Crazy Like Foxes?

Yesterday I wrote about the current debt ceiling negotiations taking place in the U.S. in a pretty negative light.  In particular I contrasted the Republican "maximalist with ultimatum" approach to the win-win approach that has come to dominate the business world as its value has become apparent.

There is, however, another perspective -- one that paints the Republicans in particular in a more favorable light (as negotiators).  As David Brooks recently put it, "Republican leaders have also proved to be effective negotiators. They have been tough and inflexible and forced the Democrats to come to them."  We'll explore that today.

In his comments to yesterday's post, David DesJardins pointed out an important potential problem with my comparison.  Business negotiations are easier to make win-win because each party's primary goal is to maximize their own profit in absolute terms rather than relative to their counterpart.  If a deal earns me $10 million and earns you $30 million I'm only "unhappy" because it suggests I could have done a better job of value capture.  I'd most likely prefer that outcome to one where I made $10 million and you made $10 million and I'd certainly prefer it to a deal where I made $9 million.

In two-party electoral politics, the dynamic is very different.  Elections are close to zero-sum: with few exceptions the main elected offices will go to Democrats or Republicans, so a gain for one is an equal loss for the other.  This means that for the purposes of electoral success there will be relatively few opportunities to create value.  As David points out, in the extreme case where all the parties care about is retaining their power the policies they enact are almost irrelevant compared with the effort to claim credit and avoid blame for their effects.

I suspect that anyone who follows politics will find this analysis unsurprising (if depressing) but today's post is optimistic, both about the strategy the Republicans have adopted and about their intent.  That is, I'm assuming for the sake of discussion that they are acting out of a sincere belief that reducing government spending is a national priority, that tax increases would be very harmful, and that seeking the one while preventing the other is worth a very aggressive and potentially dangerous negotiating approach.

The Value of Intransigence

When a ZOPA is very large (and is known by both parties to be large), there is value in being unable to accept an even division of value.  Imagine that we're negotiating over how to divide a million dollars between us.  If I say, "How about $100K to you and $900K to me," you'd most likely refuse angrily.  But suppose some external factor made it impossible for me to accept less than $900,000?  Maybe the eccentric millionaire who set up the game stipulated that as a rule.  In that case you wouldn't even be angry with me.  But what if I'd entered into a binding commitment with a third party that if I accepted anything less than $900,000 I would owe the third party two million dollars?  That side agreement would mean that my BATNA ($0) would be better than any division where I got less than $900,000 so you would know that there's no deal if you don't yield.

If I can credibly claim that I can't or won't take less than $900,000 you're faced with the choice of taking $100,000 or nothing.  Not very many people will turn down that much money out of spite or in the name of fairness.  (If you think you would turn down $100,000 just increase the size of the money.  Would you turn down $10,000,000 because I was getting $90,000,000?)

Looked at another way, if you're in a game of chicken and both cars are speeding towards each other there's value in being able to throw your steering wheel out the window, provided the other driver can see you do it.

The Republicans have taken a number of steps to throw their steering wheel away:

• Very public statements about both the amount of deficit reduction they require and the insistence that no tax increases be included.  Most dramatically, Republican leaders walked out of negotiations with Biden on the grounds that there was no point to having talks as long as Democrats were keeping tax increases on the table.  While such statements aren't legally binding they create electoral damage if Republicans go back on them.  (Think the first Bush and "read my lips.")  This is like my side deal.
• Use of Tea Party zealots.  From time to time freshman representatives have made fairly reckless and absolutist statements.  Obama and the Democrats might call the bluff of elder statesmen in the GOP, knowing them long enough to believe they wouldn't willingly cause a default but the true believers serve a dual purpose.  Republicans can claim that a moderate package won't pass and they can point to the political pressure they're under from the Tea Party.
• Claims that maybe a default wouldn't be so bad.  It's been generally accepted as an article of faith that any default -- even temporary -- on our debt obligations would have serious, long-term ramifications for us and for the world economy.  The GOP has been slowly challenging this notion over the past several months.  Some prominent Republican economists have argued that a temporary default (i.e. a delay in paying interest) wouldn't bother the bond markets if it were seen as part of getting our fiscal house in order.  One in particular compared it with someone who was a week late on their mortgage payment because they were putting their personal finances in order.  Another popular line has been that while a default would be very bad it would be even worse to raise the debt ceiling without substantially reducing our budget deficit.  Imagine our game of chicken again: if I can convince you that I think we're riding in bumper cars and that a crash won't hurt us, does that affect your thoughts on swerving first?

There are some clear indications that this approach has worked -- yielding impressive results for a party who controls the House of Representatives but not the Senate or the Presidency.  Reid and Obama have indicated a willingness to cut spending dramatically, including a limited willingness to cut Medicare spending.  After at first insisting that a deficit reduction package should include tax increases the Democrats are now fighting for the closing of some small "loopholes" that represent a small fraction of the spending cuts being considered.  Brooks calls the current offer "the deal of the century: trillions of dollars in spending cuts for a few hundred billion dollars of revenue increases".

That's something of an overstatement.  Obama has separately stated that he will not support any further extension of the Bush tax cuts on high earners; those tax cuts are set to expire next year and I don't believe Republicans have made a permanent extension part of the deal, although Republicans have said that agreeing to let them expire is off the table.  That issue may be left to next year, at which point the Democrats would likely have a much stronger hand.  Still, it seems likely that Republicans are in a position to agree a deal that gives them more than they could have achieved without the hardball tactics.

Likely, but not guaranteed.  Some Republicans will vote against increasing the debt ceiling at all, and some Democrats are likely to reject the initial agreement due to the perceived imbalance.  While some of the rhetoric is moving towards compromise there's no shortage of members of both parties saying they're willing to vote against a package they consider unacceptable.

The Chinese have a curse, "May you live in interesting times."  It will be interesting to see whether these negotiations lead to a successful result.