Friday, April 3, 2009

G-20 and John Nash

Essential task for G20 leaders is a cinema trip to see 'A Beautiful Mind' by Mohamed A El-Erian and Mike Spence;
The US is in the grips of an accelerating process of employment destruction, with over half of the 4.4m jobs lost in the last four of the 14 consecutive months of contraction. Accordingly, its policymakers are pressing other countries to internationalise a massive fiscal stimulus effort. In doing so, they also recognise that the return to the stimulus will be much higher if the financial system and housing are stabilised, because they too are part of the negative feedback dynamics.

Eurozone countries generally agree on the importance of fiscal stimulus. Yet they are not surprisingly uncomfortable with what the US is pressing for. The recession in the region is less advanced, the tolerance for economic pain is higher, and the cross-border leakages are significant.

In these European countries, the focus instead is on long-standing concerns about abuses in the financial sector which are seen to have provided both the fuel and the spark for today's global crisis. Accordingly, policymakers stress financial regulatory reform as the key components of crisis management and crisis prevention.

At one level, emerging economies do not disagree with the US and Europe. Yet, when it comes to their central revealed preference, the onus is to stress a third element: the need to counter trade protectionism and ensure the appropriate flows of international capital. Brazil's President Lula's forcefully advocated this position when he visited President Obama in the Oval Office earlier this month.

Here is where John Nash comes in. The differing onus reflects the fact that various countries start with diverse "dominant strategies" consistent with differences in their initial conditions, be they economic, political or social. Moreover, there is merit in all three. Yet, as the concept and incentive structure of the "prisoners' dilemma" illustrates, the world will undoubtedly end up with a sub-optimal outcome if each party to the solution were to follow just its dominant strategy.

Given the accelerating nature of the crisis, a Nash equilibrium of this type would go down in history as a notable lost opportunity, if not a disastrous mistake similar to what occurred in the international conference of 1933. Accordingly, and again using Nash's framework, the world needs to find a way of "imposing" a more "cooperative solution." What is needed domestically and globally is a coordinated solution that changes the payoffs and hence the virulence of the downward dynamics.

The two traditional ways to get there are ineffective in today's global economy. The IMF needs to address long-standing representation, governance and expertise deficits before it can restore its position at the centre of the international monetary system. The alternative of single country leadership requires a weakened US to step up to the plate more forcefully and, critically, in a manner that recognises that persuasion will work better than lecturing.

So, are we doomed to end up in a sub-optimal non-cooperative Nash equilibrium? The probability is high but it is not inevitable. There is still time for more meaningful cooperation among countries based on the simultaneous, rather than sequential, pursuit of the three priorities: real economy stimulus, financial system stabilisation and openness.

1 comment:

Janet Brown said...

The U.S. Chamber of Commerce has done great work on key issues facing America -- assessing our country's strengths and weaknesses and outlining the public policies we must pursue to succeed in the world economy. I was glad I could help take action on their web site ( with several petitions focusing on everything from the economy and energy to healthcare and legal reform.