Again and again while trying to understand the fiscal machinations of Congress, I find myself referring to a simple analytical approach acquired at university: game theory. The construct, popular among economists, sheds light both on what has happened in Washington and on how the bargaining power of its negotiating parties may evolve over time. And it points to less-than-reassuring prospects if the overriding objective is — as, certainly, it should be — to improve America’s economic outlook in a meaningfully and sustainable manner in the years ahead.
An important aspect of game theory sets out conditions under which negotiating parties end up cooperating well, and why they fail to do so. It does so based on analysing what drives individuals in the majority of bargaining situations: incentives, access to information, initial power conditions, the extent of mutual trust, and accountability enforcement.
This intuitive framework provides immediate insights into why members of Congress find it so difficult to come up with a coherent fiscal approach — or, indeed, a coherent approach on virtually anything. Simply put, good cooperative outcomes are unlikely to emerge when, as is the case on today’s Capitol Hill, individual and collective incentives are misaligned, access to information is asymmetrical, relative power is fluid, each party doubts that the other will deliver on their commitments, and there is no way to enforce credibility.
For reasons detailed well by Nate Silver and others, a meaningful portion of Congress responds to local incentives and selection processes. And in today’s polarised America, these regional forces do not align well with national needs.
As much as the fiscal debate seems to be always forced into extreme-corner solutions — revenue increases versus spending cuts — the underlying issue is much more consequential. It relates to fundamentally different (and, in part, quite dogmatic) views about the role, scale and scope of government — especially under present circumstances, where growth is sluggish, unemployment is high, safety nets are overly stretched, and income distribution has seriously deteriorated.
So every time the two parties come to the bargaining table, outcomes lack both content and momentum. Indeed, each round renders the next one even more difficult and contentious.
Here is the typical cycle: Responding to the “national call,” the two parties’ initial narratives trend towards “grand bargains” aimed at removing headwinds to growth, jobs, and prosperity. As differences prevail, this gets replaced by a “mini bargain,” or one that would deliver some progress together with momentum for future success.
As this also proves elusive, negotiations get quite acrimonious. If and when an 11th-hour compromise emerges, it lacks both content and momentum: The majority of meaningful decisions are postponed, and both Democrats and Republicans emerge from the experience more bitter — at each other, and also within their respective parties.
The imperfect last-minute deal on the fiscal cliff that was reached a couple of weeks ago — and which, by the way, game theorists would have told you was the most likely outcome — is a good example of this (though not a perfect one, as something beneficial did emerge for the county).
On the positive side, the deal took an important step to stop the multiyear worsening in income and wealth inequality. But it left a dysfunctional Congress the task of addressing three big issues in the next few weeks — and a policy mistake on just one could be sufficient to push the country into a new recession.
To maintain the nation’s growth and employment momentum, Congress must lift the debt ceiling, resolve the sequester and agree on a continuing resolution to keep the government running. Game theory provides three key insights on how all this is likely to evolve in the weeks ahead:
- First, do not expect the two parties to cooperate any better. Yet again, the best we can hope for is a last-minute deal that kicks the can down the road. There will be virtually no positive momentum to speak of.
- Second, Democrats have less bargaining power this time around. Unlike in December when President Obama prevailed in imposing higher taxes on the rich, Republicans do not find themselves in a corner, dreading national blame for total dysfunction. This time around, the blame would be more equally shared.
- Third, it is unlikely that an outside enforcement mechanism would force Congress into delivering a better outcome. In theory, this could come through either the creative use of exceptional powers granted by law, or some type of crisis that focuses minds and forces national priorities to overwhelm local ones. In practice, both are low probability events.
It is hard to predict a domestic crisis driver. The country’s debt and deficit situation do not pose an immediate threat. Social cohesion is holding up despite the severity of the unemployment crisis. And the disruptive headwinds blowing from Europe and the Middle East are nowhere near gale force at this time.
This explains why a growing number of people have been exploring the creative use of exceptional powers or previously-unthinkable options — and in particular, invoking the Fourteenth Amendment or issuing a platinum coin.
Section 4 of the Fourteenth Amendment states that “the validity of the public debt of the United States authorised by law … shall not be questioned.” Some legal experts see this as providing the president with the ability to sidestep a dysfunctional Congress set to trigger a technical default on U.S. debt service obligations.
Alternatively, and as I explained on Friday, legal experts believe that the U.S. Treasury has the authority to issue to itself a high-denomination platinum coin that, once deposited at the Federal Reserve, would provide it with access to more conventional forms of money to meet its payments obligations — and, critically, do so without breaching the debt ceiling.
As controversial and, in the case of the coin option, laughable as these approaches are (over the weekend, the Treasury and Federal Reserve distanced themselves from them, understandably apprehensive about their downsides) a growing number of people believe they would provide Democrats with credible threats to shift the balance of power. And, as a brilliant negotiator I know says, it is always good for your opponents to think that you are “just a little crazy.”
When push comes to shove, however, I doubt Democrats will use these approaches. And as I do not see a crisis that would catalyze members of Congress to put national interests ahead of local ones, we should brace ourselves for lots of high political drama in the next few weeks.
At best, we will get by March a last-minute compromises that kicks most of the issues down the road; at worse, this will materialise after disruptions that sap more energy out of the economy. Whatever the outcome, Congress will again contribute to the persistence of sluggish growth and high unemployment, legitimating concerns that these will be further embedded in the structure of our economy for too many years to come.
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