We build a model of two hegemons that have valuable trading relationships with each other and at the same time compete in exerting geoeconomic power over countries in the rest of the world.
We build a model of two hegemons that have valuable trading relationships with each other and at the same time compete in exerting geoeconomic power over countries in the rest of the world. When the hegemons trade with each other, their optimal policy is shaped both by classic economic considerations - the profitability of that specific trade - and by geoeconomic competition - how the trade affects the power of each hegemon vis-a-vis the rest of the world. We show that containment, a policy mix in which a hegemon limits sales of its inputs to the rival hegemon and uses its power to demand that the rest of the world shift away from sourcing from the rival, arises when the two hegemons offer relatively substitutable exports, are less interdependent with each other, and have more direct geopolitical rivalry. Countries in the rest of the world benefit, all else equal, from hegemons containing each other since they partially squander their power with offsetting demands. However, containment policy can also worsen the efficiency of global production, leaving the rest of the world worse off. We acknowledge funding by the Smith Richardson Foundation, the National Science Foundation (2441937), and Stanford Impact Labs. We thank Kyle Bagwell, Emily Blanchard, Matilde Bombardini, Lorenzo Caliendo, Laura Doval, Jesús Fernández-Villaverde, James Fearon, Jeff Frieden, Bengt Holmstrom, Alexey Makarin, Alberto Martin, Pablo Ottonello, Diego Perez, Stephen Redding, Andres Rodriguez-Clare, Enrico Spolaore, and Francesco Zanetti for useful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. In addition toworking papers, the NBER disseminates affiliates’ latest findings through a range of free periodicals—theNBER Reporter, theNBER Digest, theBulletin on Health, theBulletin on the Economics of Alzheimer's, and theBulletin on Entrepreneurship—as well asresearch spotlights, lectures, and panel videos.