As a professor of game theory, Yanis Varoufakis, Greece’s new finance minister, has spent many hours showing his students how the study of strategic interactions can help explain the behaviour of consumers and businesses.
But as he seeks to secure a good deal for Athens during fraught talks with Greece’s eurozone partners, Mr Varoufakis faces the challenge of translating these theoretical insights into a winning negotiating strategy.
The ultimate prize is a reduction of Greece’s towering debt mountain, which stands at more than 175 per cent of gross domestic product. There is also a risk, however: if the negotiations break down, Athens could lose the eurozone safety net around its shaky public finances and banks, potentially stumbling into a chaotic exit from the single currency.
But what kind of game are Mr Varoufakis and his eurozone colleagues playing?
“The simplest way of thinking about it is a game of chicken,” says George Tsebelis, a professor of political science at the University of Michigan. The two sides resemble drivers heading for a single lane bridge from opposite directions. Each knows that if they swerve first, they will concede the bridge to the opponent. However, if neither swerves, the result will be a collision, and each hopes to intimidate the other by refusing to swerve. “In these scenarios, each side has an incentive to show he means business,” Mr Tsebelis says.
This might explain why Alexis Tsipras, Greece’s prime minister, says he cannot accept a compromise that includes an extension of the existing rescue programme as it would go against the mandate he has received from Greek voters. In a way, he is trying to signal to his European colleagues that he cannot swerve.
These games typically involve each player trying to influence the final outcome until the very end, when one gives way. But game theorists warn that in real life, the end game may be one in which neither side concedes.
This could happen if each party has committed so much to its uncompromising position, that it becomes impossible for it to change it.
Alternatively, players may face extreme uncertainty over the costs of different outcomes. “Objectively, in this case, the pay-offs are not clear,” says Mr Tsebelis. Even within the eurozone, he says, governments might have different views over the exact cost of a “Grexit”.
Game theory also offers insights into why eurozone politicians may be forced to punish Greece even though they know this option would be painful for their own countries.
Germany and other creditor states have an incentive to threaten Greece by saying that if Athens reneges on its debt, it will be forced out of the euro. In theory, this intimidation is not credible. A “Grexit” would be damaging for all countries in the currency bloc, so even if Greece were to default, it could be expected that other member states would not want to eject Athens.
However, opting for forgiveness risks creating dangerous incentives for other countries to act in the same way as Athens. “Germany may decide that if the eurozone does not punish Greece, it will have problems with other countries such as Spain and Italy,” says Roger Myerson, a Nobel-winning economist at the University of Chicago.
Mr Varoufakis should therefore try to convince Germany that Athens’ situation is unique and that other eurozone countries will not seek debt relief as a result, he says. In doing so, he would follow the illustrious precedent of the citizens of Melos, to whom Athens, during the Peloponnesian war between Athens and Sparta, gave the choice of surrendering or facing annihilation.
“The Melians sought to argue that they were different and that sparing them would not set a dangerous precedent vis-à-vis other islands,” says Mr Myerson.
The problem with this strategy, however, is that the other player may choose to build a reputation for toughness. This is what Athens opted for — it laid siege to the island and starved the inhabitants into submission.
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