Saturday, March 08, 2003

Game Theory

In know of two basic game theory constructs that are common in economics, the "prisoners dilemma" and "chicken". I'm sure there are more, but I'm ignorant of them. The "prisoners dilemma" shows why collusion is unstable -- every player has an incentive to cheat even though by cooperation they would both be better off. Since collusive contracts between companies are illegal in the US, they rely on regulatory contracts to enforce their cartel agreements, often under the guise of "fair and non-discriminatory" clauses, which presumably have been supported by "consumer advocates" even though they harm consumers ultimately.

"Chicken" has to do with the role credibility plays in making threats or commitments. A threat is similar to a commitment in that you need to make the other guy belive that you are going to do something that is not in your best interest. If I make a deal to buy some equipment next week for $10, and then renege because I found a better deal at the last minute, the supplier is going to be upset with me because he invested all these resources in delivery that are now wasted. In order for him to go ahead and invest those resources, I need to credibly commit to honouring the deal, even if a better deal comes along. Since retaliation is self damaging in the same way you need to make the other guy really belive that you are going to hurt yourself in order to hurt him. You need a threat to be credible for it to be worth anything.

Why do I mention this? Arnold Kling responds to a WindsOfChange question about the likelihood of a trade war between France and the US over its foreign policy fall out. Arnold thinks it is unlikely because banning imports or exports hurts the country doing the banning, and so is ineffective. I think it's unlikely because it's a bluff.

To win at a game of Chicken, you have to throw away the steering wheel, or tie your hands with rope to make the threat of not veering out of the other car's path credible. The diplomatic equivalent of this is to make a proclamation in public, because then backing down would make you lose face and subsequent elections. It is no surprise that Bush's speech before the latest Blix report affirmed his determination to call for a UNSC vote, and then invade no matter what the result of the vote is. By making that statement publicly, it is almost impossible for him to back down. Similarly, France has made many public pronouncements that make it difficult for them to back down without losing face. Mexico is in a better position because it can hold out for higher payoffs, while still credibly supporting the US at the last minute. Turkey decided to consume pride to the tune of $30B. I didn't know Turkey valued pride that much, but you learn something new every day.

The point is that in negotiations, public pronouncements are the diplomatic equivalent of throwing away the steering wheel by playing chicken. If you belive the threat is credible and sufficiently nasty, you fold. Otherwise you call their bluff. A nice feature in democracies is that since the rulers keep changing, new governments can disavow the actions of old governments by claiming "those bums were crazy." Long term, cooperation between countries is driven by self interest.

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