Thursday, 6 August 2015

Varoufakis's flawed Game Theory

Some months ago, Game Theory was getting headlines across the world in connection with Grexit.
Zero Hedge had the best brief analysis but it was beside the point because, as Varoufakis pointed out, Greece was not playing a 'bargaining' game. It knew its own pay-off from Grexit was catastrophic whereas that for the Eurogroup was potentially positive because its credibility might increase by getting rid of a bad apple off its own bat rather than under pressure from the Market.

This being the case, what type of game was Varoufakis playing?

 Look at things from his point of view. He believed he was smart. He knew he was Hayekian (i.e. pro-market) on the crucial question of Greece's bloated, inefficient, feather-bedded Public Sector. He was a Europeanist, not a Nationalist, wishing to strengthen Europe's legitimacy vis a vis Athens by making the former, not the latter, more democratic (i.e. creating a situation where Greece's small population would have less weight in decision making compared to the huge population of the 'core' countries).
Thus, 'subsidiarity' would stop meaning that Greece could be a unique Tiebout model (i.e. choose its own mix of Taxes and Public Goods) and start meaning that Greece would be run by people with Greek names but a completely foreign outlook. In other words, this ex-pat amateur politician wouldn't need to worry about Greece's complicated internal politics because 'Democratic Accountability' would no longer be to the Greek voter but the European voter- in which case, naturally, the abstract language of Economics, in which he had an absolute advantage, gained salience over purely local shibboleths.

If such indeed were Varoufakis's beliefs, what type of game would he have wanted to play? The answer, I think, is he was looking for an Aumann correlated equilibrium- i.e. a situation where all parties can get to a mutually beneficial agreement in a repeated game by the help of 'public signals' from a wiser being above the fray. Just as wily Odysseus still requires some helpful nudges from the Goddess Athena, so too, did Europe. True, the Odyssey is a story of terrible travail but only because the Olympian Gods were at odds with each other. Varoufakis, as a Game Theorist, was however aware that if all agents are rational and their beliefs are unambiguous and common knowledge then conditions for 'Aumann agreement ' obtain- i.e. it would be impossible for them to 'agree to disagree'. Instead, an 'Aumann signaller' will quickly be recognized by all parties and so agreement can be arrived at much more quickly and lower computational cost.

We all know that Varoufakis failed ignominiously. What was his excuse? He is quoted as saying- '“There are elements that want to go back and tell their constituencies, ‘We humiliated the Greek government.’ There are elements that want us to fail, hoping that our government will be replaced. This isn’t constructive. Sometimes I wish they had a skilled game theorist on their side.”

How should we parse this statement? Let us look at 2 radically different interpretations, two extremes that define a hermeneutic spectrum, before weighing the evidence and making up our minds.
1) anti-European- 
'Some voters in Europe are either sadists or harbor animus against Greeks. Thus they will vote for those who say 'we insulted and injured Greece'. 
'Furthermore, some powerful interest groups at the heart of European Politics want new popular Parties like Syriza to fail. They want 'regime change' from which they themselves profit regardless of the will of the local people.
'This type of European voter, this type of vested interest group manipulating things at the center of European decision making, is not interested in constructing a better Europe. They have a 'zero sum' mentality. It is not enough that they get richer, more powerful. No. Someone has to become poorer and weaker, someone has to be insulted and injured for them to feel happy.
'This being the case- Europe is another name for Colonial domination and the arbitrary tyranny of an occulted cabal harboring racist views towards Greeks and motivated by an unappeasable ire against popular democracy, transparent Govt., no matter where it raises its flag.
'This evil Europe, hell bent on 'winner take all' vindictiveness, will destroy itself. Those whom the Gods wish to destroy they first make mad. Hate and Envy and the determination to control everything have driven the corrupt cabal, and their Racist voters, pathologically insane.
'Sometimes I feel pity for them- I wish they had at least one intelligent person in their ranks- a skilled Game theorist who could do the necessary complicated calculations and, no matter how hate-filled he might himself be, nevertheless recognize the cold and immutable mathematics that seals the doom of his own side. These evil men may indeed go over the cliff like the Gadarene swine. But let them at least have heard the truth, for they are men not pigs, before going to destruction'.

2) pro-European-
'The Euro, like the ERM it replaced, is vulnerable to Market attacks. What happens is, like a Lion hunting gazelles, the hedge fund managers zero in on the weakest member of the herd. Zahavi, a Zoologist whose handicap principle is extensively studied by Game Theoreticians- showed that if strong gazelles engage in stotting behaviour- i.e. jumping in a showy fashion- they can distract the Lion so that the weak gazelle is saved. All gazelles benefit if Lions go hungry and their cubs starve. It makes sense for strong members of a currency union to take on this type of cost because in saving the weakest member they also benefit themselves.
'However, in Europe there are some stupid and ignorant people who don't understand that the gazelle can triumph over the Lion. They have the ideology of the 'victim' who blames his own weakness for his predicament. Knowing they themselves will sooner or later fall victim to the Lion, their only pleasure in life is hearing that for now some other has met that grizzly fate and so they can live on another anguished day.
'There is one consoling philosophy such 'victims' might cling to. It is the belief that by being bullied, a gazelle can turn into a Lion. They can say 'if Greece is bullied and humiliated, it will decide to become stronger. Thus our strength is increased.
However, this is a delusive philosophy. It keeps the weak weak and denies them even the Gospel of Popular Democracy.
If you try to bring down the elected Govt. of your neighbor, who will speak for you when the cabal running things throws off its democratic disguise in your own home country? Do you really save on your heating bills if your neighbor's house is set on fire by debt-collectors from the Utility company?
What is happening in the Eurogroup is not constructive. Greece has a vision of a better Aumann correlated Equilibrium for us all. The only losers will be the 'vulture funds' and opportunistic Money Market speculators. Democracy's victory is Plutocracy's defeat. This is a mathematical truth. I wish the other side had a good Game Theorist. Then I could sit quietly and not have to attract publicity. After all, I too am European. How will it profit me to gain the fame of a Cassandra?

As I said these are the 2 extremes of the spectrum for the reception of Varoufakis's account of his European negotiations.
I discount (1)- the anti-European interpretation because it is now clear that everyone- except 'useful idiots' like Krugman and Galbraith- knew that Europe won't suffer much, indeed might gain, from Grexit. A Club that weeds out the weakest while starving, not just the lion, but even the vulture needs fear no attack. We human beings dominate the planet, though we are puny compared to our chimpanzee cousins. Homo homini lupus has been the secret of our success.

What about (2)?
Surely, the interpretation I have given does not square with Varoufakis's actual utterances? He has never mentioned Aumann correlated equilibrium or the Zahavi handicap principle or anything of the sort.
To do the former, he would need to present a proper model showing how the ECB could work better and the Euro fulfill a higher economic function than at present envisaged. This has not happened.
To appeal to the latter, he would need to have used emollient words to stroke the ego of the Germans and other Nordics, using flattering, thymotic, arguments to get them to engage in 'stotting' such that the pain is taken by the Money Managers of New York and London and Tokyo and Shanghai. Did he in fact do any such thing? No. This second Demosthenes, rose up to deliver a blistering Phillipic, but suddenly decided to put his hands down the back of his pants and pull out a fistfuls of shit which he called 'chocolate pudding' and which he proceeded to eat. He got very angry when his colleagues in the Eurogroup refused to share his tasty treat. He shouted it was illegal for them to go off and dine on their own far away from the spectacle of his coprophagy. But he couldn't get an injunction from the European Court to force the Eurogroup to allow him to eat his own shit at their dinner table. Still, he mentions this terrible illegality to us all the time. Good for him. This is a Marie Antoinette hasn't just told her people to eat cake but to show from where it can be costlessly procured.

Was Varoufakis's Game theory flawed? My conclusion- no; he was stupid and ignorant simply. Most Professors are.

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