The Limits of Negotiation: A Little Applied Game Theory



INTRODUCTION

Much of the political news is about negotiations.  American politicians, in both domestic and foreign disputes, don’t seem to know much about negotiation strategy.  Maybe a little applied game theory would help.

IS NEGOTIATION POSSIBLE? 

The first question is whether or not negotiation is possible or just a waste of time and effort.

Negotiations will be fruitless if at least one party believes there are no possible outcomes that are better than not negotiating.  Compromise is impossible.  Fanatics, true believers, proponents of “Victory at any cost” or “Give me victory or give me death” or parties who believe their opponents are evil are not likely to negotiate.

Sometimes leaders act to limit their options or those of their followers.  The famous historical example is when Cortes burned his boats that brought him and his men to Mexico.  Returning to Cuba was no longer an option.  Cortes forced his men to make the “credible” commitment to conquer the Aztecs.  By their past actions, Israel’s policy of never negotiating with airplane hijackers is credible.

Bashar al-Assad of Syria has put himself and his regime in this situation through the brutality of their past actions.  He has eliminated any option for himself except being dictator or being killed.  At this point, there is nothing to be gained by negotiating a political settlement.

 In business and other types of negotiations, there are two stages. Both sides of a potential agreement must believe that they will benefit from an agreement - increased sales, reduced costs, increased profit. This is the "win-win" or "positive sum" stage. The second stage is how the increased benefits are to be split. This is a "zero-sum" negotiation.

THE LIMITS OF NEGOTIATION


There are limits to what a party to a negotiation will accept.  These limits are set mostly by a party’s perception of the consequences if no agreement is reached.   When President Obama negotiated budget reductions in 2011 under House Republicans’ threats to shut down the Federal government, he was facing reelection and felt pressure to compromise.  In 2013, after winning reelection, he felt he was in a stronger position to resist Republican demands.  The consequence of losing an election had disappeared.

Knowing this, why did the Republicans again threaten to close down the government?  Because they perceived that the consequences of not challenging the president were greater than challenging the president and losing.   The Republican Party was becoming increasingly conservative.  The vast majority of House Republicans knew they came from safe districts.  The major threat to reelection in 2014 was losing to a more conservative Republican in the primary.  By again threatening the extreme action of shutting down the government they eliminated the main argument of a potential Republican primary rival.

In addition, although circumstances had changed, President Obama’s compromises in 2011, seen as a victory by many Republicans, cast doubt on the credibility of his threat not to negotiate. 

INCREASING THE CHANCES TO NEGOTIATE

One way to increase the chances the other party will negotiate is to change the “payoff matrix” or cost/benefit of analysis of the other party, preferably before negotiations begin.  The idea is to raise the cost of not negotiating or increasing the options of the other party in negotiations.

Iran is a recent example.  For years, Iran went through the motions of negotiating a moratorium on enriching uranium to develop an atomic bomb.  As long as the rest of the world thought there might be a chance of Iran slowing or stopping its atomic bomb project, there were no consequences to Iran of continuing the program.  They were even able to buy thousands of centrifuges from a West German company.  It was only after the United States and Western Europe finally imposed economic and financial sanctions that Iran was willing to seriously negotiate.  The sanctions had wrecked the economy and threatened the ayatollahs’ rule.

THE ULTIMATUM GAME 

This has become one of the most famous games in game theory.  It has been played many times by different groups in different countries.

There are two players.   One player is given an amount of money.  He has to offer part of the amount to a second player.  If the second player accepts, they split the gain.  If the second player refuses, neither player gets any money.  This puts a limit on the number of possible outcomes.  One party maybe be better off accepting a proposal than refusing to negotiate but may decline the proposal because it is not “fair.” 

To an economist, the offer is obvious.  If the amount is $1, the first player offers the second player the minimum, one cent.  The second player is better off accepting than refusing, so he accepts.  But that’s not what happens when the game is actually played.  For almost all groups and across different cultures, the second player typically rejects offers below 25-30% of the total.  There is an almost universal sense of “fairness.”  Even worse, the second party may feel insulted by the offer, making future and better offers more likely to be refused.

MORE THAN TWO PLAYERS 

In general, the more players there are in a game, the more difficult it is to reach an agreement.  Even a relatively weak or unimportant player can threaten to “hold up” an agreement at the last minute unless they get a better payoff.  This is true of global trade agreements and close votes in Congress.

This is also one reason that the Assad regime in Syria has a good chance of surviving.  There are at least 20 anti-government organizations fighting the regime.  They have different sponsors and different visions of what a post-Assad Syria should be like.  Recently, they have been fighting among themselves.  In addition, the Syrian regime can count on financial and military support from Iran and military assistance from Hezbollah.  The regime also has some military support and diplomatic cover from Russia.

CONCLUSION 

While much of the discussion about negotiation is about how to negotiate, assumptions about the players are important.  Negotiations have a greater chance of succeeding if all the players share some basic assumptions, see a noticeable advantage of negotiating versus not negotiating, see the game as fair, and intend to actually abide by the agreement.  Even when negotiations lead to a treaty or agreement, they are often only a ploy by one side to buy time, to temporarily ward off sanctions or conflict.

 ==================================================================
Related Post:

 President Obama Learns Some Game Theory




Comments

Post a Comment

Most Popular Posts

Adam Smith's Pin Factory

Image
Adam Smith - Our Founding Father ADAM SMITH VISITS A PIN FACTORY   Adam Smith’s description of a pin factory is on the first page of  The Wealth of Nations .  (Chapter 1 – “Of the Division of Labour”)  Drawings of pin factories of this period show workers using hand tools. Smith says the process can be broken down into 18 distinct steps, including packaging the pins. Smith mentions that pin factory workers were poorly paid, despite their high productivity.    Adam Smith says he visited a pin factory employing 10 men who produced 48,000 pins per day.  If each of the ten workers had done all the steps themselves, Smith says each worker could produce only 10 or 20 pins per day.  So the pin factory replaces 2,400 to 4,800 pin makers. The increase in labor productivity (output per person per day) is as high as 50 times that of individual pin makers.     This reduction in unit cost or average cost (AC) and the huge i...
Read more

Bilateral Oligopoly

Image
The best movie about the Gunfight at the O.K. Corral is titled My Darling Clementine. A great western - great cast, great photography.  DEFINITION OF A BILATERAL OLIGOPOLY Models of market structure assume that the demand side is represented by a large number of buyers.  The structure of the market, and the assumed market outcomes, depends on the number of suppliers and how they compete.  Suppliers either post one price or exploit their knowledge of buyer categories by using price discrimination.  Despite the comments about the key role of consumers in determining economic performance, consumers are fairly passive when the discussion focuses on imperfectly-competitive industries.  But many markets are not structured this way; the buyers are not passive consumers but large corporations that do not passively accept suppliers’ prices.  Net prices are actively negotiated.  These markets are often bilateral oligopolies. In a bilateral oligo...
Read more

The Stock Market Crash of 1929 and the Beginning of the Great Depression

Image
Famous Headline Introduction The usual reasons given for the Great Depression – the stock market crash of 1929 and the later collapse of the banking system – do not tell the whole story. Available economic data indicate (there were no national income accounts in 1929) that a recession had already begun before the stock market crash. The crash of October and November of 1929 was a catalyst that made the recession worse but the partial stock market recovery in early 1930 did not end the recession. Industrial production continued to fall quickly and unemployment rose rapidly in 1930. Continuing farm and businesses failures over the next two years wiped out thousands of small rural banks and threatened total financial collapse in early1933.  For a fuller explanation, we have to go back to the 1920s to see additional reasons for the origins and the rapid decline in output at the beginning of the Great Depression. We have to look at the int...
Read more

List of Posts By Topic

FIND POSTS BY CATEGORY CATEGORIES Basic Concepts and Theory Market Behavior and Structure Market Dynamics and Information:  How Markets Work The Industrial Revolution in England American Economic History American History Demographics and Economics Management World War I:  The Beginning of the 20th Century The Roman Republic and America - Differences and Some Possible Parallels Economic and Fiscal Policy Financial Markets and Investment Strategies Foreign Exchange Markets The United States American Foreign Policy and International  Relations Geopolitics and the Global Economy Geopolitics of Oil and Natural Gas Visionaries BASIC CONCEPTS AND THEORY Introduction to Economic Theory Economic Development and Economic Growth Production Functions and Supply Chains Demand  Analysis The following post was contributed by Dennis Schuchman. Artificial Intelligence (AI) and Real Intelligence (RI) You, Your Brain and Credit Card s Critique of Basic Economic Theory MAR...
Read more

Explaining Derivatives - An Analogy

Image
You go around to farmers with cows. You buy all the cows and pay the farmers a small fee to milk the cows and sell the milk. You pay for the cows with ass(et)-backed securities called MBSs (Milked Bovine Securities) that you tell investors are udderly safe. But some of the cows don't give enough milk (cow flow problem) or give no milk at all. You take some of the asset-backed securities, say they're backed by the subprime cows, and use them as collateral to sell another set of securities called CMOs (Cow Milk Obligations). Then you buy CDSs (Cow Dried-up Swaps) from AIG (Angus Insurance Company) to insure the CMOs when the cows stopped giving milk. If you work it right, you collect more on the CDSs than you pay out to retire the CMOs. The money you get from selling the dead cows go to pay the CLOs (cow leather obligations). You could also sell CDOs (cow dung obligations) that depend on how much cow dung is produced. This is a typical Wall Street product - turning sh...
Read more

Government Finance 101. Fiscal Policy: Welcome to Alice in Wonderland

Image
  PRELIMINARY SUMMARY OF FISCAL 2024 BUDGET The deficit in fiscal 2024 was around $1.8 trillion, about $5.0 trillion in revenue and $6.8 trillion in expenses. Interest on the national debt this year is around $960 billion, over twice the interest on the fiscal 2021 budget. Interest expense this year passed outlays for the military. Leaving aside Social Security and Medicare, interest expense is about 20% of total budget outlays. Interest expense is about half the budget deficit.   The fiscal 2024 deficit was 6.4% of GDP.  SOME BASIC DEFINITIONS AND A LITTLE DETAIL Some basic definitions for people in government suffering from political amnesia:   Deficit.    The difference between the federal government’s spending and its revenue in one fiscal year.  The fiscal year starts on October 1.  So fiscal year 2024 started on October 1, 2023. You know right away this is going to be confusing. Debt .  Short for national debt or ...
Read more

John von Neumann Sees the Future

Image
John von Neumann JOHN VON NEUMANN CREATES THE FUTURE If you want to understand the world we live in, you have to know about the thinking of three men – Alan Turing, Claude Shannon and John von Neumann.   I’ve talked a little about Alan Turing in an earlier essay.   All three men knew each other, discussed their ideas with each other and promoted each other’s ideas. John von Neumann has been called the smartest individual of the 20 th Century.   Even an outline of his accomplishments, which you can read about in  Wikipedia, is hard to believe.   He invented game theory, which I discussed in two earlier posts.   He headed up a group of mathematicians who invented new statistical techniques at Los Alamos that made the atomic bomb possible.   In 1944, he wrote a memo that outlined the structure of the modern computer.   He then managed the design and building of a modern general computer and consulted on the building of virtually all ...
Read more

The Roman Republic Commits Suicide: A Cautionary Tale for America

Image
Roman Legion Why Study Rome? Americans have focused on comparisons between Rome and America twice in American history.  The first time was during the period from before the Revolution to after the ratification of the Constitution and Bill of Rights, when the founding fathers and others looked to the Roman Republic for ideas and inspiration on how to structure the new government. After the American Revolution, the founding fathers, having read the Roman authors detailing the collapse of the Roman republic, worried about internal threats to the survival of their new republic.   The second time was when the United States became a superpower, especially after WWII, and then again after the collapse of the Soviet Union in 1991. Commentators compared America to the Roman Empire at the height of its power. There was some discussion about how America became a permanent warfare state and how it affected domestic democracy and civil society. ...
Read more

Josiah Wedgwood, the Wedgwood Pottery Company, and the Beginning of the Industrial Revolution in England

Image
Wedgwood Anti-Slavery Cameo A better introduction to the beginning of the Industrial Revolution than Adam Smith is the history of Josiah Wedgwood and the Wedgwood Pottery Company. This is how one company actually ushered in the Industrial Revolution. The revolutionary generation that first adopted steam engines saw the following trends and changes: Manufacturing was being modernized by a small group of entrepreneurs. Much of the new raw material processing and manufacturing was concentrated in a small area in the middle of England, away from London. These modernizing entrepreneurs formed a new economic, intellectual and social network. Modernizing entrepreneurs like Wedgwood tended to be members of Dissenting sects (like Quakers) or Nonconformist churches (not members of the Church of England), Whigs (liberals) in politics, and believers in “progress.” They were optimistic about the future, influenced by the ideas of Hume, Rousseau, Locke and Adam Smith. They believed...
Read more

“Pax Americana”: The World That America Made

Image
There are two kinds of empires: the kind that rules through ruthless exploitation, and the kind that seeks to induce allies into defending themselves through economic incentives. (George Friedman) INTRODUCTION America's power and influence in the world rests on three broad, interrelated bases: 1) Overwhelming military power that can be projected anywhere in the world,   supplemented by security arrangements with allies and supporters. 2) A large, innovative, dynamic domestic economy as the basis for global economic and technological leadership. The economy provides the resources and technology to support the military and a global foreign policy. 3) Claims to moral and ideological leadership and influence, particularly the promotion of liberal democratic societies and supporting political institutions. This post will discuss the economic aspects and related security objectives of American foreign policy. It will focus on the structure of the global...
Read more