per period.  
[00:26:25] Okay, that's my per period stage game profit if I It's a function. So, which are a function of Well, the set of people that trust me I need to know because those are the people that will accept orders.  
[00:26:37] Which is the set of That's sigma of S I. That's No, no, that's B I here. Oh, sorry, John. You're not looking at it.  
[00:26:43] That's right. Oh, you can Here, I'll look behind. No, no, it's okay.  
[00:26:47] Those are the people that trust me. Okay? I I my inputs and I choose my factory usage.  
[00:26:54] That tells me my per period profit, okay?  
[00:26:59] I don't steal. I have my continuation value next period where the set of people that trust me are the same as today, okay?  
[00:27:07] When do I When do I steal? When if I stole, this is the you know, the my bump in value that I get from stealing, and it's to be below what I lose in the continuation value  
[00:27:20] from eliminating a set of players that trust me because I stole from them, okay?  
[00:27:28] And And for all assets that S is Right. So, that one is what I showed you here in this example.  
[00:27:34] In principle, I I could steal from one, another, both of them. So, I I I have a whole set of those incentive constraints. You said something about building up where where more people trust you. Yeah, you you know, Cuz  
[00:27:49] you're not only seeing like preserving the number of people who trust you. At each point in time, I need to know, sorry.  
[00:27:56] If I look at the people that trust me, uh I need to know what happens when uh I steal from a bunch of them, okay?  
[00:28:05] So, this is what this goes to what we were discussing with John. So, imagine starting from nobody trust me.  
[00:28:12] Now, there's no production I can do. The value is zero.  
[00:28:15] Now, I go to okay, let's start to think about a an SPE where one one sector does trust me.  
[00:28:22] If I screw them by stealing, I'm going to go down to zero trusting me. So, I'm going to use the the va- the value that I build from the first conjecture as what do I go down to  
[00:28:34] uh if I steal, okay? So, there isn't a dynamic process here of getting more people to trust me.  
[00:28:41] You're finding the equilibrium where Yeah, there's an SPE, it's the same construction as a brain static. And to to to what you mentioned, I love to actually speak more about that.  
[00:28:51] I mean, the way we built it I'm pretty confident in it's the same exact way we built it the SPs and all of all of macro is we're starting from I'm trying to compute continuation values  
[00:29:05] and and I'm adding one at a time, but I have to think about building it the other way around. Yeah, but the thing is that in our paper Shabina and I were not we talked about the basically we called the inner approximation.  
[00:29:18] Where we grew out and to fill in and we could find no no proof that that always converged.  
[00:29:27] Now, what so what we did though is we looked at the outer then shrink it down and that's also what recently there was a paper a brewing somebody that did a refinement of faster approach of ours and they only looked at the  
[00:29:42] shrinkage. I should look at it. I think there was a um some Minnesota guys um that had a paper many years ago and they did just the shrinkage.  
[00:29:53] Okay. I the building so I don't know if any paper where the building starting in and going out works because you see there are possibly multiple fixed points. Oh, that I'm happy with. You  
[00:30:08] could be starting you could be building and then you get stopped at a fixed point but whereas you remember in this theory it's the maximal fixed point that is the one we're looking for.  
[00:30:20] So, that's why the That's a good point. That's why shrinking it down works. I should look at it.  
[00:30:25] But that a building this in inner out building out Let me look. may fail because of may Let me Let me look at it.  
[00:30:33] That would be interesting to look at. Uh I did the the Sargent textbook construction, but let You can That kind of makes your everything tense point. If if you find an equilibrium by going up, then he's found an  
[00:30:47] You're just saying Is that Equilibrium definition here typically is maximum fixed point of this No, no, no, that's not what we're using.  
[00:30:55] Here we That's what I was saying like Okay. But I'm saying that's That's the No, no.  
[00:31:00] What is he talking about? Yeah, no, here we use That's actually The set of all Nash equilibrium is the maximum No, no, no. I understand he's not going to find not what we're doing. Here we're not doing the set What threatening you with the worst to sustain the best. That's not what we're doing. Here we're simply  
[00:31:15] saying In fact, here this is definitely not the worst possible threats. Oh, no, it's I'm just pointing out that there are multiple fixed points. I'm totally happy with that. Okay, now I understand.  
[00:31:25] Okay, now I understand where you're going.  
[00:31:27] Yeah, sure. There's several Nash equilibria is the maximum No, no, no, okay.  
[00:31:32] We're not going there at all, which is what It seems like you're other solution concepts like Shapley values and things like that. No, this is not I'm Jewish.  
[00:31:40] Okay, now now I got your question better. I This is now I got your question your question better. No, here we're not doing that at all. What we're doing is we're building it from the bottom up.  
[00:31:53] Finding one, we're not making any claims that this is the Okay. the maximum one.  
[00:31:57] Uh In fact, that's why we're not doing that search. Yeah. Okay, now I understand. Okay, got No, we're not doing it. I'm perfectly fine with this being an SPE. Uh Definitely we're not trying to play the game of sustaining the best possible outcome. You'll see in  
[00:32:11] fact the paper is written that way even more. We're restricting to Markov strategies. Here you're definitely going to do better by for example looking for uh punishments that are back loaded.  
[00:32:22] Uh and expanding the set. Okay. Okay, good. Can you tell how many supplier uh uh suppliers are there to start with? Uh for a given sector, it's exogenous. It's uh there's a set SJ uh that you start  
[00:32:36] with. Here we're not doing any It's the last step here. This J I here is exogenous.  
[00:32:42] Here we're not doing any network formation, which would be pretty interesting, cuz you could literally buy relationships. Here we're not. You cannot You start with a set of relationships, and you can only go down if you stole.  
[00:32:53] It seems like you're building up to coalitional response to an individual action. Very good.  
[00:32:59] imagine there's a coalitional action response to a coalitional action.  
[00:33:03] Very good. Um All of the above. I'm going to be there in one slide.  
[00:33:06] So, market clearing I'm going to do it very fast. It's pretty straightforward.  
[00:33:10] There is output the other goods into intermediate inputs or into consumption, and factors have to be used, okay? Local factors. Nothing Nothing difficult there. Okay, that's what Doug was going.  
[00:33:22] Is Remember, I wanted to start thinking about joint threats, which are essentially a form of coalition building or collusion. And then first I'm going to define them, and then I'm going to start thinking The paper comes alive  
[00:33:35] when I endow one country, the hegemon, with the ability to make the threats, okay? So, first, what is a joint threat?  
[00:33:41] There's nothing else in some sense that a war's partition. Simply saying, if I start from the previous example, I'm going to build a joint trigger strategy where if you steal, J will say like if you steal on K, I will not trust you next period. And K  
[00:33:56] will have a symmetric one. If you steal on J, I will not trust you also next period. Now, the construction is a bit more involved than that. But ultimately, what does it end up with? It ends up essentially with a consolidating consolidation of ICs, right? Clearly, if  
[00:34:11] I know that I'm Since this is a public common knowledge, if I know that that's what I'm facing, I will never steal from J but not from K, cuz I get punished from both. And so, what it really does in this particular example, it transforms the problem from having three  
[00:34:23] ICs to only having the joint IC. Now, for those of you that are deep into this, you can already see how this is going to work out in equilibrium. I'm giving you higher power incentives by telling you if you deviate on anything, I will punish you all across the board,  
[00:34:37] okay? And that's, you know, coming from a long literature before us. Can I just ask a question about, I guess, the modeling strategy?  
[00:34:46] So, you're allowing these coalitions to form, but you're taking off the table some punishment costs other than just with withdrawal of my supply.  
[00:34:55] Very good. You're I don't quite see why I would realistically Why did you do it?  
[00:35:00] Why did you do it this way? That's an excellent question. Um so, I think what what we try to strike uh is a a nice middle ground between the following.  
[00:35:11] Particularly once you go to these games, this the strategies can get very complicated and very arbitrary. So, we restricted attention to one Markov two like this particular set, which we found sensible. Now, why do we find it  
[00:35:25] sensible compared to something else? Well, you will see in a second that what I really wanted was um China that wants to pressure Lithuania in not recognizing the Dalai Lama, but has no relationship with Lithuania. But it turns out to have  
[00:35:39] a lot of relationship with Germany, who is a major supply supplier to Lithuania.  
[00:35:43] And so, it's going to use that indirect route to form a threat. So, that's why I want them.  
[00:35:49] The question of why you're not allowing other things, um so, there are many that we we don't in the interest of, you know, writing a paper, but they're easy to do. There are a few that are actually pretty expensive to allow. So, the one that comes I'm not  
[00:36:03] sure if that's the one you have in mind, but the one that comes up the most in seminars is the blunt threat. Is he a rather than doing something sophisticated that is a value to you, I could simply say if I if you don't do what what I say, I will not supply to  
[00:36:18] you ever again, okay? That one is an inefficient threat.  
[00:36:22] Why? Because Well, you're you're up it's a hold up. I'm making your outside option worse off, but that worsens your incentives compared to increasing your inside option. A basic real world one you've taken off the table is  
[00:36:36] I hand over resources to a neutral third party that we both trust. I'll adjudicate whether or not I honored the contract. And if I'm on the losing side of that adjudication, I forfeit something.  
[00:36:47] Perfect. So that that seems like you think that's off the table.  
[00:36:51] Perfect. No, no, it is I'm going to argue it's not, but certainly in in a cheap way. So remember that we said you can't steal everything.  
[00:37:02] You can steal a fraction. And that fraction is exogenous. So I'm going to think of some relationships where that solution is possible.  
[00:37:09] The data is very close to one. These are legally enforceable. This thing doesn't do anything.  
[00:37:14] And I can't threaten you there. There are some I'm building a mine in Africa.  
[00:37:19] Everybody understands that after after I build it, I'll get expropriated. And there is no amount of asking somebody else for an escrow that's going to solve this expropriation problem. Or think of sovereign lending.  
[00:37:29] So I I I think that's what I'm using to and it does matter why because in a second what I want to argue is that governments always like threats. But most threats in equilibrium make no sense.  
[00:37:42] For the reasons you have in mind. There are other ways around that are perfectly credible. Or I can threaten you all you want. You can substitute the input somewhere else.  
[00:37:51] Uh and so I actually do want to capture that economics. I'm not going to go for upfront contracts for collateralization.  
[00:37:59] I'm simply saying set the data to one. There's no threat that I can make. At least individually. But here the problem we're getting around is if you cheat on Steve, I can see it, but I trust you anyway. So the government has to get  
[00:38:13] together, go and enforce me to not trust you after you cheat on Steve.  
[00:38:17] That's you know, why don't I You're J.P. Morgan. Well, I would argue that if you look at it for example the history of the US, there's a lot of the State Department doing that.  
[00:38:30] It's telling J.P. Morgan, you're not going to make new loans if, you know, one of our firms got expropriated in manufacturing. And then, you know, while we're making it extreme where, you know, it's sort of a simple  
[00:38:44] assumption, I think in practice it does capture an important part of this coordination elements that the firms themselves might not might not do. But just to be To be clear, some of it I I think actually happens at the firm level. Here I'm going to make the  
[00:38:57] hegemonic country, but I think of large industries, for example, are doing some of these perfectly on their own. Um so I I I think it The point is we're saying that there's some of this that will happen even in the private sector.  
[00:39:10] With lending to third world countries, we've seen this over and over. They default, and then the next thing you know, some other bank goes and lends them money.  
[00:39:17] But but I thought we started to get into the Peter Navarro question, and and this doesn't seem to have much to do with why we want to put in tariffs on electric vehicles from China.  
[00:39:27] Let me get there. I I I disagree, but until we say it I don't think For now it's a bit too early, but give me a second and we'll get into exactly that. Cuz I mean, that is not a problem of China will welch on its, you know, if they buy  
[00:39:41] something on us they'll welch. We'll send them a bill and they say, "No, we No, let me give you the example I have in mind of China. China has built an immense amount of infrastructure in Africa in a place where enforceability has always been a problem. Now, if Italy  
[00:39:55] did, we'll get expropriated the next day. So, why doesn't China get expropriated? Well, because the threats that China makes are to suspend lots of other economic activities that are very valuable to that country for any one one  
[00:40:08] deviation. So, what they're doing is essentially cross collateralization.  
[00:40:12] They're using some relationships to back up others. And they're being big and and being able to make this threats is quite valuable. That's right. I mean that goes back to the whole history of of trade. Why did Why did trade always involve military power rather than just  
[00:40:27] going to India and buying stuff? Because you go in and they'll screw you.  
[00:40:29] So that's the that's what we want to capture.  
[00:40:32] That's not that's you know, the sort of geo-economics that that sent me and Casey ballistic was not about that at all. It was about us fighting against China for who's bigger.  
[00:40:44] I'm going to get to that too, but give me a second cuz we haven't started that part yet.  
[00:40:48] Okay? Oh, okay. So that's the whole So this is just a micro part. As I'm making threats and what in a second we're going to let the hegemon make them. Then there is the sort of like why do we fight each other on the size of semiconductor? Oh, without micro amplification you're not going to get it. And here it's all  
[00:41:03] micro. Everything is taken as given so far. But your your externalities that you introduced are none on the production side. They're on the production side. Oh, I didn't see that.  
[00:41:12] Yeah, do we? Not yet. Give me a second. Just hold on. I'm happy that we don't have them cuz I You'll you'll see them, but that that's going to be pretty key.  
[00:41:19] Okay. So first these I'm going to go fast cuz to most of you this is pretty obvious.  
[00:41:25] Uh joint threats here can be valuable. When are they valuable? Well, they're valuable because uh by threatening you with a worse continuation value if you deviate, they're providing high-powered incentives and that for you as a firm  
[00:41:39] it's good. Okay? So that's pretty straightforward. Now, what is interesting, particularly if you're in macro, is that these values are computable.  
[00:41:47] Like I'll give you a very simple example. Think of a um nested CS, okay? So there's lots of types of oil around the world and if you shut oil is almost a perfect substitute in production. So the threat  
[00:42:01] of withdrawing one of them is totally useless. Next period I just simply increase my uh inputs from some other oil provider, nothing happens.  
[00:42:10] The threat of shutting all oil down. Might be very severe cuz for example, the basket of oil might be entering almost in the LMP in production. If you don't have it, oil at all, you can't sustain anything. Okay? So, that that's  
[00:42:23] a very simple example of how to compute this, which Oil is a very good example because that's what the United States and Britain tried to do to freeze them Breaking, you know, for example Or there was a war.  
[00:42:35] That's exactly right. Now, you haven't mentioned this, but in your paper you said the prices are fixed. No. No?  
[00:42:42] In the paper we said that there was an example we fixed prices to avoid terms of trade.  
[00:42:46] This is flexible prices. Okay. Flex- flexible prices.  
[00:42:49] Okay. Okay, now let's get going, okay? Now we're now we're in business. We did the micro. Now, I I need to make some choices, okay? And to Steve, these are going to be pretty arbitrary. I'm going to tell you why we make them, but these can be changed.  
[00:43:02] So, a hegemonia, we already said it, it's a country that essentially can coordinate these threats. He can coordinate his domestic sectors and he can coordinate some foreign sectors. I'm going to have to restrict the sectors. I'm going to assume that  
[00:43:16] you have to be one step removed. So, if you're downstream from one of my industries, I can use you. Uh but if you're two steps removed, you're too far from me. It's totally arbitrary. I could I could make the threats propagate farther. That That's easy, okay? But to  
[00:43:29] fix ideas is my firms and the firms in D, which is the downstream sectors of my firms.  
[00:43:36] What do I do? Well, first we said joint bets, okay? That's what I'm going to offer. What am I going to demand?  
[00:43:44] I'm going to demand transfers. Okay? From the firms that I can target.  
[00:43:49] These are essentially Simplest example is monetary transfers, but this could be markups on goods that I sell you. Uh surcharges on the loans I make to you.  
[00:43:59] Okay? And I'm going to These are not revenue neutral. They come out of your profits.  
[00:44:04] But I'm also going to allow for taxes, in particular for revenue neutral wedges.  
[00:44:09] What are these? This is where the connection with public finance and macro comes in.  
[00:44:14] If you deep into those fields, you will recognize that those are the typical wedges we put in order equation.  
[00:44:19] We love them because they can be specialized to cover tons of stuff.  
[00:44:23] In particular, they can be specialized to cover tariffs at valorem. They can be specialized to to do quantity restrictions.  
[00:44:32] In this particular paper that she the cleanest thing is to think about quantity restrictions.  
[00:44:38] Okay, so I'm I'm asking you to reduce your input uh your usage of a particular input.  
[00:44:44] Okay? That's a that can be implemented with a tariff or with a quantity restriction.  
[00:44:50] I'm going to do local rejection of the contract. Uh and because this is Markov, I'm going to keep assuming that the agent can commit to future contracts, okay? Um Can. Cannot. Cannot.  
[00:45:02] Oh, cannot. No, here I'm so what I want to avoid this is the discussion we're having before. I could try to do better by, for example, back loading the punishment and things like this. You know, the government can't commit to the contract. They can do only one period contracts.  
[00:45:16] Um Okay, good.  
[00:45:19] This one I I'm going to skip. This one I'm going to skip, too.  
[00:45:23] Um if you're confused, I will do it again. This one I'm going to also skip except one thing.  
[00:45:29] What's special about this environment compared to domestic macro policy is that very often here I'm contracting with entities that are foreign.  
[00:45:38] I'm going to ask a foreign firm to do something or a foreign government to do something.  
[00:45:42] I can do it by legislating on them. This is not domestic taxation.  
[00:45:48] So, they have to voluntarily participate in my contract.  
[00:45:51] I'm offering a threat and I'm asking for actions.  
[00:45:55] So, I'm going to have to have a participation constraint.  
[00:45:58] So, and this is what I was saying here what we're avoiding is the blunt threat.  
[00:46:02] Here what I want to do is I want to give you something of value, which is the commitment that comes from the fact that I can threaten you a lot.  
[00:46:09] But then I'm going to ask you for costly actions. Now, there's a limit to my power. If my threats are invaluable, I can't ask you to do anything cuz you're going to simply reject the contract.  
[00:46:18] So, the participation constraint here tells me how much power do I have over you at the beginning. In some sense, this is micro power. This starts to get to the to where we're going with macro. This is saying, "Take us given all aggregate  
[00:46:32] prices and quantities. I have some power over you. I can ask you to take actions." That power is being tracked by how much slack do I have in your participation constraint.  
[00:46:41] If I'm supplying rare earths and without them you're screwed, I have a lot of power over you. There's a lot that I can ask out of you uh in equilibrium. If I'm supplying water uh in a Nordic country, I have very little power over you. You can  
[00:46:56] substitute me away with anybody else, okay?  
[00:46:59] Now, macro kicks in when I start thinking about what do I want to do as I adjure them.  
[00:47:05] Why? Because well, I can manipulate I understand that I'm not contracting with each firm only. I'm contracting with a whole set of them.  
[00:47:14] And that's going to affect equilibrium prices and quantities.  
[00:47:17] The firms in accepting the contract are only thinking about their private costs.  
[00:47:22] But I'm thinking about changing the world equilibrium. Now, this is crucial cuz if you think you're a national security, that's a clear problem. The clear problem is every firm that is thinking about accepting a contract from China is thinking about given the  
[00:47:34] equilibrium, what happens if I accept? The government is thinking what happens if the entire Eastern seaboard of the United States, all the ports were controlled from China.  
[00:47:44] That's the So, that it's pretty important to distinguish these two levels. Uh and I'm going to I'm going to go there. So, what is the adjure them doing? This is straightforward. It's maximizing its representative consumer welfare. Those are the two terms from an hour ago which I we definitely don't  
[00:47:59] remember. These are the indirect utility from the consumer and these are, you know, potentially political preferences that we that we mentioned.  
[00:48:07] What is the wealth of my consumer? What is the profits of the domestic firm?  
[00:48:12] But also the transfers that I get from the foreign firms.  
[00:48:15] Okay, so transfers domestically are a wash. They get paid out of firms to consumers that own the firm.  
[00:48:22] But transfers out of foreign entities are not a wash.  
[00:48:25] Cuz I don't own those those profits. Okay? Good.  
[00:48:30] So, I mentioned that we rigged the problem to have cheap threats. Uh and what do I mean? Um I mean that in fact in equilibrium, I will do all the threats that I have on my disposal as an agent.  
[00:48:43] Okay, this you can modify. You can make some threats expensive to make in equilibrium, but here the threats are actually cheap. Cuz in some sense we've assumed uh each of the buyers is small and there is a market out there. If instead you're thinking of a world where  
[00:48:58] if I don't sell to you, whatever I produce gets goes to waste, that would be a very expensive type to make, okay?  
[00:49:04] We're not We're not doing that. So, that's the cheap part.  
[00:49:07] Okay. Each of the firms in my coalition promised to believe till the end of time that this they will never get paid from any of this.  
[00:49:14] Yes. So, I mean in the fact there's no learning like there's like an extra Yeah, this is totally static.  
[00:49:20] These guys don't really care and they're going to have these beliefs Yes. And it's totally self-fulfilling. So, you can see that the model is very static.  
[00:49:28] In fact, you know, if you if you had seen this presentation in Chicago a month ago, this would have been a two-period model. It turned out that the two-period model was actually a pain because the the problem with the two I mean, this is an aside, but the problem with the two-period model was the following  
[00:49:43] that um the continuation because you're not doing markup, the continuation values are not taken as given.  
[00:49:49] And so, guaranteeing that some of the optimizations were convex uh problems was a bit more difficult. This one actually turned out to make it easier, but fundamentally it's a two-period model. And there's there's really no real dynamics here. Okay? We started  
[00:50:02] with a two-period model. In fact, for those of you that don't like longer models, to me my preferred version of this model is two periods. The second period there is no incentive problems. Everything is essentially an IO matrix exogenous.  
[00:50:17] You're solving the one-time uh the the exam period. That would be by far my preference. The referees will hate it.  
[00:50:24] So, we can do infinite horizon repeated, but turns out to be that. Um Following up on Doug, in both theory and in reality, uh one period of punishment and then forgiving go back seems to be, you know, robustly what you  
[00:50:38] do in repeated games, and it seems to be what people do in in reality. You don't punish forever.  
[00:50:45] Yeah, so okay. So, there's lots of things that you can relax.  
[00:50:49] With these problems, it's very easy to go crazy in terms of difficulty. Um uh one thing that is certainly possible to do uh I've done it in a previous paper.  
[00:50:59] I need to be careful and think whether it works here. But, I think if we did exogenous re-entry, like a Poisson arrival or changes of beliefs would be just fine. Uh cuz all it does is it scales down the continuation value by the expert  
[00:51:12] the the punishment by the probability that we reset.  
[00:51:15] I have to think carefully about those. In general, those are possible to do in this class of models.  
[00:51:22] Isn't it I think the fancy word is something being perfect, but I may be wrong. If I could punish you one period and then you agree, "Oh, I'm sorry. I won't cheat on you again." Yeah.  
[00:51:30] That's better It's better from my point of view to go back to trusting than it is to punish you forever just cuz I said I would. No, to be clear, that's so this is where you play with this with these models. Um here, um given that everybody else doesn't trust you and they're you're  
[00:51:45] Markov, they're taking that in the future, I'm not going to trust you.  
[00:51:48] There is no incentive to sort of I don't do anything better from trusting you this period.  
[00:51:55] So, in that sense, your threats are credible. There's no credibility issues.  
[00:51:58] At most, you're indifferent. Uh they're they're fully credible.  
[00:52:03] Now, that that's a technical answer. That's not an answer about uh but what if we did, you know, X periods exclusions? And you can you can play those games. You know, I I really wanted to make it two periods.  
[00:52:14] So, in my mind, I keep thinking of this model as tomorrow the world ends, uh but there is lots of good things that come from simplification that come from the full Marco structure. Otherwise, we wouldn't have done it uh up to a month ago, but we didn't do it that way. But it turned  
[00:52:28] out to be actually stranger uh and less standard, and so it was easier to recast it. Okay, now let's start looking at the optimal part. This is the fun part when we do the application. So, first, and this goes to what you were  
[00:52:41] asking me about prices. I want to start thinking about the simplest possible environment. So, what I'm going to do is shut off general equilibrium prices.  
[00:52:50] The way I'm going to do it is pretty simple. I'm going to assume that the preferences of the consumers are quasi-linear, and they're going to be marginal on all the goods, okay?  
[00:52:58] And I'm going to assume that the production functions don't depend on any aggregates.  
[00:53:03] Okay? Now, that's a very simple environment.  
[00:53:07] Why? Because there is essentially no macro amplification.  
[00:53:11] So, what does the hegemon want to do there?  
[00:53:14] He wants to impose no wedges. He has no reason to alter your probably optimal allocations, okay?  
[00:53:21] So, no wedges, but on foreign firms, I want to extract transfers. So, what do I do? I don't extract any transfers from my domestic firms. Why? Well, transfers are a wash in terms of profits. They come out of firm profits and go to my  
[00:53:35] consumer cuz they own them. But, because they come out of firm profits, they worsen incentives.  
[00:53:41] They tighten the IC. So, transfers here are purely distortionary. So, on the domestic firms, I don't do them.  
[00:53:48] On the foreign firms, I do want to do them. Why? Because I don't care about their profits. I don't own them, but I do get the transfers. They're not a wash for me as a hegemon.  
[00:53:58] So, formally, what is happening, which we will do when when we think about efficiency?  
[00:54:02] Here, if you go back to the original motivation of what's good and bad about these powers, the power that comes from being able to make the threats, it's positive sum globally. Why? Because it relaxes constraints, it expands the  
[00:54:15] production frontier of the of the world economy, and so it describes a new Pareto frontier that is better than the old one.  
[00:54:22] But then the problem is once I have that power over you, what the hegemon does is he picks a contract that is to the inside of the global frontier.  
[00:54:31] Because he tries to redistribute wealth towards himself, even if he knows he's distorting incentives. He doesn't care about the foreigners.  
[00:54:39] Okay? So, this gives you a very simple baseline to think about what happens when you have macro amplifications. In particular, here you can see I only have micro power.  
[00:54:49] All of the aggregates are not affecting anything, cuz prices are constant.  
[00:54:54] And here, if you think about the word that people use strategic, in what sense is a sector strategic here?  
[00:55:01] Well, a sector is strategic if it lets the hegemon make valuable threats.  
[00:55:07] And this goes back to Schelling in the '50s. In fact, recently I had written this beautiful page of the paper, that it was all about how strategic has to be assessed in equilibrium. And it did turn out that Schelling had written the same page in '52. So, now it's out of the  
[00:55:20] paper, but it's still true. Which is, strategic cannot be, oh, I know the parameters of a CES function.  
[00:55:27] Which very often we think about that informal in economics that way.  
[00:55:32] Well, that's one input, but strategic is an equilibrium. It's uh the set of threats that I control.  
[00:55:38] This The typical example is controlling one variety of oil is useless.  
[00:55:42] Controlling all of them is very valuable.  
[00:55:44] Uh that sort of starts giving you this baseline. Now, let me switch on macro.  
[00:55:50] Okay. So, um how does macro amplification work out in this model?  
[00:55:58] Let's start think about a world where I remove the the the assumptions that lead to constant prices. What if prices are moving around?  
[00:56:07] If you remember your Leontief inverse uh from grad school, what's happening is as a sector, if I produce more, that changes the price of that output in equilibrium, but that means that it's changing the price of that one  
[00:56:20] as an input to everybody else. They'll respond and so on and so on and will get amplified until we reach an equilibrium.  
[00:56:27] Okay, that's one form of amplification that comes to prices.  
[00:56:31] The other one that you're familiar with is from aggregate Sorry, external economies of scale.  
[00:56:36] If I produce more as a sector, that might make some other sector more productive.  
[00:56:42] And that in turn will make some other sector change our productivity, and we're getting an aggregate propagation that comes from external economies of scale, which are an externality.  
[00:56:54] It turns out and I I believe that actually we're the first to do it in generality, but it's a sort of 15 lines of algebra, but it's kind of nice. That you can you can put  
[00:57:06] all of these things into a simple demand system and do the entire endogenous amplification uh in pretty much the same way you do a Leontief inverse. You can see it here.  
[00:57:17] Uh I'm not going to go through the entire notation, but for any shock, the aggregate response of all of the vector of all outputs has two components. It has the direct component multiplied by a matrix that looks like a Leontief inverse,  
[00:57:32] And then he has the effect on prices and the effect that those prices will have on output. Okay?  
[00:57:39] So, when you when you start thinking about macro, you have to think about, okay, if I'm the hegemon, I can manipulate the system in my favor. I'm not going to choose a contract for the world economy not thinking of what happens.  
[00:57:53] Now, almost all of international macro and trade have been about terms of trade manipulation.  
[00:57:59] Uh essentially, all of the WTO literature, all of that sort of uh motivation comes from manipulating relative prices.  
[00:58:07] Here, we're going to also allow to manipulate uh production externalities.  
[00:58:12] Okay? And you'll see an an application to national security in a sec. Now, if you have that one, the contract becomes more interesting and and more complicated.  
[00:58:21] Uh and I'm going to try to unpack it.  
[00:58:24] Well, let me actually not go through this, which is long and complex, and directly do the formulas.  
[00:58:30] So, let me fix for for a second a foreign sector with binding constraints.  
[00:58:37] Okay? What is the tax formula? What do I want to manipulate and why?  
[00:58:41] So, the first part looks pretty standard from macro problems. This epsilon here is capturing the marginal benefit to the hegemon of altering the activity that I'm imposing the tax on.  
[00:58:55] Okay? So, terms of trade, input-output amplification, all of that is inside this epsilon.  
[00:59:02] What do I trade it off against is the fact that because I'm making you deviate from your privately optimal decisions, I'm worsening your participation constraints and your incentive constraints.  
[00:59:13] So, the tighter the constraints, the less I will ask of you.  
[00:59:16] So, you can immediately see that one of the things that power does for me is because I can offer you something very valuable, I'm creating slack in the constraints, I can then ask you to deviate from your privately optimal  
[00:59:28] decisions. So, I'm asking Nvidia not to sell to China, or I'm asking European firms not to use Huawei technology.  
[00:59:38] To each of them, that ask is privately costly.  
[00:59:41] They comply because I'm offering to withdraw lots of other things in support if they don't comply.  
[00:59:48] That's what I'm constantly trading off. Is how much can I ask out of you depends on how much power I have over of you in the first place.  
[00:59:56] And now we're going to go for, okay, but even if I can ask you, what exactly am I asking you to do and why? What is the lambda bar?  
[01:00:05] These are the Lagrange multipliers on the participation constraint and the some combination of the ICs. Is that the ICs that enter in the threats I make.  
[01:00:14] Well, what makes you think that they're unique?  
[01:00:17] What makes you think that they're unique? These are only necessary conditions, so they're definitely not unique.  
[01:00:23] These propositions here Okay, so they you have that that formula could imply a variety of things.  
[01:00:29] Yeah, these are these are only necessary conditions, which why I'm saying an optimal contract and the optimal contract uh it's they they are not their motives.  
[01:00:37] He and Is if on an equilibrium, this will be the contract, uh it's definitely not the only one.  
[01:00:45] Okay, now let me unpack it because that's the interesting part. So, if you take the so the benefits to the hegemon, what do they come from? They come from the direct impact. This is like I move that activity, suppose if for example, I don't like it  
[01:00:59] for a reason or another, that's a direct impact.  
[01:01:03] But there's an indirect impact. There's a whole part of the world economy that I don't control.  
[01:01:08] I don't have any threats on them. I don't even trade with them.  
[01:01:12] But they're going to respond in equilibrium to the actions I asked out of the part that I control.  
[01:01:18] In principle, I might care more about them than the ones I control.  
[01:01:24] So, think about thick market externalities.  
[01:01:26] I might only control a small part of the world, but if I can get those people to move the to be enough to move the equilibrium, what I enjoy is an overall outcome.  
[01:01:38] Okay? And of course, I care about the impact on prices.  
[01:01:42] So, I'm going to give you an example where you have national security that looks like this. But what I what I want to go through is once you're thinking about macro, sectors that are strategic are now about something else. They're about their  
[01:01:56] influence on the world economy. I don't care so much about telling Nvidia not to sell to a particular firm in China.  
[01:02:05] What I care about is that if they did sell, that firm in turn will use the chips to produce military technology.  
[01:02:11] That military technology will be installed on ships. The ships might threaten my shipping lanes, and in equilibrium I I I have to go around, I don't know, some shipping route that before was open and now it's not.  
[01:02:24] What I care about is this essentially the the full propagation. And I'm trying in this sense, sectors that are strategic are those that have very high indirect influence.  
[01:02:34] I'm I'm I'm twisting a few levers and letting the world propagate, uh which is a very different definition of strategic from the micro perspective. Also, this one is one that you can take to a data.  
[01:02:46] I mean, while these equations might look very fancy, this is what we always do when we take like input-output matrices to a data.  
[01:02:53] They can be measured with things like, you know, sales shares and the model weights and things like that.  
[01:02:59] Where do I see the in this formula the impact of my decisions about which sectors to penalize or or not on the decisions of other hegemons? I don't somehow showing up here.  
[01:03:13] no. Very good. No, no. That's not showing up.  
[01:03:15] It's not showing up. No, no, yeah. That's Sorry. For now I'm thinking about a single hegemon offering a contract.  
[01:03:21] Everybody else is reacting, but everybody else is not offering contracts.  
[01:03:27] Okay, thank you. I got it. At the very end of the paper, we do a couple of So, there's only one hegemon.  
[01:03:34] Yes. No, not a multi- Yes. We have a separate paper that hopefully we'll write at some point thinking about multiple hegemons. It's actually interesting, but there the the the strategic interactions get a lot more complicated. Complicated.  
[01:03:45] Yeah. I'm sure. So, What? at the end of the current paper, we have three pages on this, or maybe actually now that during the appendix, but they're really just proving a couple of setups, like examples. We haven't characterized it generally uh with multiple hegemons.  
[01:04:00] That's So, it's more like a dynamic principal agent problem.  
[01:04:03] Yes, but when you have multiple hegemons, you Yes. When you have multiple hegemons, you have a lot of other things I can That that is a game. Yeah, exactly. Uh which is why it's interesting. It's also why the whole story is a different paper. Here, the other thing to that is  
[01:04:18] important is the target countries in some sense take it on the chin.  
[01:04:22] They're they're given this contract. There is a very clear role here for anti-coercion policy. If you're Suppose you're the go the government of a small open economy being targeted by the US or China, what you might want to do is make  
[01:04:35] them feel that the outside option for accepting the contract is better than it really is to induce them to not give up so much surplus. So, the That's yet another paper that we're working on, but they're not here. Here is a single hegemon. The the rest of the  
[01:04:50] world is small. So, so Matteo, the the the single hegemon, the the industry structure is fixed because I'm I'm thinking about I want to to make it so  
[01:05:02] uh that I increase my strategic power. Absolutely. So, uh the answer is yes, it's fixed. And the second part is like you, I find it very interesting to think about endogenous  
[01:05:16] formation of the industries. Now, let me be clear. What's fixed here is the sectors you have to begin with and who they supply to and to the rest of the world.  
[01:05:27] Yeah. So, what I cannot do here is say I want to build new new relationships.  
[01:05:32] What I can do, uh which is what this task formula is showing you, if I have a sector that is strategic because it has a lot of influence on the rest of the world. And it's an activity that I want to grow. I would want to crank it up.  
[01:05:46] So, I can make it bigger in the intensive margin. As in, I can subsidize these activities, which is what this formula is telling you.  
[01:05:54] Uh think of like, for example, my domestic semiconductor is a sector that has a huge impact on the world equilibrium. I want to subsidize it a lot given the constraints.  
[01:06:06] That it's fully it's fully solved. The fact that I have that sector to begin with here is exogenous.  
[01:06:13] And I think it would be interesting to relax it because it might lead, for example, to um increasing returns to scale as a hegemon. Like, being in a here I'm not talking about what made you a hegemon to begin with.  
[01:06:27] But very clearly there is a sense of like being big and having many sectors is kind of valuable. Uh but it's too informal to say.  
[01:06:35] over time, right? It's like it's not like I shut them out of all the semiconductors. They can never get semiconductors and they can't form their own semiconductor industries.  
[01:06:44] Yeah. That that's exactly right. Here If you get too big on this, then you're going to there's and you cut off enough people.  
[01:06:49] So, so that's exactly right. So, that's what the participation constraint does.  
[01:06:53] If you if you if you try to ask too much out of them, they're going to simply reject the contract. Uh that's what I like about the this paper. It's telling you, "Look, this isn't I'm dictating rules to domestic firms. Here everything is willing participation."  
[01:07:07] But what I'm not allowing is for for a new sector that was never there to emerge or for new links to form.  
[01:07:14] I control you know Swift, I can kick them out of Swift, but they can't kick them out of payments forever. That's exactly right. What But you here you can't kick them out. Here you can.  
[01:07:23] Uh here what they can So that's a great example. So let's think about Swift. So Swift is a is a wonderful For those of you that I'm sure everybody knows, but it's a payment system.  
[01:07:34] So the reason why we we care about them is you can see it here. They're essentially they have very high external return um um external scale uh properties. I like being on Swift cuz everybody else is on  
[01:07:48] Swift. Now those are the typical things you use in threats. Why? Because in equilibrium everything else is an extremely good substitute. They're the typical natural monopolies where one system governs almost everything.  
[01:08:00] Okay? So the US likes to use them in threats cuz that's a pretty meaningful threat to um to provide to other countries to kick you off Swift.  
[01:08:09] Now what am I allowing here? Uh I'm allowing the US to subsidize Swift activities to make it even bigger because he values it.  
[01:08:19] What I'm not allowing is either for the Chinese government to respond. That's the question from Steve. Here the rest of the world is small. Uh we're not considering the full game of of them responding. Second, I'm not allowing for somebody else to create  
[01:08:34] a sector in that country that does this if it wasn't there to begin with. Those are given. They're all things that we would like to work on.  
[01:08:43] But you know the first paper was fix the fix the structure of the economy, look at all the intensive margins of how you would like to manipulate the activities.  
[01:08:52] That's exactly right. But what I had in mind was also taking the example Swift.  
[01:08:58] Swift becomes very important if first the biggest countries joins with so in some way there is a secret and optimal sequences  
[01:09:13] on how I allow my supplier to serve certain activity and that could give me more power.  
[01:09:22] So yeah yes and no in this paper. So in this paper what you can definitely capture is through the external economies of scale is that having big players join your system impacts the value of the system to everybody else  
[01:09:35] much more than small players. All of that we can allow. We have no dynamics.  
[01:09:39] So here there is no sense in which you build this slowly over time. We have a separate paper that has little to do with this but it's about building that kind of dynamic construction.  
[01:09:50] Here it's totally absent. What what's present is just the idea of of externalities impacting So is this intuition right that if I think about a strategic sector not in the hegemon's country but some little countries think about think about oil in  
[01:10:04] the 70s right it was mainly in the Middle East I think I think that's probably right.  
[01:10:08] These contracts are less likely to to solve that problem because everybody needs it and I don't control it and What what I want what I want to do as the US is I might want to if oil is is for example controlled by three countries I might want to find very powerful  
[01:10:23] threats over those countries so that they get to do my bidding.  
[01:10:27] Right but it's harder to find an economic threat because no one's going to go along with not buying oil because they all need it so this tells me why we have military bases. It also tells you that if you yeah if you make the oil supply very dispersed for example now the US is a  
[01:10:41] big is a big supplier that minimizes the power that you get out of all that because there's another willing supplier. What it tells you the current situation where it's very difficult to punish Russia if China and India willing to buy.  
[01:10:56] This is a it's a bit different from this cuz it's a it's a supply on buying on selling rather than than buying, but it's relatively similar. Okay. Now, let me tell you we're we're done with the difficult part. So, let me try to just  
[01:11:09] do examples and applications, okay? First, I wanted to get back to what are strategic sectors in this model? Uh and how do you judge them? So, I I I wanted to distinguish micro from macro.  
[01:11:21] So, we mentioned micro is essentially the ability to give threats.  
[01:11:25] Take prices and quantities as given. If I have valuable threats over a particular sectors, that tells me the micro power I have over them. And a sector is strategic if it lets me make these threats.  
[01:11:37] Now, once I have micro power over you, the actions I ask you to take might have to do with me exerting macro power. I might simply ask you to give me money.  
[01:11:48] Or I might ask you to modify the way you produce because that impacts somebody else that I care about, and so on. So, macro power here is measured very differently. It's measured by looking at sectors with high indirect  
[01:12:01] influence in a Leontief sense. Um now, the the origin for macro power is micro power. So, I can't have one without the other.  
[01:12:11] Um but they're they're exerted for very different reasons, and you will measure them in the data very differently um very differently.  
[01:12:19] Um I actually, you know, for everybody after I have questions about this. I'm kind of we kind of started thinking about this as a more general problem. For example, think about regulatory capture.  
[01:12:30] It's a little bit like this. Like you know, I'm essentially a big player, and what am I doing? I'm asking people for to do individual actions cuz I have some power over them. They accept to do my bidding, but they think that the equilibrium is constant.  
[01:12:44] But the reason why I'm actually asking them is I'm changing the equilibrium, and they're not noticing that. That's my source of ultimate power. So, it seems like a very general thing like all general things I'm assuming some  
[01:12:57] previous economist defined it otherwise have probably done it and I'm rediscovering it, but the flavor of some antitrust issue.  
[01:13:03] Yes, it has the flavor of exactly that and I would like to get deeper into that. So, I would love to to know more cuz it seems that the modeling tools these concepts are very general and here I picked a country, but it could have been an industry. It could have been  
[01:13:16] like the financial industry doing this. The leading firm in an industry.  
[01:13:20] Yes, exactly. Could be a big player in an industry is coordinating this.  
[01:13:24] And I I quite like it and it's measurable. So, I love to know what people's reactions about this.  
[01:13:30] But then let me finish with this paper which are So, how much time we have?  
[01:13:34] Okay, 20 minutes perfectly. So, first I told you that you know, how much you want to influence things, but not the direction.  
[01:13:41] And this goes to the idea of political enemies and uh and political friends. So, there's a very easy way to see who who are your friends and enemies in this equilibrium.  
[01:13:52] Pick anybody like a country, a sector, a firm around the world. Look at how they affect your value function.  
[01:14:00] So, a friend is nothing else that is somebody where all their externalities on you are positive. A neutral is somebody that has no externalities on you and an unfriendly is somebody that has negative externalities on you.  
[01:14:12] And the sign of these objects tell you what you want to do with them. You want to tax unfriendly sectors.  
[01:14:21] Untax the neutral, zero wedges, and subsidize the friendly. Now, the nice thing is that these concepts aren't based on who you are, what you do, they're based on how you influence the equilibrium. So, at the you know,  
[01:14:35] Nvidia is unfriendly to the US for its activity of selling to China despite the fact that overall we might want Nvidia to be very successful and big in the US.  
[01:14:46] So, they're about how you influence the equilibrium rather than simply some example characteristics.  
[01:14:53] Okay, genetic inefficiency stuff. So, this is pretty intuitive and I'm only going to do it intuitively.  
[01:15:00] Even in the general sense of the full contract, in general having an hegemon is inefficient. Why? It's a bit of the same as the the simpler version I gave you before. What an hegemon is doing here is  
[01:15:14] is moving up the Pareto frontier. It's supplying very powerful threats.  
[01:15:18] The fact that there's this big police watchdog around the world is making the world work better. It's providing more enforceability.  
[01:15:27] But by the same token, that country now has power. And what it's going to do is it's going to choose a contract that moves to the inside of the world Pareto frontier to maximize his own welfare. It does it in two ways. First, it extracts  
[01:15:42] markups and transfers or loans at higher rates because it can.  
[01:15:46] Second, it imposes wedges that don't maximize world welfare, they maximize the country welfare. The typical example is China having a large semiconductor industry might be unfriendly to the US,  
[01:16:01] but might be very friendly for the rest of Asia. And a world planner would have chosen a different set of instruments than the than the hegemon does.  
[01:16:09] So, this clarifies why I think the sort of newspaper version of what's positive and what's negative sum doesn't work that well. So, your way your way of thinking about this, how would you characterize  
[01:16:22] on the first day Biden issued executive orders saying that all benefit cost analyses in the federal government have to take account of global benefits?  
[01:16:30] Yeah, I don't think we we ever do. I mean, we care about our national benefits. Yeah, but he issued an executive order forcing agencies to take account of global benefits, not just Then they should, but um the global benefits are I mean so  
[01:16:43] he's acting in a he's acting in a counter counter to your way of thinking about Let me put it this way. I'm not saying it's political, but that's an Yeah, yeah, no, no.  
[01:16:55] example It's pretty obvious that if you're if you're acting in the global benefits I think that only counted if it was global carbon reduction benefits. Other global benefits I don't think they were interested in. Well, maybe they weren't but the executive order was for all of us fraud cost benefit He also said you  
[01:17:09] have to count uh uh reductions in inequality as a benefit. Yeah, yeah, yeah, yeah, equity I forgot.  
[01:17:16] Let me let me stay on this for a second. Okay, let me do the example. So I promised a national security example. So let me give you the construction. This boils down the model to literally three three or four sectors in total. So I'm going to think of a country like the US  
[01:17:30] that has some unspecified sectors. I don't care what they are, okay? But it has some threat on some firms in some sectors in the rest of the world, okay? Potentially there are many in the rest of the world.  
[01:17:42] I'm going to assume just two, okay? And I'm going to assume external economies of scale. So if I is using a technology from China, J finds on the margin that technology more productive  
[01:17:55] and vice versa, okay? Are I and J in the same country?  
[01:17:59] No, they could be in any generic rest of the world, okay?  
[01:18:04] Uh China I'm going to assume it has a single sector, Huawei, that is selling technology to the rest of the world firms, okay?  
[01:18:12] And this goes to the question of you know, liking or not liking activity.  
[01:18:16] This is the only time I'm going to really use heavily the the term in the utility function. I'm going to assume very directly that the US suffers a utility loss if the rest of the world is using this Chinese technology. Now you can write  
[01:18:31] full models of that. I like to spy on enemies and friends, and the only way I can do it is if I control the infrastructure of telecommunication like they did for it AT&T downtown. Uh We  
[01:18:45] separate utility laws if our electric cars aren't built by union labor in the US.  
[01:18:49] Yeah. Whatever whatever it is that that and that's why I said like I you know, I want to claim that we don't have a model of that. I want to claim that we have a simple model to capture it uh in the way that most the time we do in economics with a term on the  
[01:19:03] utility function. Okay? Now, see what happens in this one. Um If you think about Okay, so sorry.  
[01:19:11] First, um the only thing I'm going to focus on is that the US has some powerful threat over a part of the world economy. So, we can ask them for some actions. In the particular example of Huawei, I think of this as Western Europe.  
[01:19:26] Okay? We can ask some governments in Western Europe to reduce their usage of uh telecommunication technology from China.  
[01:19:34] The question is what How much do I ask them to do it and why?  
[01:19:39] This is kind of interesting. So, this goes to the idea of why the externalities matter so much.  
[01:19:44] Well, first, I want to ask the government that I that I control, I, to you to use it less.  
[01:19:51] That's a direct benefit for me cuz they're not using it. I don't like them using it. That's a a direct benefit.  
[01:19:58] Second, I know that the other governments or the other sectors that I have no relationship with, I couldn't ask them to do anything.  
[01:20:07] Because of external economies of scale, Germany will stop using a technology if England is not doing it because the technology all of a sudden isn't so valuable to to Germany on the margin.  
[01:20:18] Now, I'm fully incorporating that. So, what that means is that I'm going to really push hard on the government that I do control.  
[01:20:26] Uh I'm going to ask them to do more than I would have otherwise asked them because I I to use their indirect influence.  
[01:20:33] Also, this last term, which is the indirect effect on the participation constraint, tells me that to the extent that I'm moving the equilibrium in my favor, it makes it easier for people to accept.  
[01:20:44] Why? Think about the beginning. The first time, everything else given, I ask England to not use this technology, they'll complain a lot.  
[01:20:53] They'll perceive it as very expensive cuz they're thinking of a world where France and Germany are on it.  
[01:21:00] But as this amplifies and France and Germany are using it less, England itself is going to perceive it to be less valuable to be on it. So, I'm tightening their participation constraint less.  
[01:21:11] So, what I'm really doing is I'm I'm probably manipulating this in my favor through both the effect on others and how it filters back on the people that I do control. And ultimately, I might get to reach the equilibrium even if I  
[01:21:25] control only a small part of the world economy. So, that's a pretty good example of the macro aspects. Now, it also tells something else, which we're not doing in this paper. It's a separate paper.  
[01:21:37] Suppose that you're a government being targeted from a foreign hegemon.  
[01:21:41] You can be sure that the hegemon isn't picking a random.  
[01:21:45] Here, the hegemon loves strategic sectors. Why?  
[01:21:48] From a macro perspective, because they have a the largest gap between the private cost to all of the firms in your country participating and the social benefit.  
[01:22:00] The hegemon is essentially distorting their margin against you. So, they're they're guaranteed to pick or to want to use the most sectors that have very high indirect influence because everybody's going to participate  
[01:22:13] because they're not taking into account the overall market effect.  
[01:22:17] Now, as a government, that gives you a rational for doing anti-coercion policy.  
[01:22:22] It's to make every every sector or every firm in your country understand that that they shouldn't participate so willingly because they're changing the overall equilibrium, okay? We're not studying those policies here, but we I would like to study them.  
[01:22:35] Okay, last example and then we're done. Is I'm going to think about the China Belt and Road Initiative. Um and I'm going to make it super simple.  
[01:22:44] So, you all know what it is approximately, but in this particular framework, I'm going to think of it as I have two sectors as China. So, my agent is now China. I can lend.  
[01:22:57] So, think of it as making loans. This could be sovereign lending, they could be official loans.  
[01:23:03] And I'm providing some manufacturing input, okay? To a firm. Here I'm going to pick the target country to be say a small open economy in Africa, okay?  
[01:23:14] And this actually connects to Jeremy's wonderful work with Can on on the bull rogue of results.  
[01:23:20] So, here I'm going to start with Okay, I'm making you a loan each period. Um it's a fixed interest rate.  
[01:23:27] If you default, I'm not going to trust you.  
[01:23:30] I'm going to assume that there is no legal enforceability. So, the contract is totally unenforceable, okay?  
[01:23:36] But I also have available manufacturing activity and by converse I'm going to say that the manufacturing activity is fully enforceable.  
[01:23:44] There is nothing that you can do about stealing it.  
[01:23:48] So, think about what happens. First, if you do isolated threats, you can only sustain a small amount of lending. This actually goes to your work. Here in fact, we're rigging it because if we allowed up front contracts  
[01:24:01] in savings, we would get back to your result of you can't sustain any lending at all. Here the only reason you can sustain some is I'm not allowing you to write up front contract.  
[01:24:12] But the second part is really a suggestion from their paper where they say, "Look, one thing that I can threaten you with if you default on me on a loan is with other relationships that have nothing to do with the loan, that are themselves very valuable.  
[01:24:24] Like trade. That relationship is going to essentially act as a cost as a sort of collateral for the loan.  
[01:24:32] And here you can see that what it does is that it shifts up the maximum amount that you can borrow.  
[01:24:38] Now, from the perspective of these countries, it tells you though something else. There's a large empirical literature trying to measure is China getting a good or a bad deal on the on the loans? And was the Marshall Plan of  
[01:24:50] the US a good or a bad idea? This is telling you to be very careful with the analysis. Why? Because both the sustainability and the actual money that you the actual profits you make out of this might not come from the interest rate on the loans. For all we know,  
[01:25:05] China might be making horrible returns on the loans, but if he's getting political recognitions or to use naval bases, that might be worth a small fortune. Or it's securing, you know, critical mineral supplies.  
[01:25:18] But it's not just the outcome, it's also the the fact that the activities are sustainable in the first place is because they're jointly coordinated.  
[01:25:25] Uh so it gives you a very different way or a cautionary tale of how to assess these projects. But I think a lot of the sort of literature on China has been on the interest rates on the loan.  
[01:25:38] But that's like a thermal like another. It's part of a big threat with tons of other things and where you see the profits or the losses might be in seemingly very unrelated activity the moment you think of it as a hegemonic power.  
[01:25:50] Um okay. Um I'm going to let you stop here. Uh lots of things came up during the talk. I mentioned that there's a few that we're working on. So I wanted to give you a sense. So first of all, working on the empirics.  
[01:26:03] A lot of this framework, despite the fact that it looks, at least to me, rather complex, it's pretty easy to it's pretty measurable, at least by the standard of macro models.  
[01:26:14] Uh second, we mentioned uh competition. What if you have multiple hegemons? Uh and you're studying a full game where they're both offering contracts. Uh so we we've only done minor sketches of  
[01:26:27] that, but we'd like to do a lot more. Uh similarly, uh we mentioned that even if you're not a hegemon, you're a small country in this game, uh we're not studying your optimal defensive policy.  
[01:26:39] Here, your sectors are doing uh behaving sometimes competitively and accepting contracts. Uh right now, a lot of governments, including the governments of Western Europe, are passing what is called anti-coercion policies. Um it's  
[01:26:54] unclear what are you trying to correct, uh what why are you doing them, uh there's a there's a nice set of policy tools that can be studied in this framework that we haven't introduced yet.  
[01:27:07] That's it. Um hopefully, uh this gave you a list my rendition of what I think is a very large topic that I've been out of economics for many, many years, uh and that I think we can treat uh with modern tools quite efficiently. Uh I'm  
[01:27:22] sure people will have different ideas about how to do it, uh better ways to do it, uh but I think it shouldn't be a topic that we don't deal with. Uh in fact, there's I'm going to argue that there's lots of good standard theory tools uh and empirics that can be  
[01:27:35] brought to bear on this on these questions, and there seems to be a large policy relevance, and I think collectively as a field, we should have good things to say about this, and right now, it's pretty massively understudied.  

## Q&A (01:27:49 – 01:30:13)

[01:27:49] Thank you. Thank you. Great great presentation. One question. Oh, please.  
[01:27:54] Can I give you a summary and tell me where I went off? So, already we had monopoly power in international markets in these arguments. Already we had domestic increasing returns.  
[01:28:07] But you seem to be telling us, well, the value of those things is more than the sum of the individuals.  
[01:28:14] That's correct. So, here Did I miss anything? No, no, no. I I I don't think you're wrong. I I think here the notional power is much more general cuz it's not just market power. In some sense, markups are one of the things I might ask you, but I might  
[01:28:28] My power is my power to ask you to do costly actions.  
[01:28:32] But also, it's different from the typical micro power cuz some of the actions are driven from changing the equilibrium and not often simply extracting surplus out of you.  
[01:28:43] In fact, I like those that extract minimal surplus out of you and affect the equilibrium a lot because I can convince you to do a lot of those for me.  
[01:28:53] That That's exactly right. So, the mechanism is is different, but also you I mean, in the future work, you have the potential of the creation of coalition because even a small country I mean, the one-way story is very  
[01:29:07] interesting because at one point, for example, Italy positioned to to acquire it and then they immediately and they were playing a game, obviously, and this is a small country, but you know, in coordination with some of the other  
[01:29:19] countries were actually trying to position toward one hegemon versus the other one. I mean, you know, also the I I think the the China I think there's a lot of China relationship between Italy and the I I think there's a lot of  
[01:29:34] scope for that. I mean, here a very obvious coalition or cartel is OPEC.  
[01:29:37] Each of the country would have little power for the threats, but threats for all of them since they're a large part of the world supply of oil are very valuable.  
[01:29:47] But I think what you have in mind is a little bit more of like if I have two hegemons, how do I play against each other?  
[01:29:52] Yeah. That's what I'm thinking. Yes, absolutely. So, I'm very interested in that problem. We've only started sketching it.  
[01:29:59] Um Thank you.  
[01:30:07] I love you. Hey.