Game theory can only get Greece so far in its fight with Germany

Game for a fight? Varoufakis arrives in Brussels. EU Council Eurozone, CC BY-NC-ND

As Greece prepares to go head to head with Germany again in a bid to settle rancorous talks over its debt burden and austerity policies, it can all sometimes seem like an elaborate game of chess. That feeling is heightened by the media’s perception of one of Greece’s key negotiators, finance minister Yanis Varoufakis, as an academic “game theorist” who really should have a crucial advantage over his adversaries in the cut and thrust of negotiations.

Of course, it’s not as simple as that. The Greece talks provide a hugely useful test bed for the ideas of game theory, but also offer a telling glimpse of its flaws.

As soon as the Syriza party was elected with a populist mandate for debt write-offs and an end to painful cuts, the new government always seemed to be heading for a deadlock of sorts with the “Troika”, the three-headed beast of Eurozone finance ministers, the European Central Bank (ECB) and the International Monetary Fund (IMF).

The perception seems to be that Varoufakis and prime minister Alexis Tsipras have so far failed to play it smart.

A theory of everything

This poses some interesting questions. What exactly is “game theory”? How would it help Greece in these talks? And can it help us understand the dysfunctional situation in the Eurozone?

Well, game theory is indeed very useful in understanding specific negotiation processes and in general helps us to understand how negotiating parties might respond to the others’ actions. It is when it gets down to specifics that the usefulness can start to wane.

Strategic risk. Plotting the Battle of Britain from RAF Uxbridge. Anguskirk, CC BY-NC-ND

Game theory was created by mathematicians in the first half of the 20th century to understand and analyse board games, in particular chess. During World War II, it was developed further to understand the effectiveness of military strategies. And in 1944, it was promoted as a mature scientific pursuit in a book by John von Neumann and Oskar Morgenstern.

In the following decades, game theory quickly branched out into a number of subfields based on how one approaches decision making. The object of study encompasses a broad sweep of situations in which multiple decision makers interact with each other. This ranges from board games, to dividing an inheritance among warring family members, to corporate rivalries, to countries negotiating nuclear non-proliferation and pollution abatement treaties. And, of course, to debt restructuring negotiations.

Tooled up

And so we arrive at modern game theory. Here we can find models considering the consequences of purely selfish behaviour in interactive decision making (so-called “non-cooperative” game theory); the emergence of cooperation (“coalition formation theory”); approaches on how to divide the generated gains from collaboration (“cooperative” game theory); computer algorithms to determine optimal strategies (“computational game theory”); and models of the evolution of social behaviour in biological ecosystems (“evolutionary game theory”).

Therefore, game theory today can best be understood as a toolbox of theories, models and formulas that can be applied to a wide variety of interactive decision situations. These theories can be applied to problems in economics, politics, computer science, business management and even biology, where it is used to understand the evolution of species.

Piece by piece. Steve Berry, CC BY-NC-SA

To work smoothly, then, whichever form of game theory you are using requires that the environment fits the specifications of the particular tool or model you choose to employ. Game theory might cover many interactive decision situations, but real life usually throws up amalgamations of a variety of such theoretical situations. You can get hints on how to conduct yourself; but beware thinking you will find a complete solution.

That said, the many models in game theory have resulted in very useful insights that should help make wise decisions, and perform better in any complex decision making process.

Rules of the game

For example, one of the most important lessons of game theory is that optimal individual decisions do not necessarily have to result in a socially optimal outcome. This is known as a “Prisoners’ Dilemma” (which boils down to a test of whether two separately held suspects should blame the other or keep quiet). Our society and economy is riddled with situations that can be understood as Prisoners’ Dilemmas. Thus, selfishness should not be expected to result in a socially optimal outcome; a lesson that our neo-liberal politicians try to forget.

Poles apart? Sam Ley, CC BY-NC-SA

From a game theory viewpoint there are two major problems with the eurozone as it is set up currently. First, by design, the eurozone was created as a purely non-cooperative environment. Instead of building a system that binds the member states in a cooperative structure, the institutions were deliberately weakened at its inception to allow maximum flexibility for members.

Second, since its inception as a non-cooperative game, the eurozone has become a Prisoners’ Dilemma in which the pursuit of self-interest by member states has resulted in a bad collective outcome. Initially, Greece was able to exploit the system to build up unsustainable debts, facilitated enthusiastically by the German banks. Now these debts have become a collective burden, for which Greece is blamed. But the problem really is in the design of the rules of the euro game.

From theorist to negotiator

Yanis Varoufakis’ fame as a game theorist is based on writing a critical textbook on game theory. But perhaps he has not been able to wisely use the lessons from game theory in the negotiations with the Troika. As in any real life negotiation process, game theories can never be applied in their pure form; there are too many aspects of these real negotiations that do not fit these theories. In those circumstances, savvy politicians might be better negotiators than academic game theorists. Practice (rather than theory) makes perfect!

Politicians learn to conduct negotiations by doing, rather than through theoretical introspection. They may well be better at dealing with the shifting sands of a real-life negotiation than a game theorist. Especially since game theory is not really like engineering; it is much harder to apply directly. And it means that Varoufakis cannot be expected to have any advantage over the Troika’s representatives, even if he might be able to explain very well what happened when a deal gets done or Greece finds itself suddenly out of the eurozone.