# **1 Introduction**

The two largest trading economies in the world, the United States and China, increasingly see each other as geopolitical rivals. For both the US administration and the Chinese government, this great-power rivalry is central to their foreign and national security strategy (Wolff, 2023). While other reasons contributed to the surge in trade policy activism on both sides of the Pacific in recent years, geopolitical considerations are increasingly cited as a driver of new trade and industrial policy. For instance, data from the New Industrial Policy Observatory show that a significant number of measures imposed by China and the United States in 2023 and the first half of 2024 are motivated by geopolitical and national security concerns (Evenett et al., 2024). Irrespective of the validity of these concerns and the efficacy of new trade measures to achieve the intended goals, an increasingly commonly held view is that US-China rivalry, and the change in policies that it generates, could reshape trade flows and fragment the world trading system and the global economy more generally (Aiyar et al., 2023 and Gopinath et al., 2024).

In this paper, we study the implications of geopolitical rivalry for trade cooperation and for the purpose and design of the rules-based multilateral trading system. Our work builds from an understanding of the logic of the multilateral trading system that comes from the literature on the economics of trade agreements (see Bagwell and Staiger, 1999, for an initial statement of the framework that provides this logic, and Bagwell et al., 2016, for a review of this literature). The key findings of this body of work can be simply stated. The first is that the fundamental source of inefficiency associated with the unilateral trade policy choices of governments is the presence of cross border spillover effects in the form of a terms-of-trade externality. Second, the primary purpose of a trade agreement is to mitigate these externalities, meaning that countries agree to limit their protectionist policies thus preventing them from manipulating trade prices to their advantage at the expense of other countries. Third, the rules of the world trading system initially negotiated through the General Agreement on Tariffs and Trade (GATT) and later embedded into the Agreements under the auspices of the World Trade Organization (what we will refer to as the GATT/WTO rules) provided a governance system that allowed countries to escape from the trap of non-cooperative protectionist trade policy and promoted mutually benefical trade cooperation.

While rich in insights, the framework underpinning this body of work has been developed without explicit consideration of issues related to geopolitics. To introduce geopolitics into this framework, we turn to the literature on international relations. In particular, the so called “realist school” emphasizes the importance of rivalry among countries to improve their power, and assumes that in their rivalry governments are concerned with _relative_ rather than absolute power, in the sense that they aim to increase their power _at the expense_ of their rivals. The following quote from Mearsheimer (2003) is illuminating: Saying that states are power maximizers is tantamount to saying that they care about relative power, not absolute power. There is an important distinction here, because states concerned about relative power behave differently than do states interested in absolute power. . . . Thus states motivated by relative power concerns are likely to forgo large gains in their own power, if such gains give rival states even greater power, for smaller national gains that nevertheless provide them with a power advantage over 1