Game theory drives Greek finance minister in duel with creditors

Yanis Varoufakis has written texts on logic behind negotiations, and it shows as he plays chicken with the euro zone

PUBLISHED : Sunday, 01 March, 2015, 6:58am
UPDATED : Thursday, 16 April, 2015, 12:10pm

The appointment of Yanis Varoufakis as the Greek finance minister has been a godsend for pundits and academics.

An economist who has authored or co-authored several popular textbooks on game theory, he has naturally led commentators to speculate how far he will use his expertise in the mathematical theory for his hard, almost existential, bargaining with Greece's euro-zone creditors.

Given his current employment, I hope Varoufakis' books enjoy a sales boost; they deserve it. Game Theory: A Critical Introduction, which he co-authored with the economist Shaun P. Hargreaves Heap, is my all-time favourite textbook, an example of how such books ought to be written.

My university teachers used it for an advanced course in logic. Lively and humorous, the book is full of game-theoretic examples taken from real life as well as from western moral and political philosophies. The rows and columns used to represent simple one-off games at the start of the book were easy enough to follow. The heavy algebra and probability theory completely went over my head.

Still, even if you skip the maths and graphs, it's fun to read for the most part, minus the stuff about ordinal and cardinal utilities, Bayesian probability and backward induction, things which no-one cares about except specialists.

There are fun pages devoted to game theory's take on such classic problems as Immanuel Kant's formulation of a categorical imperative; John Rawls' notion of justice behind his thought experiment on "the veil of ignorance"; what reason and rationality are; whether you should accept Thomas Hobbes' argument to give up all your rights and freedoms to the sovereign in the hope that he or she might let you live and prosper. (Our Chinese leaders, by the way, are more Hobbesian than Marxist.)

Should you pay your taxes, accept environmental protection laws and vaccinate your children? They all fall under the so-called free-rider problem in game theory. If you have read A Beautiful Mind, or seen the movie of the same name based on the biography of deranged mathematician John Nash and wondered what all the fuss was about, Varoufakis and Heap offer a concise introduction to the powerful notion of Nash equilibriums.

The pages on Kant now look especially relevant. In an opinion piece in The New York Times this month, Varoufakis claims to have abandoned game theory as finance minister in favour of Kant's moral teaching.

"Some commentators rushed to presume that I was busily devising bluffs, stratagems and outside options," he wrote.

"Nothing could be further from the truth. If anything, my game-theory background convinced me that it would be pure folly to think of the current deliberations between Greece and our partners as a bargaining game to be won or lost via bluffs and tactical subterfuge.

"This line of argument presumes, along with game theory, that we live in a tyranny of consequences ... that there are no circumstances when we must do what is right not as a strategy but simply because it is ... right. [Over] this retreat from game theory, the major influence here is Kant, the German philosopher who taught us that the rational and the free escape the empire of expediency by doing what is right."

This sounds as if the poker player has suddenly found God or at least morality. Varoufakis is being disingenuous, of course. It probably sounds better to be a follower of Kant than Richard Nixon.

But in real life, there may be little difference between Kant's moral imperative to do what is universally right and Nixon's "mad man" theory of negotiations, a tactic he used with the North Vietnamese. Both, in effect, say consequences be damned, or at least the latter approach pretends to.

Game theorists have long pointed out that in negotiations, it can be very rational to pretend to be irrational. Kantians argue it is purely rational to do only what is right. If you can convince your opponent you are crazy or that you only do what is right, he realises you will not compromise and so may concede. But usually both sides claim they are doing what is right and so end up playing chicken with each other.

A game of chicken, however, is a one-off game. In Greece's case, it would mean exiting the euro zone and seeing its economy collapse. The rest of the euro zone would face a potential breakup.

In reality, both sides - Greece and its euro-zone creditors - want to avoid a crash. What they are playing resembles what game theorists call "tit for tat". Typically, debt negotiations involve endless rounds of financing and refinancing. These are then multiple rounds of the same game. One side simply follows the other's strategy in the next round. If he cooperates, you cooperate. If he defects, you defect in the next round, until he cooperates again.

This strategy often yields the highest expected pay-off, and that may be what we are seeing now in Europe. The latest four-month extension of Greece's financial bailout is an instance of cooperation - until the next round.