China’s Reduction of EU Dairy Tariffs Reveals the Power of Iterated Cooperation Over Short-Term Retaliation
On February 12, 2026, China made an unexpected move in its simmering trade dispute with the European Union: it substantially reduced tariffs on EU dairy imports from a punitive 21.9–42.7% to a more modest 7.4–11.7%. To casual observers, this might appear as a simple concession or diplomatic olive branch. But viewed through the analytical framework of game theory—particularly the iterated prisoner’s dilemma—this decision reveals a sophisticated understanding of how long-term cooperation generates greater benefits than short-term defection, even in the competitive arena of international trade.
The dairy tariff reduction is not an isolated event. It represents the second time in two months that China has softened retaliatory measures against the EU, following similar reductions in pork tariffs from rates as high as 62.4% to a maximum of 19.8%. These sequential de-escalations occur against the backdrop of the EU’s controversial tariffs on Chinese electric vehicles—the original catalyst for China’s investigations into European agricultural products. Understanding why both parties are now stepping back from the brink requires examining the strategic logic that governs repeated interactions between economic powers.
The Prisoner’s Dilemma Framework: Why Trade Wars Are Tempting but Costly
International trade inherently creates a prisoner’s dilemma structure. Each nation faces a fundamental choice: cooperate by maintaining open markets, or defect by imposing protectionist measures to capture short-term advantages for domestic industries. The dilemma emerges because while mutual cooperation yields the highest collective benefit, each party has an individual incentive to defect if they believe the other will cooperate.
In the China-EU case, the payoff structure was clear. When both parties maintained relatively open markets (pre-2024), European dairy producers accessed Chinese consumers while Chinese EV manufacturers expanded into European markets. Total trade value was maximized, and both economies benefited from comparative advantages. However, once the EU imposed EV tariffs in October 2024—reaching up to 37.6% on subsidized Chinese vehicles—China faced a strategic choice: accept the loss of market access, or retaliate to signal that protectionism carries costs.
China chose retaliation, launching anti-dumping investigations into EU dairy, pork, and brandy. The initial dairy tariffs of 21.9–42.7% represented a classic defection move: impose maximum pain on the opponent’s politically sensitive sectors (French cheese producers, Italian dairy cooperatives, Danish agricultural exporters) to generate domestic pressure for policy reversal. From a single-game perspective, this response appears rational—punish defectors to deter future transgressions.
Why Iteration Transforms the Strategic Landscape
The critical insight from game theory research—pioneered by Robert Axelrod’s famous tournaments in the 1980s and refined by subsequent scholars—is that repeated games fundamentally alter strategic calculations. When two players know they will interact indefinitely, cooperation becomes not just possible but rational, even in situations where single-round logic dictates defection.
The mechanism is straightforward: in an infinitely repeated game, the threat of future retaliation makes present cooperation valuable. If China maintains punitive dairy tariffs, the EU has every incentive to sustain or even increase EV tariffs. This triggers a tit-for-tat spiral where each defection invites counter-defection, progressively eroding the gains from trade. The shadow of the future—the expectation of continued interaction—creates a powerful incentive structure that rewards cooperation and punishes sustained defection.
China’s February 2026 decision to reduce dairy tariffs by more than half signals recognition of this dynamic. By moderating its retaliatory stance, China communicates willingness to move toward mutual cooperation rather than escalate into a protracted trade war. The timing is revealing: just weeks before the EU must finalize its approach to Chinese EV tariffs, China offers a concession that demonstrates flexibility. This is not capitulation—the reduced 7.4–11.7% tariffs still provide meaningful protection for Chinese dairy producers—but rather a strategic signal designed to invite reciprocal cooperation.
The Discount Factor and the Value of Tomorrow
Game theorists use the concept of a “discount factor” to represent how much players value future payoffs relative to immediate gains. A high discount factor means actors are patient and value long-term benefits; a low discount factor indicates preference for immediate gains even at the cost of future losses. Cooperation in iterated prisoner’s dilemmas becomes sustainable only when the discount factor exceeds a critical threshold—when tomorrow’s benefits from sustained cooperation outweigh today’s temptation to defect.
In international trade, discount factors manifest through several channels. Economic interdependence increases the value of future cooperation—China and the EU conduct over €700 billion in annual trade, making continued market access extremely valuable. Political stability considerations also raise discount factors: predictable trade relationships facilitate long-term investment planning and supply chain development. Finally, reputational concerns matter: nations that consistently defect in trade disputes acquire reputations as unreliable partners, potentially triggering exclusion from multilateral agreements or preferential arrangements.
China’s dairy tariff reduction reflects a calculation that the long-term benefits of avoiding escalation exceed the short-term domestic political gains from maintaining maximum pressure. Chinese dairy producers facing overcapacity and falling prices will receive some protection from the reduced tariffs (7.4–11.7% still creates meaningful competitive advantage), but not so much as to permanently close the European market or invite permanent retaliation. This calibration balances domestic constituency demands with strategic foreign policy objectives.
Tit-for-Tat: The Surprisingly Effective Simple Strategy
In Robert Axelrod’s computer tournaments testing strategies for iterated prisoner’s dilemmas, the winning approach was remarkably simple: tit-for-tat. This strategy cooperates on the first move, then mirrors the opponent’s previous action. If the opponent cooperates, you cooperate; if they defect, you defect once in retaliation, then return to cooperation if they do. Tit-for-tat succeeds because it is nice (never defects first), retaliatory (punishes defection immediately), forgiving (returns to cooperation quickly), and clear (easy for opponents to understand and predict).
The China-EU trade interaction closely resembles a tit-for-tat dynamic. The EU defected first by imposing EV tariffs in October 2024, citing concerns about Chinese subsidies creating unfair competitive advantages. China immediately retaliated with anti-dumping investigations and provisional tariffs on dairy, pork, and brandy—a clear tit-for-tat response signaling that defection carries costs. However, China is now moderating its stance, reducing dairy tariffs and having previously reduced pork tariffs. This moderation functions as an invitation to return to cooperation, consistent with tit-for-tat’s forgiving nature.
The EU has responded with signals of its own openness to de-escalation. In January 2026, Brussels issued detailed guidance on how Chinese EV tariffs could be replaced with minimum price commitments—a form of managed trade that would maintain some protection for European manufacturers while allowing Chinese producers continued market access. These negotiations represent both parties exploring alternative equilibria that preserve their core interests while avoiding the mutual destruction of a full-scale trade war.
The Aggregate Welfare Case: Cooperation Maximizes Total Gains
Beyond the strategic logic of iterated games lies a fundamental economic truth: trade liberalization generates net welfare gains that protectionism cannot match. When China and the EU maintain relatively open markets, specialization according to comparative advantage allows both economies to produce more efficiently. Chinese manufacturers leverage advantages in EV battery production, vertical integration, and scale economies. European dairy producers capitalize on sophisticated agricultural techniques, established quality reputations, and favorable climatic conditions for milk production.
Trade barriers destroy value across multiple dimensions. First, they raise consumer prices: Chinese consumers pay more for imported cheese when facing 42.7% tariffs, while European consumers pay more for electric vehicles facing 37.6% duties. These price increases directly reduce consumer welfare, falling disproportionately on lower-income households who spend larger shares of income on food and transportation. Second, tariffs create deadweight losses through inefficient allocation: protected Chinese dairy producers maintain production at scales and cost structures that cannot compete without government support, while protected European automakers delay necessary investments in EV technology and supply chain efficiency.
Third, trade wars generate uncertainty that suppresses investment. When firms cannot predict whether tariffs will remain at 40%, drop to 10%, or rise to 100%, they postpone major capital commitments. A French dairy cooperative considering expansion to serve Chinese markets will delay investment until trade relations stabilize. A Chinese EV manufacturer evaluating whether to build European factories pauses plans when future market access remains uncertain. This investment paralysis compounds the static efficiency losses from misallocated resources.
The aggregate welfare case for cooperation is therefore compelling. China’s dairy tariff reduction, while maintaining modest protection, represents a movement toward more efficient market allocation. By allowing European dairy products greater access to Chinese consumers, both sides gain: Chinese consumers access higher-quality or more diverse products, European producers expand sales, and total economic welfare increases. The same logic applies to potential EV tariff reductions—European consumers benefit from access to more affordable electric vehicles, accelerating the continent’s climate transition, while Chinese manufacturers maintain the production volumes necessary to achieve economies of scale that benefit all buyers globally.
How International Institutions Facilitate Cooperative Equilibria
The World Trade Organization and similar multilateral frameworks exist precisely to transform single-shot trade interactions into iterated games with credible enforcement mechanisms. By establishing dispute resolution procedures, transparency requirements, and structured retaliation rights, the WTO increases the shadow of the future and reduces the temptation to defect. When China filed a WTO dispute against EU EV tariffs in November 2024, it invoked these institutional mechanisms designed to channel conflicts toward rule-based resolution rather than escalating retaliation.
However, the China-EU dairy case also reveals institutional limitations. The WTO’s dispute resolution system, while valuable, operates slowly—panels typically take 12–18 months to issue findings, and appeals can extend resolution by years. During this time, provisional measures remain in place, economic damage accumulates, and political pressures build for additional retaliation. This temporal lag creates space for bilateral negotiations that bypass multilateral processes but may generate outcomes more tailored to specific circumstances.
The EU’s proposal for minimum price commitments on Chinese EVs illustrates this hybrid approach. Rather than relying solely on WTO adjudication of whether Chinese subsidies constitute actionable violations, the EU suggests a managed trade arrangement where Chinese producers agree to price floors that preserve European market shares while maintaining access. Such arrangements occupy uncertain terrain in WTO jurisprudence—they avoid explicit quotas or discriminatory tariffs while still constraining trade through negotiated restraints. Yet they may represent pragmatic solutions that prevent destructive spirals when pure liberalization proves politically untenable.
The Two-Level Game: Balancing Domestic Constituencies and International Strategy
Trade policy never occurs in a purely international vacuum. Political scientist Robert Putnam’s concept of two-level games captures how negotiators must simultaneously satisfy domestic constituencies and international counterparts. China’s dairy tariff reduction reflects this dual constraint: it must appear to protect Chinese dairy farmers facing market pressures, while also signaling flexibility to European negotiators that could yield reciprocal concessions on EV market access.
The selection of agricultural products for Chinese retaliation demonstrates sophisticated political targeting. Dairy, pork, and brandy exports concentrate in specific European regions with outsized political influence. French cognac producers in Charente and Cognac regions have historically wielded significant power in French agricultural policy. Danish and Dutch dairy cooperatives represent not just economic interests but cultural institutions central to rural identity. By threatening these constituencies, China applies pressure directly to member states that must approve EU trade decisions, potentially fracturing the bloc’s cohesion.
Similarly, the EU’s EV tariffs reflect internal political dynamics. Germany, home to Volkswagen, BMW, and Mercedes-Benz, initially opposed harsh measures on Chinese imports, recognizing these manufacturers’ significant production in China and sales to Chinese consumers. France and Italy, with smaller Chinese exposure but greater concerns about domestic automotive employment, advocated stronger protection. The final tariff structure—ranging from 7.8% to 35.3% depending on cooperation with investigations and subsidy levels—represents a compromise satisfying multiple constituencies while maintaining flexibility for negotiation.
Understanding these domestic constraints illuminates why gradual de-escalation proves more feasible than immediate liberalization. Neither side can afford the domestic political backlash from appearing to capitulate completely. China’s dairy tariff reduction to 7.4–11.7% maintains enough protection to claim success in defending farmer interests, while reducing enough to signal genuine flexibility. If the EU responds with partial EV tariff reductions or alternative arrangements, both sides can claim victory with their respective domestic audiences while actually moving toward the cooperative equilibrium that maximizes joint welfare.
Fragility and Noise: Why Cooperation Remains Difficult
While game theory demonstrates cooperation’s rationality in iterated games, sustaining it remains challenging. Evolutionary game theorists have shown that cooperation is not automatically stable even under iteration. Martin Nowak and colleagues demonstrated that in large populations playing iterated prisoner’s dilemmas, cooperation and defection tend to cycle in waves rather than settling into permanent cooperation. The intuition is straightforward: when most players cooperate, defectors can exploit them with impunity; once defectors proliferate, cooperators suffer badly and their strategies become less prevalent; but pure defection yields poor results for everyone, creating space for cooperators to re-emerge.
International trade exhibits exactly these dynamics. Periods of liberalization—the decades following World War II through the 2000s—saw generally declining tariffs and expanding trade volumes. But the late 2010s and 2020s witnessed a protectionist resurgence, with multiple major economies imposing new barriers under national security, industrial policy, or anti-subsidy rationales. The China-EU dairy case exemplifies this fragility: just months of relative cooperation collapsed into retaliatory spirals once one party perceived violation of cooperative norms.
Additional challenges arise from “noise”—misperceptions, misunderstandings, or ambiguous signals that can trigger unwarranted retaliation. Did the EU impose EV tariffs because of genuine subsidy concerns, or as industrial policy protectionism? China genuinely believes the former represents the latter, viewing Western concerns about Chinese subsidies as hypocritical given extensive EU and U.S. support for their own automotive and battery industries. This asymmetric perception complicates cooperation: if China interprets EU actions as defection warranting retaliation, while the EU views its actions as legitimate self-defense, each side’s responses appear unjustified to the other, potentially triggering escalation spirals even when both parties prefer cooperation.
Transparency and communication mechanisms help address noise problems. The EU’s preliminary disclosure of tariff calculations, China’s public announcement of investigation findings, and ongoing bilateral consultations all function to reduce ambiguity about intentions and actions. When both parties understand what actions triggered responses and why, they can more easily distinguish legitimate grievances from opportunistic defection, facilitating return to cooperative equilibria.
Beyond Game Theory: Complementary Explanations for De-escalation
While game theory provides powerful insights into the China-EU tariff reduction, alternative explanations merit consideration. Domestic economic factors may independently drive policy changes. China’s dairy sector faces genuine overcapacity—domestic production exceeds consumption, prices have fallen, and producers face financial distress. Maintaining extremely high tariffs on imports might provide short-term relief but delays necessary industry consolidation and efficiency improvements. Moderate tariffs (7.4–11.7%) create competitive pressure that incentivizes restructuring while preventing catastrophic import surges.
Similarly, China’s broader strategic calculations extend beyond bilateral EU relations. As the United States under a new administration explores its own trade policies, China may seek to avoid simultaneous confrontations with both Western powers. Softening the EU dispute frees diplomatic bandwidth and demonstrates to other trading partners that China responds to negotiation rather than only to pressure. This reputational consideration transcends the bilateral game—China signals to all current and potential trade partners that engagement yields results.
Geopolitical considerations also matter. China and the EU face common challenges: climate change requiring accelerated clean energy transitions, supply chain vulnerabilities exposed by recent crises, and concerns about economic dependencies on various partners. These shared interests create potential for cooperation in domains beyond immediate trade disputes. By de-escalating agricultural tensions, China keeps channels open for collaboration on climate technology, infrastructure investment, and multilateral governance reform. The value of these broader cooperative possibilities may exceed the specific gains from maintaining maximum agricultural protection.
Strategic Lessons: Building Cooperative Equilibria in International Relations
The China-EU dairy case offers several strategic lessons applicable to international trade disputes more broadly. First, retaliation serves an important signaling function but should be calibrated to invite de-escalation rather than lock in permanent confrontation. China’s provisional tariffs communicated resolve—defection will be punished—while the subsequent reduction signals willingness to cooperate if reciprocated. This two-stage approach balances credibility with flexibility.
Second, face-saving mechanisms facilitate cooperation when domestic political constraints bind. Neither China nor the EU can simply reverse course without appearing weak to domestic constituencies. Gradual, sequential reductions in tensions allow both sides to claim victory: China protects farmers with moderate tariffs while demonstrating diplomatic flexibility; the EU maintains some automotive protection while securing better dairy market access. These compromise outcomes, while potentially suboptimal from pure economic efficiency perspectives, prove sustainable where winner-take-all solutions would collapse.
Third, maintaining multiple channels of communication and negotiation increases the probability of finding cooperative solutions. The China-EU dispute involved simultaneous WTO litigation, bilateral ministerial consultations, and informal industry-to-industry discussions. This multiplicity allows parties to explore creative arrangements (like minimum price commitments) that might not emerge from purely formal adjudication, while the threat of adverse WTO rulings provides background pressure incentivizing negotiated settlements.
Fourth, linking issues can facilitate trades that improve both parties’ positions. If dairy tariff reductions can be exchanged for EV market access arrangements, both sides gain relative to permanent confrontation. The challenge lies in structuring these linkages to be clear and credible—both parties must believe the other will deliver on commitments—without creating hostage dynamics where one side’s cooperation depends entirely on the other’s ongoing performance.
Systemic Implications: What This Case Reveals About Modern Trade Governance
The China-EU dispute unfolds amid broader questions about international trade architecture. The WTO, designed for an era of simpler tariff-based protection, struggles to address 21st-century issues: state capitalism models that blur lines between public and private, industrial policies involving direct subsidies alongside tax benefits and preferential regulations, and non-tariff barriers embedded in technical standards and certification requirements. China’s comprehensive support for its EV industry—encompassing R&D subsidies, consumer purchase incentives, preferential land access, and mandated market share targets—does not fit cleanly into WTO subsidy disciplines designed for discrete government transfers.
Similarly, the EU’s response illustrates tensions between multilateral rules and unilateral action. While the EU invoked WTO-consistent countervailing duty procedures, the Commission initiated the investigation without a petition from affected industries (the traditional trigger for such cases), and applied provisional measures before completing the full analytical process. These procedural innovations reflect frustration with perceived inadequacy of existing disciplines but risk fragmenting the rule-based system if other countries adopt similarly expansive interpretations of their rights.
The case thus highlights a fundamental dilemma: maintaining rules-based trade requires adapting those rules to contemporary challenges, but rule changes require consensus among parties with divergent interests and economic models. China views its industrial policies as legitimate development strategies no different from historical Western practices. The EU and U.S. see them as market-distorting subsidies creating unfair advantages. Resolving this impasse requires either successful negotiation of new disciplines acceptable to all parties—a challenging prospect given the stakes involved—or gradual development of practical norms through repeated bilateral and plurilateral disputes like the China-EU case.
From a game theory perspective, this systemic uncertainty raises discount factors for cooperation. When parties cannot clearly distinguish legitimate from illegitimate actions, the shadow of the future becomes cloudier—will today’s cooperation be reciprocated tomorrow, or exploited as naive? Will retaliation be viewed as justified punishment for genuine defection, or as unjustified aggression inviting counter-retaliation? These ambiguities make cooperation more difficult to sustain, suggesting that clarifying rules and norms—even if those rules differ from historical precedents—may prove valuable for facilitating long-term cooperation despite requiring difficult negotiations in the short term.
Conclusion: The Enduring Logic of Cooperation
China’s decision to reduce EU dairy tariffs from 21.9–42.7% to 7.4–11.7% represents more than a tactical concession in a trade dispute. It exemplifies the fundamental insight that game theory offers to international relations: when actors interact repeatedly over indefinite horizons, cooperation becomes rational even in situations where single-round logic dictates defection. The shadow of the future transforms payoff structures, making the long-term benefits of sustained cooperation exceed the short-term gains from opportunistic defection.
This does not imply cooperation emerges easily or automatically. As the China-EU case demonstrates, achieving cooperative equilibria requires navigating domestic political constraints, overcoming perceptual ambiguities, managing retaliation calibration, and building credible commitments. Institutions like the WTO help by extending time horizons and providing transparency mechanisms, but they operate imperfectly in addressing contemporary trade challenges that diverge from the circumstances they were designed to handle.
Yet the fundamental mathematics remain unchanged: repeated games create space for cooperation that one-shot interactions cannot sustain. When China and the EU step back from maximum retaliation, when they signal willingness to negotiate rather than escalate, when they calibrate responses to invite reciprocity rather than permanent confrontation, they act consistently with the logic that tit-for-tat strategies and positive discount factors make cooperation the rational choice.
The dairy tariff reduction therefore carries significance beyond agricultural trade statistics. It demonstrates that even in an era of rising economic nationalism and great power competition, the basic incentives favoring cooperation persist. Nations that understand iterated game dynamics—that value tomorrow’s trade relationships, that calibrate today’s retaliation to permit tomorrow’s reconciliation, that build institutions extending the shadow of the future—position themselves to capture the substantial welfare gains that open markets generate.
Whether this particular de-escalation proves durable remains uncertain. Cooperation in iterated prisoner’s dilemmas can be fragile, vulnerable to misperception and political pressures that discount future benefits. But the game theory framework clarifies what successful cooperation requires: credible retaliation mechanisms to deter defection, forgiving strategies that permit return to cooperation after conflicts, transparent communication to reduce noise and misunderstanding, and patient time preferences that value sustained relationships over short-term gains. When these conditions align—as China and the EU’s recent actions suggest they increasingly do—cooperation benefits more people over longer periods than any alternative strategy, precisely because it unlocks the gains from exchange that protectionism inevitably destroys.
The path forward for China-EU trade relations, for the multilateral trading system, and for managing economic interdependence in a multipolar world will require sustained application of these insights. Maximizing aggregate welfare means overcoming the temptation to defect in pursuit of narrow advantages. Game theory demonstrates this is possible—not through naive optimism, but through sophisticated strategic calculation that recognizes how repeated interaction transforms incentives. China’s dairy tariff reduction offers a case study in this logic at work, revealing that even in competitive international environments, cooperation remains not just morally preferable but strategically rational.
