Finance Minister Yanis Varoufakis speaks during a Parliament session in Athens, Monday, Feb. 9, 2015. Varoufakis dismissed the 240 billion euro ($270 billion) bailout packages crafted by Greece’s lenders as a “toxic fantasy” that had always been doomed to fail. (AP Photo/Petros Giannakouris)
Greek finance minister and academic game theorist Yanis Varoufakis has an op-ed in the New York Times today arguing that he does not really believe in game theory.
Because I spent many years during my previous life as an academic researching game theory, some commentators rushed to presume that as Greece’s new finance minister I was busily devising bluffs, stratagems and outside options, struggling to improve upon a weak hand. … The trouble with game theory, as I used to tell my students, is that it takes for granted the players’ motives.
The context is the negotiations between Greece and the other member states of the European Union over Greece’s debt program, where Greece and other member states (especially Germany) are engaged in hard bargaining. Varoufakis argues that he has sincere motivations which mean that he will not give into EU threats to abandon Greece if it does not stick with some version of the current bailout program.He believes that Europe is thinking about how to deal with indebted countries in a fundamentally incorrect way. It needs to re-engage with European citizens, and recognize the appalling poverty that its current policies are creating. Varoufakis argues that his only ethical choice is to stick to the lines he has laid down, even if this potentially causes pain to the Greek people whom he represents.
I did a video discussion with Varoufakis a few years ago, and am certain that he is entirely sincere in his belief that the EU has a profoundly flawed (and appalling) understanding of the politics of debt. Nonetheless, the problem that Varoufakis faces is a twist on one that the famous game theorist and Nobel Laureate Thomas Schelling identified over fifty years ago. Schelling argues that it can be very rational to seem irrational when you are negotiating with other people:
among the certified “irrationals,” there is often observed an intuitive appreciation of the elements of strategy, or at least, of particular applications of them. I am told that inmates of mental hospitals often seem to cultivate, deliberately or instinctively, value systems that make them less susceptible to disciplinary threats and more capable of exercising coercion themselves. A careless or even self-destructive attitude towards injury – “I’ll cut a vein in my arm if you don’t let me …” – can be a genuine strategic advantage.
So too, Schelling might argue today, is Varoufakis’ Kantian belief that one must do what is right, regardless of the consequences.
Varoufakis and the Greek government are threatening not to cooperate with the European Union – even if that results in a run on Greek banks and catastrophe for the Greek citizens they represent. If that threat is to be credible, it has to be, at least in part, irrational in game theoretic terms. A belief that one must do what is right, regardless of the consequences is just as irrational from the point of view of game theory as a threat to cut one’s wrists if one doesn’t get one’s way on some small matter. But then (a point that Schelling doesn’t dwell upon) the threat will only be credible if other people believe that it is genuinely irrational, and isn’t just a clever bargaining ploy.
Varoufakis is caught in a dilemma where the only way that he can bargain effectively is by convincing people that he isn’t actually bargaining, but instead is stating ethical principles that he is prepared to stick to no matter what. Which means, conversely, that if he is just stating his sincere bottom line, people may mistakenly think that he is bluffing, and call him on it. Which is why he is writing this op-ed (although it will probably not solve the problem, since it is exactly the kind of op-ed that a canny bargainer inspired by Thomas Schelling’s take on game theory would be inclined to write).
The German government faces a weaker version of the same problem. It has a stronger bargaining hand than Greece but is still sensitive to the political fallout from a catastrophic failure of the eurozone. It too is making noises that it is sincerely committed to maintaining principles of not giving in, no matter what the consequences. And, it may indeed be truthfully representing its actual position. It may actually believe that a Greek catastrophe would be bearable and appropriate.
Game theory can identify the rational advantages of appearing to have sincerely held non-rational beliefs – people holding such beliefs are unlikely to back down no matter what. However, it often doesn’t provide any very good way to distinguish people who only apparently have sincere irrational beliefs from people who actually have such beliefs. The only way that actors can try to prove their (real or apparent) sincerity is by doing things that increase the risk of disaster, in the hope that it will demonstrate that they are really, really, committed to sticking to their guns. This helps explain why Greece has withdrawn from negotiations today, and why Germany has said that it will not resume negotiations unless Greece signals that it is giving in. Both sides know that their moves are increasing the risk of financial catastrophe – but each wants to demonstrate its resolve and get the other side to give in.
This means that we are in the world of what Schelling calls brinkmanship and crisis bargaining, which, contrary to the arguments of some is not a very good place to be. The worst possible scenario in the current EU negotiations is the one where both sides have sincerely held but irrational beliefs that profoundly conflict with each other, so that no bargain can be reached. The second worst case is the one where they do not have such beliefs – but financial markets are sufficiently spooked by the possibility that both are irrational that they start panicking. That second worst case is rather more likely than one might like it to be in the best of all possible worlds.