Home > Behavioural Economics, Euro > Euro Crisis – is it the Ultimatum Game all over again?

Euro Crisis – is it the Ultimatum Game all over again?

Jame Surowiecki in the recent edition of The New Yorker likened the euro zone crisis to the fairness trap. With Greek politicians looking at renegotiating its aid package and austerity measures, the German government has indicated that they are running out of patience and money to lend to Greece. Policymakers have talked about a Greek exit from the Euro – Grexit – which would mean they would default on their debts and no longer be part of the Euro currency.

As many economists have pointed out when economies go through a recessionary or contractionary phase their exchange rate starts to depreciate. This makes exports more competitive and imports cheaper which ultimately helps growth. However for Greece to leave the Euro it would destroy vast amounts of capital as well as costly for the rest of Europe. Greece owes almost half a trillion euros and containing the damage would mean the recapitalisation of banks, continent-wde deposit insurance and more aid to Portugal, Spain, and Italy. However it seems that this would be a much more expensive option than Greece staying in the euro zone.

Rationally there should be some sort of compromise with maybe a relaxing of austerity measures and giving Greece a bit more time to bring about some serious structural reforms especially to its tax system. However according to Surowiecki Europe isn’t arguing just about what the most sensible economic policy is but what is fair.

The Germans see it as unfair that they have to bailout Greece especially as the Greeks have continued to live beyond their means – how did they afford to host the Olympic games in 2004? Borrow more money? Why should the Germans be obliging when there is no meaningful reform in Greece?

From a Greek perspective it is equally unfair that for them to suffer years of slim government budgets and high unemployment in order to repay foreign banks and richer northern neighbours.

This fous on fairnes could prove disastrous – remember the Ultimatum Game.

The Ultimatum Game by Werner Goth 1982
In this game somebody offers John £100 under the condition that he shares it with Sarah. The two of them cannot ex- change information and John can make a single offer of how to split the sum. Sarah, who is aware of the amount at stake, can say yes or no. If her answer is yes, the deal goes ahead. If her answer is no, neither John or Sarah gets anything. In both cases, the game is over and will not be repeated. You may not be surprised to learn that two thirds of offers are between 40 and 50 percent.

From research carried out (Karl Sigmund et al.), only four in 100 people offer less than 20 percent. Proposing such a small amount is risky, because it might be rejected. More than half of all responders reject offers that are less than 20 percent.

However, why should anyone reject an offer as “too small”? The only rational option for a selfish individual is to accept any offer, as £1 is better than nothing. A selfish proposer who is sure that the responder is also selfish will therefore make the smallest possible offer and keep the rest.

This game-theory analysis, which assumes that people are selfish and rational, tells you that the proposer should offer the smallest possible share and the responder should accept it. But this is not how most people play the game.

The fairness problem is exacerbated by the fact that our definition of what counts as fair typically reflects what the economists Linda Babcock and George Loewenstein call a “self-serving bias”. This is even more pronounced when both parties feel they are not part of the same community – known as “Social Distance”. For instance:

1. The Greeks’ resentment of austerity might be attenuated by the recognition of how much money Germany has already paid and how much damage was done by rampant Greek tax dodging.

2. The Germans might acknowledge that their devotion to low inflation makes it much harder for struggling economies like Greece to start growing again.

The pervasive rhetoric that frames the conflict in terms of national stereotypes is the following:

Hardworking, frugal Germans v frivolous, corrupt Greeks
Tightfisted, imperialistic Germans v freewheeling, independent Greeks

This makes it all the more difficult to reach a reasonable compromise.

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  1. Simon
    June 5, 2012 at 8:36 pm

    In many ways Germany has as much to lose as Greece. They just do not recognize it. When they do… how fast can you say “fiscal union”. Hopefully the alternative will not mean war. The so called “elites” had better prove they are worth their salt now.

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