Saturday, November 17, 2012

Fiscal cliff prediction: Dems will prevail

People are wondering what will happen as we approach the fiscal cliff. Neither side wants to go over it, but how can they come to an agreement? Political analysts debate the election outcome and who has what kind of mandate. The analysis gets murky, because both sides have arguments that the election ratified their position - Obama won, but GOP retained the House.

Some people look to game theory for clues on how this might play out. I've read several analyses that liken the situation to a game of chicken. Think of "Rebel Without a Cause," where the two teens are driving cars straight for a cliff, and the first one to "chicken out" is the loser. This is obviously not a great game to find yourself playing, because it's very possible that not losing could also mean not surviving.

But thinking of the fiscal cliff negotiation as a game of chicken is dead wrong, because a necessary precondition of the chicken game is that shooting off the cliff is an equally undesirable outcome for each player, and that's not the case with the fiscal cliff.

The way I see it, there are 5 basic consequences of our going over the fiscal cliff, each with varying degrees of alignment to the parties' policy objectives:

1. Analysts say the cliff will cause a recession: no one wants this to happen.
2. Tax rates of rich people will rise: Good for Dems, bad for GOP.
3. Tax rates of regular people will rise: no one wants this to happen.
4. Defense spending will be slashed: Good for Dems, bad for GOP.
5. Non-defense discretionary spending will be slashed: Bad for Dems, Good for GOP.

So, no one wants #1 and #3 to happen, but Dems want to see #2 and #4, while GOP only gains from #5. In my admittedly simplistic scoring, Dems win, 2-1.

The great game theorist John Nash provided a very simple means for predicting the outcome of a negotiation, which boils down to this: whoever has less to lose from a breakdown in talks will wring the most from their opponent. From a policy perspective, it's clear that the Democrats have the least to lose from going off the cliff and therefore the most likely outcome is that the two sides will reach an agreement to avert the cliff and the terms of the agreement will favor the Dems, though probably not without at least some compromise along the way.

Of course, just because the Dems have the upper hand doesn't mean they won't misplay it somehow. Many liberals feel like Obama has a poor track record in negotiating with Republicans. I have the exact opposite view, as evidenced by the simple fact that those earlier negotiations have led us to this scenario where the rules are so clearly tilted in his favor. Game, set, and match.

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