VAROUFAKIS PUTS THEORY TO TEST IN GREECE’S HIGH-STAKES GAME
With the fate of global markets resting on a deal, not even mathematicians can guess the outcome By James B Stewart
That Yanis Varoufakis, the rakish Greek finance minister, would meet with senior European officials wearing a leather motorcycle jacket and open-collar shirt would probably have fascinated John Nash Jr, the Nobel prize-winning mathematician, game theorist and Princeton professor who was thrown from a taxi and killed last month.
Is Mr Varoufakis really a radical, or simply acting like one to increase Greece’s negotiating leverage — what game theorists mean when they say it can be rational to behave irrationally?
Mr Varoufakis is a noted game theorist, co-author of the textbook Game Theory: a Critical Introduction and a longtime admirer of Nash. The two met in Athens, Greece, in June 2000 after Nash delivered a lecture on money. After learning of Nash’s death, Mr Varoufakis wrote on Twitter: “Reading your work was inspirational. Meeting you, and spending time together, was an unearned bonus, Farewell John Nash Jr.”
The intense and hard-fought negotiations between Greece and its creditors, which have roiled global financial markets for months and appear to be nearing a climax, are the sort of high-stakes game that fascinated Nash, who won the Nobel in economic science, and lend themselves to the analysis he pioneered. On Thursday, markets were rattled when Greece deferred a payment to the International Monetary Fund as it continued to seek a new debt deal.
“It’s exactly the kind of game that Nash had in mind,” said Sylvia Nasar, author of the definitive Nash biography A Beautiful Mind, which was the basis for the Academy Award-winning movie. “There are more than two players. They have common as well as opposing interests. Not making a deal leaves everybody worse off.”
Unfortunately for the financial markets and the future of the European Union, that’s no guarantee that Greece and its creditors will reach a deal that averts the doomsday scenario — a debt default by Greece that could cause it to lose its membership in Europe’s currency union and set off another crisis.
I asked Mr Varoufakis last week how it felt to have the fate of the global economy to a large extent resting on him.
“I don’t really feel the weight of the world economy,” he said. “I feel the weight of the Greek people resting on my shoulders. If little Greece, in order to survive, brings down the financial world, it can’t be our fault. It would be as if Delaware brought down the United States economy. That would be the fault of the US, not Delaware.”
Virtually everyone agrees that a Greek default is the least desirable outcome for Greece and its creditors — among them Germany and France, the European Central Bank, and the IMF. Yet one of Nash’s critical insights is that there may be many possible outcomes — so-called Nash equilibriums — that produce suboptimal results. A Nash equilibrium exists when each side’s strategy is optimal given what they believe to be the others’ strategy.
For example, if Germany and other creditors don’t believe Greece’s threat to default, and underestimate the severity of such an outcome, they might see their optimal strategy as remaining firm in their demands for Greek fiscal austerity and structural reforms. If, on the other hand, Germany believes Mr Varoufakis to be ideologically motivated to reject further austerity, it might well cave to Greek demands for leniency.
That may be part of Mr Varoufakis’ strategy — his colourful demeanour and public statements have been so provocative that in April Greece lessened his role in the negotiations, a move that seems only to have enhanced his considerable popularity back home. He continues to be a leading player in the talks and remains a key adviser to the Greek prime minister, Alexis Tsipras.
In our conversations last week, Mr Varoufakis came across much more the sober economist than a wild-eyed radical or motorcycle-riding daredevil. He displayed a sophisticated grasp of both game theory principles and the complicated dynamics of the current negotiations between Greece and its creditors.
Those on the other side of the negotiations are “portraying me as an irrational fool, which is doing my work for me,” Mr Varoufakis said. “I’ve been stoic. I haven’t let myself get agitated.” Speaking like a true game theorist, he added, “I know who I am and I know they know who I am.”
“Both sides agree it’s better not to push Greece over the cliff. But how far can you push? Each side knows the other side should be willing to make concessions because it’s in their interest. Neither side does because they believe the other side will. So there’s a standoff,” said Barry Nalebuff, a professor at the Yale School of Management and an expert in game theory. “It’s very hard when it’s in both side’s interests and there are multiple solutions or equilibria, which is the situation with Greece.”
Mr Varoufakis agreed that in the Greece example, “the game has multiple equilibriums and, therefore, a failure to agree may trigger a chain of outcomes that no one can either predict or control”. He added, “We have many interlocutors. Some are painfully aware of the disaster that awaits Europe if Greece defaults. Others are less aware. Some are utterly unaware. They think it can be contained. There’s a great divergence of opinion on the other side regarding the potential outcome. Even in Germany, there are many divergent views.”
Uncertainty of outcome vastly complicates any game theory analysis. Citing the work of University of Chicago professor Frank Knight, Mr Varoufakis pointed to the difference between risk and uncertainty. Betting on the flip of a coin involves high risk, but the potential outcomes and their probability are known.
“Uncertainty is when you can’t know all the outcomes or the probability with which each potential outcome will occur,” he said. “This is deep uncertainty.” Complicating matters further, “these negotiations are also about hearts and minds, both of the participants and of the wider community — investors, citizens in Greece and outside of Greece. Those who think that game theory can cut through this Gordian knot are badly mistaken.”