Ananish Chaudhuri: Obama ploy could avert fiscal cliff

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Negotiating with individuals rather than self-interested groups improves odds of avoiding another recession.

Speaker of the House John Boehner (left) and President Barack Obama are working to avert the fiscal cliff. Photo / AP
Speaker of the House John Boehner (left) and President Barack Obama are working to avert the fiscal cliff. Photo / AP

As the deadline for averting the so-called "fiscal cliff" looms, President Barack Obama and the Speaker of the House of Representatives in Congress, John Boehner have decided to resort to one-on-one negotiations rather than involve a group of players. If no agreement is reached then, come the New Year, taxes will go up and there will be sweeping cuts to government spending. This will send the slowly recovering US economy into another recession which, in turn, will have significant spill-over effects on the rest of the world economy.

At first, the decision to do away with others seems counter-intuitive because we instinctively expect groups, with members engaged in vigorous debate, to be more deliberative and to find it easier to arrive at a mutually acceptable outcome.

But this decision may actually improve the chances of averting disaster.

This is because research suggests that groups behave in a more self-interested manner than individuals.

Obama and Boehner find themselves caught up in a "prisoner's dilemma", a situation where there is tension between co-operation and self-interest, an idea introduced, most likely, by the Princeton mathematician Albert Tucker.

A crime has been committed. The police arrest a couple of likely suspects: Butch and Sundance. They are placed in different cells and cannot talk to each other. Each of them is told separately: "look, we know you guys did it but it is not too late to save yourself. All you need to do is to rat on your mate and finger him for the crime; then he will get 10 years in prison, and we will let you go free. But all we need is one confession. So if the other guy takes the deal first, then he goes free while you go away for 10 years."

"What happens if I keep mum and so does my mate?" asks Butch (or Sundance). "We still have enough to put each of you in jail for a year." "And if we both rat on each other?" asks Butch (or Sundance). "Then you both go to jail for five years," says the officer.

Let us assume that Butch cares only about what happens to him. If Sundance confesses and fingers Butch, then Butch's best bet is to do the same as well; by staying mum Butch gets 10 years in jail, but by also confessing and ratting out Sundance he gets five years.

But suppose Sundance does not confess; even then Butch is better off confessing and ratting out his mate! Because this guarantees that Butch will go free instead of one year in prison, while Sundance gets 10 years.

Self-interest suggests that we should expect both Butch and Sundance to rat on each other and end up in prison for five years. Except if only both could have kept their mouths shut, they would both be better off and spend only one year in jail! This particular scenario is, in fact, a regular feature of TV cop shows like NYPD Blue. The fiscal cliff negotiations set up a similar tension. Both Republicans and Democrats have an interest in protecting the priorities of their core voters. Democrats prefer fewer cuts to entitlements while Republicans wish to preserve lower tax rates for the wealthy. Yet both sides need to make compromises in order to achieve an outcome that benefits society as a whole.

Compromise is the same as staying mum; leads to a better overall outcome. But the problem is that each side has an incentive to renege; that is to confess and protect their own interests. Each has a vested interest in extracting concessions from the other side without offering any of its own. But if neither side compromises we are faced the worst possible outcome; a five-year jail sentence which in this case would be another impasse like the one we had over raising the debt ceiling.

Economists and psychologists have long been engaged in understanding behaviour when compromise and self-interest collide. The usual method is to have volunteers take part in a "game" where at times they can earn real money based on the decisions that they make.

Chester Insko, a professor of psychology at the University Of North Carolina, Chapel Hill, along with many of his colleagues, has done extensive work demonstrating that groups are more self-regarding.

They identify two primary reasons behind this. The first one is "social support for shared self-interest". The greater self-interest among groups arise from the fact that group members provide each other with moral support for acting in more selfish and in-group oriented ways.

The second reason has to do with "schema based distrust". This holds that groups expect their opponents to act in a self-interested manner and therefore protect themselves against possible exploitation by acting in a self-interested manner at the very outset. The degree of distrust increases when group-membership is particularly salient as it is with entrenched political affiliations.

One would think that allowing participants to talk to one another should help break the gridlock. But it turns out that while unrestrained communication does improve co-operation among individuals, it makes things worse among groups, partly because the distrust of out-group members makes such communication less credible.

Whether knowingly or unknowingly, Obama and Boehner have made the right choice and I think we can be cautiously optimistic that an agreement will be reached before the deadline.

Whether Boehner can then get his Republicans colleagues in the House to support him or whether he finds himself faced with a challenge for the Speaker's post is, of course, a whole different question.


Ananish Chaudhuri is professor of experimental economics at the University of Auckland Business School.

- NZ Herald

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