How Game Theory Explains Washington's Horrible Gridlock

Why Congress can't even reach a mini-bargain -- and why kicking the can down the road will remain the most likely outcome.

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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 analyzing 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 polarized 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.

Presented by

Mohamed A. El-Erian is CEO and co-chief investment officer of Pimco, the world's largest bond investor, and author of When Markets Collide.

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