‘The game is the game’: Greece and Germany
In the first series of the blockbuster American TV show The Wire, the anti-heroes Avon Barksdale and Stringer Bell employ murder, serious violence and threats to stay one step ahead of the police and rake in profits from drug dealing.
The stakes are high: capture means a heavy jail term but success translates into a small fortune. Given the options, the pair carry on in the face of any setback with the catchphrase: “The game is the game.”
While few normal people would consider drug dealing and murder a “game”, economists - by definition not normal people - have found the concept of game theory useful in analysing how people make decisions with economic implications.
Game theory says that one player’s decisions are dependent on how he/she thinks the other will behave. The aim is to reach an agreement with which both sides are satisfied - albeit to different degrees.
One of the best-known examples is the auction of 3G mobile phone licences in the UK designed by British economist Ken Binmore. The government wanted to maximise its revenue while each bidder wanted to win the licences without having to pay too much to outbid its rivals.
The government decided to offer all licenses at the same time and run a series of auctions with all bids made transparent so each bidder could see the value their rivals were putting on the licences. This transparency forced each bidder to tell the truth about its own estimate of a licence’s value while the public information meant each could update their own opinions accordingly. The auction raised 10 times what was expected; the bidders got their licences.
In a wholly unrelated area, Nobel Prize-winning economist Robert Aumann has used game theory to show that Israel, a strong state, has often opted for weak peace deals with its nominally weaker enemies because it accepted the intransigent views of its enemies as a fact. Israel would rather have some deal than no deal, while its enemies stuck to certain red lines they claimed they would never cross.
GREECE’S GAME THEORIST
The title of this article indicates that it would talk about the recent impasse between Germany and Greece over the latter’s demand to cancel or renegotiate the eye-watering €172 billion of debt it holds as a result of its bailouts by the “troika” of the European Central Bank, European Union and International Monetary Fund.
One intriguing aspect to this episode is that the lead Greek negotiator, finance minister Yanis Varoufakis, is a renowned academic expert in game theory. His opponent Germany's finance minister Wolfgang Schaeuble, is a career politician who studied law and economics at university.
Both players held apparently intransigent positions. Varoufakis said his party, Syriza, had been elected on a mandate of ending the austerity programme and cancelling or restructuring the debt. Schaeuble insisted Greece was legally required to repay the debt and must abide by the terms of the bailout that had been agreed. He would not make German voters pay for Greek debts.
Both had strong reasons for taking that view. Varoufakis was aware that returning to Athens with a deal that kept in place the austerity measures that he had described as “fiscal waterboarding” would be political suicide. For his part Schaeuble knew that neither the German electorate nor countries such as Ireland and Portugal that had enacted austerity nor states that had funded the bailout would accept any relaxation.
Both sides knew that by taking such an intransigent and irrational stance they were making it clear that they would stick to their guns - even if it materially increased the risk of financial catastrophe such as the break-up of the euro after a Greek exit. Initially both sides played the game by the rules insisting there was no way Greece would accept anything other than debt cancellation and Germany nothing less than full sign-up to the original deal.
Then Greece blinked, asking its official creditors to extend their loan agreement by six months, meeting the deadline set by the Eurogroup. Germany initially held firm stating simply: “The letter from Athens is not a substantive proposal for a solution.” In the end Greece won a four-month extension.
What happened? The first factor was there was a key difference in the importance the two sides put on the threat of a Greek exit from the eurozone as the result of a failure to agree a deal. Syriza had made clear that it wanted to stay inside the euro and the EU - an aspiration shared by the majority of Greeks.
An exit followed by a massive depreciation in the value of the restored drachma would almost certainly trigger a string of Greek bank failures and a depression that would be larger even than the austerity-driven recession Greeks have endured.
OTHER PLAYERS IN THE GAME
Germany however let it be known at an early stage in the debacle that it believed that the eurozone - not Greece, but the eurozone - was now in a strong enough position to survive a Grexit.
Secondly, an auction of sorts started to emerge on the sidelines. Countries such as Ireland and Portugal and eurozone members such as Slovakia came out saying they would not accept a deal to soften the Greek bailout. German newspapers claimed German voters would be outraged by any deal.
A host of leading economists such as Joseph Stiglitz came out arguing that Germany should forgive the Greek debt for many reasons - including the fact that German debt was forgiven in 1953. A strong argument, sure, but in our game theory analysis these people, unlike Ireland et al, were not in the game as Germany saw it.
Finally, and most importantly, Varoufakis did not follow the rules of game theory. He began by setting down debt reduction as a line in the sand. But rather than stick to that until the very last minute, he abandoned it and set out new demands. Game over.
This is not an article about the rights and wrongs of austerity or the German or Greek approach. There are plenty of those such as here and here. There are many more deadlines Greece needs to meet to avoid bankruptcy. Maybe in future games Varoufakis will negotiate in a way that shows he understands the incentives, motivations and red lines that German voters impose on their politicians.
About the author
Phil has run Clarity Economics, a London-based consultancy, since 2007 and, before that, was Economics Correspondent at The Independent.
Phil won feature writer of the year Work Foundation Work World media awards in 2009, and was commended by the Royal Statistical Society in 2007.
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