Game theory, Caillé’s 'third paradigm', and two options for global relationships

The quantitative easing adopted by the Fed, the ageing population in Japan, the Arab Spring, and the threats of climate change appear as distinct and distant events. The same is true for Mario Draghi’s monetary policy, the US presidential elections, the slow-down in Chinese economy, the risks posed by Brexit, oil price fluctuations and the nuclear agreement with Iran. As a matter of fact, these phenomena are much more intertwined than it appears. Links between monetary policy, economic growth and international affairs have always existed, but have presently reached a level that makes it difficult to understand the cause/effect relationship and to efficiently manage crises. Therefore, an understanding of interdependencies in the present world is a must for policy makers.

The simple world of (the two) opposing blocks

Complexity and interdependencies have grown fast. Up to a few decades ago, the world was “simpler”. In foreign policy, the clear contrast between the two blocks of the cold war ensured the constant maintenance of a certain balance. Crises were mostly handled through explicit or de facto agreements between Washington and Moscow. In case of conflict, enemies and allies were easily identifiable.

In the economic field, the subdivision was between developed and developing countries. The U.S. were the only locomotive driving the world economy through imports of goods and energy, while most of the world financed the two major American deficits. Growth drivers were clear: Fed decisions, the only truly relevant ones, to which other Central Banks complied. Usage by Washington of traditional levers of monetary policy determined fairly predictable consequences on American and world economy. Economic crises could be managed by small groups such as G7.

Also in the field of energy, the different forces were clearly defined: on one side the oil producing countries and on the other the energy-importer industrialized countries. Many of the former were organized in the OPEC cartel. The latter, with large needs and few alternative energy sources, were particularly vulnerable to increases in oil prices. In this case too, realpolitik facilitated agreements and compromises in critical situations affecting oil prices and supplies.

Bipolarism, game theory and rational behavior

In the “simple” world of the (two) blocks, players were few and well acquainted with one another. Foreign and economic policies were a kind of chess game between rational players. Mutual trust was scanty but, borrowing the terminology of game theory, the “repetition of the game” ensured a rational behavior by the players.

Game theory indicates that a cooperative behavior yields more benefits than a selfish attitude. This is subject to mutual trust between the players, or to a long-term relationship (i.e., the game is repeated several times) leading to rational behaviors. The prisoner’s dilemma - one of the simpler versions of game theory, applied to economy, international affairs, military strategy, ecology - shows that a selfish behavior by the players causes a general damage while, on the contrary, an attitude of rational cooperation is the best possible solution for all parties, the assumption being that all players, and not only one, behave cooperatively. This is more likely to happen if players are few, know each other well, and tend to remain the same over time.

From a single superpower to the multipolar world

With the end of the cold war and an extended period of diffuse economic growth, the world balances changed. In the span of time between the two symbolic dates of November 9, 1989 (the fall of the Berlin wall) and September 11, 2001 (the terrorist attack to the World Trade Center in New York), the US is the only political, military and economic superpower at a worldwide level and consequently succeed in imposing a “cooperative” attitude to the world, which facilitates crisis management and reach of international balances. On an international level, this is the application of the English philosopher Hobbes’s intuition from four hundred ago in regard to national states. According to Hobbes, the solution of the natural tensions among men is “constriction”, i.e. the introduction of the State that, with its laws, forces cooperation among citizens. The US, thanks to their economic and political-military strength, and the Fed, have exercised this role with good results for the global balance. Today – while Washington is still the main superpower – a new multipolar situation has arisen, which is characterized by a higher number of players and their growing interdependency. Cause/effect relationships, in all sectors, are much more complex to decipher, crises more demanding to manage, and decisions regarding policy more difficult to make.

The complex world of interdependencies

In foreign policy, the U.S. partial disengagement from several fronts and the establishment of several regional powers have modified previous balances and increased the degree of uncertainty. The events in Syria, Libya and Iraq are an example. In economy, there are at least four drivers towards world growth: the United States, Europe, China and other emerging economies. On one hand this widens the base for growth while on the other makes it more difficult to make an efficient use of the traditional tools of fiscal and monetary policies. The expansionary monetary policy of the Fed, aiming to lead the US out of the crisis, drives capitals looking for returns towards risk sectors and emerging countries, besides creating speculative bubbles difficult to manage and dangerous for all. This happened in the early ‘90s in South East Asia, after 2001 with real estate and the risk exists in Brazil today. On the other side, the mere expectation of an interest rate increase in the US is causing anxiety and volatility of the financial markets, capital reflows in the US, and strengthening of the dollar, and thus risking to bring emerging economies to their knees.

Oil and commodity prices are also important. The crude oil peak which occurred a couple of years ago, an event that in the past was considered unquestionably negative for Washington, has encouraged investments for shale gas extraction, thus bringing the US closer to independence in energy supplies. On the other hand, the recent drop in oil prices, certainly favorable to industrialized economies, has (negative) side effects and risks for Europe and the US, among which the difficulty of the oil producing countries to finance public expenditure, thus creating risks of social and political instability. It is the case of Russia, Saudi Arabia and Nigeria. The same is true for prices of other raw materials, in particular food products, which has a bearing on the internal stability in developing countries. After all the Arab Spring of 2011 coincided with the peak of raw material prices.

In the new “complex” world, even climate change is more and more a risk for economic growth and financial market stability. The Paris COP21 agreement has a high international value also from an economic point of view.

Unstable equilibria and Caillé’s “third paradigm”

In today’s multipolar world, each country has the temptation to pursue its own interests. This makes it much more complex to reach equilibria and effectively address crises. Whilst also in “complex games” the most rational and convenient solution for the various players is mutual cooperation, despite the temptation to play “against” each other being stronger. In this contest, “constriction” to cooperate as outlined by Hobbes is arduous, maybe impossible. The US cannot and do not want to exercise it, nor can the UN achieve it.

The alternative is trust, at the same time source and result of a strong relationship among the parties. Only in the presence of mutual trust can governments, economies and institutions enter into cooperative relations. The introduction of what the French sociologist Alain Caillé calls the “third paradigm”, based on mutual relations, can help overcome contrasts and reach equilibria among the players.

In today’s complex world, apparently distant phenomena are in fact strongly intertwined. This makes it difficult to reach a situation of balance and to handle crises in all sectors. Alternatives are twofold: chaos, which often causes conflict situations, or an increase in cooperation, which can be obtained by improving the quality of relations among countries and institutions. The starting point is the creation of leaders fully understanding interdependencies among monetary policy strategies, economic growth and international affairs.

Marco Magnani will teach the course Monetary Policy, Economic Growth and International Affairs in the Fall 2016 at LUISS Political Science in Rome. Non-resident fellow of Institute for International Affairs and Senior Fellow at the Harvard Kennedy School, he has published Sette Anni di Vacche Sobrie (UTET), Creating Economic Growth (PalgraveMamillan), and Terra e Buoi dei Paesi Tuoi (UTET). He is a columnist of IlSole24Ore.

(This article, in a slightly different version, was published in Italian by AffarInternazionali http://www.affarinternazionali.it/articolo.asp?ID=3244 and translated in English by Laura Campiotti)

www.magnanimarco.com