The Positive Sum Strategist

Is Iran the Cool Hand Luke of World Politics?

American politics, History, International Politics, Negotiations, Politics, Theory No Responses »

Nov 222011

Previous posts have discussed Nobel Laureate Douglass North’s comments about the importance of trade in human development, Steven Pinker’s thoughts on increased trade leading to a decline of violence, and Kyle Bass’s suggestion that a dropoff in trade leads to social unrest.

If so many agree that trade is a good thing, why do economic sanctions — one country stopping trade with another country — exist?

Economic sanctions go back at least as far as Ancient Greece, with Pericles’ Megarian Decree excluding the farmers of Megara from the markets of Athens as punishment for an offense. During the Cold War, sanctions boomed in popularity, with at least 116 cases of sanctions between 1948 and 1990. Now, sanctions are used mainly for “rogue” nations like Iran, to cut them off from the global market as punishment for bad behavior.

Just yesterday, new sanctions were imposed on Iran:

The U.S., the U.K. and Canada targeted Iran’s central bank and oil industry yesterday with sanctions aimed at cutting the regime off from international financial transactions. The actions are in response to a Nov. 8 United Nations atomic agency report concluding that previous efforts have not stopped the regime from clandestine nuclear-bomb work.

The new sanctions target companies that provide goods or services to Iran’s oil and gas industries. Existing U.S. laws have forced most international oil companies out of Iran. The new measures aim to stop it from obtaining technology and money from smaller foreign companies.

From the U.S. perspective, here’s what the sequence of games with Iran looks like:

If this looks familiar, it’s because this is the same sequence of games that occurred between Cool Hand Luke and the prison Captain. Here, Iran plays the role of Cool Hand Luke, the U.S. is the Captain.

The U.S. would prefer that Iran choose the collaborate path, but under the terms of giving up its nuclear program. Sanctions are being used to punish Iran, in an attempt to move Iran onto that collaborate path. There are two main reasons why the U.S. chooses to use sanctions, despite the long-term benefits from trade: a) Sanctions impose a punishment short of full scale war and b) Sanctions allow the U.S. to ratchet up that punishment over time.

The problem for U.S. policymakers is that they have to guess at Iran’s payoffs, just like the Captain had to guess at Cool Hand Luke’s payoffs. They even have to guess at whether Iran collaborating with the U.S. brings positive or negative payoffs.

The U.S. has gone through several rounds of this game already with Iran. Each time, the U.S. hopes a new sanction will tip the payoffs for Iran toward collaborate. That the prospect of stopping the punishment through collaboration will be better than choosing to fight.

So far, it hasn’t worked. It could be that the U.S. has guessed wrong on Iran’s payoffs. Or it could be that, like Cool Hand Luke, Iran’s payoffs from collaboration are infinitely negative. If that’s the case, Iran will never collaborate with the U.S.

The U.S. can keep going. It has at least one more way to ratchet up the pressure on Iran: stop the Iranian Central Bank from engaging in oil sales. According to some, that sanction would cripple the Iranian economy.

That sanction, like all other economic sanctions, also hurts the U.S. economy. Keeping Iran out of the oil market means oil prices rise. The U.S. gets a negative payoff from imposing economic sanctions (represented as -5 above).

What’s Iran’s answer to these latest sanctions? Iran will still fight the U.S., no matter what, they say.

It’s a drama being played out between Iran and the U.S., a cycle of ever increasing punishment with the goal of collaboration. Albeit, collaboration on the U.S.’s terms.

Will the U.S. find a punishment that pushes Iran to collaborate?

Or will Iran be the Cool Hand Luke of World Politics and never give in?

The Decline of Exchange, the Rise of Violence?

Business, History, International Politics, Media, Politics No Responses »

Nov 182011

Michael Lewis’ new book Boomerang: Travels in the New Third World features Dallas hedge fund manager Kyle Bass. Bass came to fame as one of the few hedge fund managers who made money in the subprime mortgage crisis. Now, with Europe teetering, Lewis asks Bass where he would tell his mother to put her money.

Bass’s answer: “Guns and gold.”

Why? Bass says that there’s too much debt in the world, and sovereign nations can’t pay it back. After Greece may come other European nations, but Japan is not far behind.

And when there’s a “deleveraging” of national debts, history tells us there’s usually some social unrest, according to Bass. Here he is talking to a BBC reporter about his thesis (a long, but entertaining interview, especially for the culture clash between a Londoner and Texan):

In a previous post, we talked about how the rise of trade and exchange (positive sum games) has led to a decline of violence, as Steven Pinker says.

The world today is based on impersonal exchange, a beneficial but fragile state. Impersonal exchange depends on trust and both sides following up on obligations. When that trust is taken away, whether by default on a debt or some other zero sum act, exchange takes some time to recover. It may take a series of repeated games before a level of trust can be reestablished and impersonal exchange can again thrive.

If positive sum exchange leads to the decline of violence, does the loss of positive sum exchange lead to violence? Hopefully, we won’t have to find out.

Cool Hand Luke and Negative Sum Games

Movies, Negotiations, Theory No Responses »

Nov 152011

In Paul Newman’s Cool Hand Luke, there’s a famous line from the Florida prison Captain to the prisoners: “What we’ve got here is failure to communicate.” Here’s the clip:

In the film’s plot, Paul Newman’s Luke wouldn’t bow to the prison Captain, no matter the punishment. Luke fought the Captain’s authority time and again, then escaped to go to his mother’s funeral. After being caught, Luke is sent back to the chain gang, setting up the delivery of the famous line above.

The Captain thought he was in a game sequence with Luke that looked like this:

The “failure to communicate” was the Captain’s way of saying Luke wasn’t getting the message on future payoffs. If Luke chose to go into the zero sum game of a fight, the Captain would follow that with a negative sum game of punishment. And the punishment would be harsh (represented in the graphic by-100).

This worked with the other prisoners. Punishment put the other prisoners back on the “collaborate” path. As a reward for being nice, the prisoners would get small rewards like better food, less work, and no punishment. And the Captain would have less work to keep them in line. It was positive sum.

But Luke was different. He saw the same game, but the payoffs at the end were different:

Collaborating with the Captain was always negative for Luke (represented in the graph as – infinity). Looking at his payoffs, Luke knew he always had to fight the Captain. Even if Luke lost, it would be less painful than playing along.

Luke didn’t like the situation, and asked God for help changing the payoffs (video). In the end, Luke plays the game with the payoffs he saw, setting up a tragic ending. When the Captain comes to the church to take Luke, Luke throws the line back at the Captain: “What we have here is a failure to communicate!”

As noted in the post Do Games Always Alternate? games usually alternate between zero sum and positive sum games. This is one instance where, instead of a positive sum game following a zero sum game, a negative sum game follows.

Competition is Not a Fight

History, International Politics, Philosophy, Positive Sum Strategist, Sports, Theory, Zero Sum Strategist No Responses »

Nov 112011

Competition and fighting are often used to describe the same things: Sports, a spat between spouses, conflict at work. And why not? These are zero sum games, where one side can only win what the other side loses.

Yet there’s a deeper meaning that Ludwig Von Mises pointed out in 1922 (scroll to bottom of link for text):

Fighting in the actual original sense of the word is anti-social. It renders co-operation, which is the basic element of the social relation, impossible among the fighters, and where the co-operation already exists, destroys it. Competition is an element of social collaboration, the ruling principle within the social body. Viewed sociologically, fighting and competition are extreme contrasts.

Competition is welcomed by the Positive Sum Strategist, because it leads to collaboration (a positive sum game). Conflict or fighting is the realm of the Zero Sum Strategist, who plays the zero sum game as if there’s no other game to follow.

For the Zero Sum Strategist, here’s what the world looks like:

For the Positive Sum Strategist, the world is turned upside down:

Fighting, then, means that the zero sum game is the final game. Competition is when the zero sum game is subordinate to a positive sum game.

After World War I, the Allied Powers took the conflict approach. Germany was saddled with reparations (which amazingly were not paid off until 2010) and other restrictions (like having no guns for their army). The Allied Powers wanted to be sure Germany couldn’t ever fight again. We know how well that worked.

After World War II, the Allied Powers shifted their strategy. Rather than trying to stop Germany from ever playing a zero sum game ever again (impossible, short of killing every member of the enemy), the Allies changed the game. They invited Germany to play a zero sum game of competition, instead. They replaced fighting with competition, and to show good faith, helped them on their way with the Marshall Plan.

American businesses competed against German businesses, so their armies wouldn’t fight. Competition replaced conflict.

Competition allows for more games, conflict doesn’t. In fact, the goal in a real fight is to destroy the enemy, to win and never play again. A player in a competition wants to win, but they also want to play next game and the next game.

A Zero Sum Strategist is always looking for the decisive, final fight; the Positive Sum Strategist is willing to compete, and play on, win or lose.

Fortunately, the world is choosing competition over conflict, as violence is declining.

Greece And The Games That Matter

Business, International Politics, Negotiations No Responses »

Nov 082011

In this interview with Charlie Rose, author Michael Lewis (The Big Short) talks about Greece (transcript here):

MICHAEL LEWIS: One story — not a story — one anecdote that completely captures the tone of the place. There is a public national railroad in Greece it generates 100 million Euros in revenues a year. It pays 400 million Euros in salaries.

CHARLIE ROSE: In salaries.

MICHAEL LEWIS: Four times what it takes in.

CHARLIE ROSE: Right.

MICHAEL LEWIS: The average salary of a Greek railroad worker is 65,000 Euro a year, which is more than in any private company in Greece. That’s just one example.

Now those salaries are going away.

Greek railroad workers did everything they were told. They played the game how their culture said it should be played. It worked. Everyone got nice paychecks.

Until the paychecks stopped.

To get good results (usually called “payoffs”) from any game, the first question is this: Which type of game are we playing? Zero sum or positive sum?

If it’s a zero sum game, then the main question is, “Am I stronger than my rivals?”

In the zero sum game against the private sector, the Greek railroad workers were winning, Lewis points out. They got higher salaries. They better benefits. They were stronger than their rivals in the game of Greek politics. And they made sure things stayed that way by supporting Greek politicians.

As long as the zero sum political game mattered most, Greek railroad workers got nice payoffs.

But it turned out that wasn’t the game that mattered most. In fact,there was another game, a positive sum game, that supported the Greek government. And by extension, supported Greek railroad worker salaries.

The positive sum game was this: Banks would lend the Greek government money, and the Greek government would pay the banks back more money later. Both sides acted voluntarily. Both sides would win.

When we shift to a positive sum game, the main question shifts. Instead of being, “Am I stronger than my rivals?” the main question becomes, “Is my partner happy?”

The Greek railroad workers asked themselves the first question many times. But the second question?

For a long time, it didn’t matter. Banks lending money to Greece were happy. Until questions came up about Greek accounting, tax receipts, and government employee benefits. Then the banks began to wonder.

The longer Greek budget deficits went on, the more the banks wondered.

Soon, the banks weren’t happy.

The positive sum game fell apart. And the ability of the Greek government to pay Greek railroad workers Euro 65,000 ($84,500) per year?

It’s falling apart, too.

Repeated Games and the Exit Option

Business, History, Negotiations, Politics, Positive Sum Strategist, Theory No Responses »

Nov 032011

For the Positive Sum Strategist, deals look like this:

The positive sum part of the deal is the biggest, most important part. It’s the final game, and the more valuable. To the Positive Sum Strategist, the zero sum part of the deal is just something to get past.

But often we can’t get past the zero sum part. If the other side thinks they’re worth more than we think they are. If the other side is worried about being taken for a ride. If the other side doesn’t trust us to deliver on our promises.

Then the deal stops. The positive sum part never happens. Neither side gets paid.

How do we get past zero sum games? Most of the time we use what Nobel Laureate Douglass North calls “institutions,” defined this way in his Nobel Prize speech:

Institutions are the humanly devised constraints that structure human interaction. They are made up of formal constraints (rules, laws, constitutions), informal constraints (norms of behavior, conventions, and self imposed codes of conduct), and their enforcement characteristics.

Institutions are society’s tools for getting us past zero sum games. They stop us from doing bad things. They make it easier for one side to trust the other.

But sometimes institutions don’t work. Either there’s no law that applies to our particular deal. Or there’s a cultural gap between us and our potential partner. Or there’s a chance of post-contractual opportunism. Or the value to be gained from cheating on the deal is so large, one side has a strong incentive to cheat.

What do we do then?

One tool was mentioned in the prior post on tipping: Repeated games.

Repeated games give each side the opportunity to change the deal over time. If one side feels like round one gave them a bad deal, they can rectify it in round two. If enough games are played, the deal settles into an equilibrium where each side knows what payoff they’ll get from the interaction.

But sometimes the equilibrium gets out of whack. Maybe one side exerts too much power as the repeated games play out. One side takes advantage of the other. One side saps all the value from the positive sum exchange.

Here’s an example:

Fortunately, there’s something else: Repeated games with a low-cost exit option.

If it doesn’t cost too much for one side to leave the deal, then everything changes. The exit option forces each side to make sure the other side is happy. The exit option forces each side to resist the urge to take advantage of the other. If one side or the other is unhappy, one side leaves. If the repeated game settles into an equilibrium that doesn’t work for one side, one side leaves.

A low-cost exit option in a repeated game is one way to keep the focus on the positive sum exchange.

Alternate Futures, Bonds and the Euro Crisis

Business, International Politics, Taxes No Responses »

Oct 312011

Stories based on alternate futures are a favorite in pop culture. From the old Choose Your Own Adventure books for kids to Back to the Future to the most recent Star Trek movie (where new Spock meets old Spock), the idea of having alternate futures never gets old.

In Europe, we have two main alternate futures right now. They are: 1) The debt problems in Greece are contained, leaving the Euro intact, and 2) Greek debt problems spread to countries like Italy, Spain, and Belgium and some of those countries default on their debt. Which will it be?

We don’t know. After all, no one can predict the future.

What we can do is guess and put probabilities on those scenarios. We can judge the chance of debt problems spreading to Italy, Spain, and Belgium to be 0% or 5% or 10% or 50%. Then we place a bet.

That’s what bondtraders do. If a bondholder thinks the debt of those countries is safe, he bids down the interest rates of that country’s bonds. If he thinks the debt of those countries is not safe, he bids up the interest rates.

As noted in this Bloomberg article, bonds today are earning higher interest rates on Italian, Spanish, and Belgian debt than they did last week. That means that bondholders, in a weighted (by volume) aggregate, believe the probability of a future in which Italy, Spain, and Belgium don’t pay back their debts is higher than it used to be.

Politicians like to say that the probability of their governments defaulting is o%. Bond markets say different. For that reason, government leaders don’t like bond markets.

It doesn’t have to be that way. Government leaders could take away all power from the bond markets by drawing down their debt. But government leaders need that debt to pay for the things their constituents want (or what the politicians think their constituents want). As a result, bondholders have to judge the probability of governments defaulting on their debt.

And for the rest of us, it’s good. Bonds give us an independent probability of one alternate future: whether politicians can keep a promise to pay back debts.

The Benefits and Fragility of Impersonal Exchange

Business, History, Negotiations, Positive Sum Strategist, Psychology No Responses »

Oct 252011

In his 1993 Nobel Prize in economics lecture, Douglass North described the key milestones on humanity’s road from tribes to modern society. One of those milestones is the de-personalization of trade. Whether it’s a factory owner in China who makes the goods we buy or the retail clerk who makes the sale, we don’t know the people we trade with. Some we will never meet.

According to North, here’s how it happened:

With growing specialization and division of labor the tribes evolved into polities and economies; the diversity of experience and learning produced increasingly different societies and civilizations with different degrees of success in solving the fundamental economic problem of scarcity. The reason is that as the complexity of the environment increased as human beings became increasingly interdependent, more complex institutional structures were necessary to capture the potential gains from trade. Such evolution requires that the society develop institutions that will permit anonymous, impersonal exchange across time and space.

There’s a fundamental problem of scarcity. It’s not just goods that are scarce, so are knowledge and an individual’s time. In a tribe, you might have someone who was a good hunter, good with herbal cures, and a good cook. But it’s better if instead of one person with those skills, there are three people who specialize in each skill. Then each person could do what they’re good at, and trade their services to each other. It’s positive sum exchange.

As knowledge and skills spread ever wider, exchange becomes more impersonal. It becomes impossible to know everyone with whom we want to trade. A Westerner cannot know every Chinese factory owner before she buys his goods. A Chinese factory owner cannot know the Mongolians who mined the coal which fueled his factory’s generator.

Scarce goods, knowledge, and time drive us toward impersonal exchange. Without impersonal exchange, we wouldn’t have a global economy. We wouldn’t have the benefits of economic growth.

Yet impersonal exchange is fragile. It only works if society also develops “institutions” that support it. North says:

Such evolution requires that the society develop institutions that will permit anonymous, impersonal exchange across time and space.

Those institutions include contracts, a legal system, and a corruption-free political system. In the language of this blog, institutions must ensure that the benefits of positive sum impersonal exchange are not trumped by zero sum losses. If they are, people stop trading. The global economy shrinks.

If the economy shrinks enough, we go back to tribes. In a tribe, we exchange with the people we know and feel safer. In a tribe, we’ve solved the problem of trust. But we still have the problem of scarcity.

Traders, entrepreneurs, and savvy consumers have long recognized the tradeoff between trust and solving the problem of scarcity. It’s why we write contracts and use non-legal tools like repeated games. It’s why we develop a moral code, called the Positive Sum Code.

We get past the zero sum games quickly, so we can grow the scope and magnitude of positive sum games. That’s when the benefits come, for everyone.

Just the Strategy and Details Left To Work Out in Europe

Business, International Politics, Negotiations, Positive Sum Strategist, Zero Sum Strategist No Responses »

Oct 172011

Over the weekend, the finance ministers of the G20 met about the problems in Europe. Europe has a plan to fix everything, they were told. Europe will solve the Greek debt issue, limit the impact on European banks, and wisely administer the European bailout mechanism called the EFSF. The details are secret. But at least one guy has seen the plan: Tim Geithner. Bloomberg got the following quote:

“The plan has the right elements,” U.S. Treasury Secretary Timothy F. Geithner said in Paris. “They clearly have more work to do on the strategy and the details.”

Just the strategy and the details left to work out. Everything else looks good.

Some say there is no strategy and there are no details. There’s not enough money in Europe to bail everyone out. Greece will leave the Euro (along with maybe Portugal and Spain), European (and other) banks will suffer, and the problem may spread wider. The Emperor has no clothes.

European politicians say that’s not true. No one will lose from their plan. They’re just keeping it a secret because . . . because why, exactly?

When there are positive sum solutions, you want to publicize them. When everyone can win, you want everyone to know it. You don’t want secrets in a positive sum game. That’s why openness and honesty are marks of a Positive Sum Strategist.

When you think you’re in a zero sum game, you keep secrets. You especially want to keep secrets from the people who are going to lose, at least until it’s too late for them to fight back. That’s why deception is a mark of a Zero Sum Strategist.

Right now, European leaders and bankers and bondholders are preparing for the zero sum game of a bailout. They are negotiating, cajoling, and politicking to get their favored parties bailed out. To make sure they are on the winning side, not the losing side of European tax money distribution.

Meanwhile, European leaders tell the world there is a positive sum solution to the Euro crisis. Judging by last week’s stock market boom, a lot of people believe them.

Maybe there is a positive sum solution. But it’s troubling that European leaders aren’t acting like it. They’re acting like they’re in a zero sum game. They’re keeping secrets.

Usually people keep secrets because they don’t want the losers to know that they’re losers. Until it’s too late.

Tipping and Repeated Games

Business, Media, Negotiations No Responses »

Oct 142011

In San Francisco, there’s a proposal to stop diners from tipping their servers. A 25% tax on food would replace tips. That would put San Francisco restaurants in the same league as most restaurants outside the U.S., where service is included in the cost of the meal. Which way is better? Tipping or covering the cost of service with the price of the meal?

Let’s look at the transaction between server and diner as a deal. The server will bring the diner their food, and the server will receive a tip. It’s a positive sum game. Both sides win.

There are two other zero sum games, one before and one after the win-win of being served a meal. The first zero sum game involves the costs that each side puts into the deal. In the case of the diner, it’s the amount she’s agreed to pay for the food. In the case of the server, it’s the time spent taking orders and delivering the food, with some quality control thrown in. After the meal is served, there’s a distribution of gains. The diner got a meal, the server gets paid.

Like all deals, the types of games tend to alternate. Graphically, it looks like this:

The deal between server and diner can go bad at all three stages. It could be that server doesn’t put enough into service. It could be that the meal is bad. Or it could be that the diner refuses to pay. These are the risks (or, “uncertainties” in the Knightian sense, since they usually can’t be measured) that every deal faces.

We could limit the risk of a bad meal with a contract. There could be a piece of paper every diner and restaurant owner sign before a meal. That contract could impose penalties on the restaurant if the meal is bad. Or have the diner put up some kind of collateral before ordering food. They could write it all down and agree that an outside party can make a judgement if either side feels wronged.

But that would be a lot of work. Instead, restaurants encourage tipping.

Tipping does something similar to a contract: it gives an opportunity to redistribute profits at the end of the deal. After dining, the food’s gone. There’s no going back. That game is over.

But tipping gives the diner a second game to play. She has a chance to decide whether the meal was really worth what she agreed to pay. If not, she can take it out on the server, if she wants. She can leave a smaller tip to make up for the poor meal.

In the end, the diner is the final judge. She may leave a small tip or a large tip, but she doesn’t leave angry.

If repeated games are good, why don’t restaurants outside the U.S. encourage tipping? It may be because restaurants outside the U.S. have more repeat business, so they are already in repeated games with their customers. Or it could be that cultural mores provide other post-deal tools for retribution. Or it could be that they get so much business from being in a tourist locale that they don’t care if clients leave unhappy (maybe why food is notoriously bad in tourist locales, including San Francisco).

That may be why San Francisco restaurants want to do away with tipping. They don’t want to give tourists a second chance to redistribute the profits from their dining experience.

Tipping creates two games where there was only one before. It creates a repeated game.

Adding more games doesn’t guarantee that everyone will be happy at the end of the deal. But the more games there are, the less likely it is that one side will take advantage of the other. And more likely that the overall deal will be positive sum.

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