Game theory and America’s budget battle

By Anatole Kaletsky
October 3, 2013

So far, the battle of the budget in Washington is playing out roughly as expected. While a government shutdown has theoretically been ordered, nothing much has really happened, all the functions of government deemed essential have continued and financial markets have simply yawned. The only real difference between the tragicomedy now unfolding on Capitol Hill and the scenario outlined here last week has been in timing. I had suggested that the House Republicans would give way almost immediately on the budget, if only to keep some of their powder dry for a second, though equally hopeless, battle over the Treasury debt limit. Instead, it now looks like President Obama may succeed in rolling the two issues into one and forcing the Republicans to capitulate on both simultaneously.

The ultimate outcome of these battles is now clearer than ever. As explained here last week, the Tea Party’s campaign either to defund Obamacare or to sabotage the U.S. economy was doomed by the transformation in political dynamics that resulted from November’s election — above all by the fact that the president never again has to face the voters, while nearly every member of Congress must. This shift in the balance of power made the Republicans’ decision to mount a last stand on Obamacare, instead of attacking the White House on genuine budgetary issues, politically suicidal as well as quixotic. But while the outcome now looks inevitable, the timing of the decisive battle is important. Financial markets and businesses have responded with a tolerance bordering on complacency to the shenanigans in Washington, but this attitude could change abruptly if the House Republicans’ capitulation is delayed too long. As they say in the theater, the only difference between comedy and tragedy is timing.

The risk, as everyone now realizes, is that the battle of the budget — which turns out really to be just a minor tussle over the funding of a limited range of worthy but nonessential government services — remains in a stalemate right up to October 17, when U.S. Treasury is expected to hit its debt limit. At that point, an immediate settlement will be needed or all hell could break loose. The key question for businesses and investors around the world, therefore, is whether the Republicans’ impossible demands to defund Obamacare are removed from the budgetary bills comfortably before the October 17 deadline, or whether this capitulation is triggered by a financial crisis once the deadline draws too close.

Until recently, the Republicans believed October 17 would be their moment of maximum leverage, since President Obama would have no choice but to make concessions or face an economic meltdown. But now it is becoming clear that Republicans will be the ones facing maximum pressure as the debt limit draws near.

Game theory teaches that in such confrontations we must assess the costs to the players of fighting and also of backing down. Republican Congressmen, if they continue fighting right up to the debt limit, will have to answer to voters for the economic mayhem that a Treasury default could cause. Obama, on the other hand, has nothing to fear from elections since he will never run again. The costs of retreat also favor the White House. For the president to back down and gut Obamacare would destroy what he sees as his greatest achievement and would confirm his lame duck status. For the Republicans, by contrast, allowing the budget and debt ceiling to pass would leave them exactly where they were a few weeks ago.

In logic, such calculations should force the Republicans to back down quickly, extracting whatever small face-saving concessions the White House might offer them to avert any further political embarrassment and economic harm. Such concessions might include agreement to go ahead with the Keystone oil pipeline, or to reduce the unpopular excise tax on medical equipment, or to launch a formal process of discussions on revenue-neutral tax reforms.

Many Republicans seem to be making such calculations. Within 48 hours of the government shutdown, the Washington Post had identified 18 Republican Congressmen who had publicly expressed willingness to vote with the Democrats on a “clean” budget resolution, plus four leaning that way — and the numbers were growing every hour. Since only 17 Republican defectors would be needed to pass the budget, the deadlock seemed almost over — and this whole manufactured crisis may indeed be resolved by the weekend.

Unfortunately, however, such a happy outcome is far from certain. The reason, ironically, is that the Republicans have backed themselves into a position that is now too weak, thereby tempting the Democrats to overplay their hand.

By any rational standards, Obama should now offer the Republicans some minor concessions in exchange for a long-term deal on the debt limit that would permanently cure this headache blighting his presidency. Such a deal would save Obama from lame duck status and maybe even boost him into the ranks of transformational presidents if his health policy gains the popularity he expects. Long-term resolution of the debt limit would also be a powerful economic tonic, catapulting Wall Street to new records, underpinning the dollar and perhaps inspiring the upsurge in business confidence, investment and hiring that has remained so frustratingly elusive since the Lehman crisis.

The danger, however, is that Obama is now so confident that he will refuse any small concessions that might allow the Republicans to surrender with dignity. By trying to drive too hard a bargain, the Democrats could push the rational Republicans who are almost ready to surrender into the arms of their suicidal colleagues. The suicide mission to defund Obamacare, even if it continues, will probably be abandoned well before the Treasury debt limit is breached on October 17. But the risk of financial panic and serious economic damage will mount every day as the deadline approaches. Why take this risk? Game theory says that skillful negotiators should offer their opponents a relatively painless way to back down. Obama should look for a way to help moderate Republicans save face.

PHOTO: U.S. House Speaker John Boehner (R-OH) walks from a meeting with U.S. President Barack Obama, House Minority Leader Nancy Pelosi (D-CA), Senate Majority Leader Harry Reid (D-NV) and Senate Minority Leader Mitch McConnell (R-KY) outside the West Wing of the White House in Washington, October 2, 2013. REUTERS/Jason Reed

23 comments

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What game theory actually says is: ”F**k you buddy”:

http://www.youtube.com/watch?v=3fSCRxoEd j0

Posted by satori23 | Report as abusive

As far as I understand, the game is not as simple as my favorite Reuters’ author says.

Only the Speaker of the U.S. House of Representatives has the right to arrange the voting.

It is the procedure. And this is The Problem everybody everywhere is discussing.

Mr. Boehner would hardly have started it without this right of the Speaker of the House.

It makes the whole game more intriguing, doesn’t it?

Posted by OUTPOST2012.NET | Report as abusive

They can increase the debt ceiling even if they haven’t come to terms on the budget. In fact, they should do that first in order to take the debt ceiling off the table and reassure the financial markets (and the American public). It is true that the government shutdown makes October 17 a softer number for determining when the debt ceiling is reached, but it is not clear that the Treasury Department is allowed to recalculate that date as long as the government is shut down. Only public safety workers are deemed essential for shut-down workers, and this would be a stretch for Treasury’s accountants. Not only are government employees not paid as long as the government is shut down, but the 1870 Anti-Dilution Act makes it illegal for them to volunteer to work for free. So October 17 is a hard date even if it is a soft date. They should take care of that first and then deal with the appropriations issues.

Posted by Bob9999 | Report as abusive

Mr. Kaletsky, you’ve got the game wrong, and thus come to an incorrect conclusion. It’s Congressional Dems vs. Reps, not Obama vs. Reps. In that scenario, both Dems and Reps have an equal something to lose; i.e. being voted out. The Rep strategy of approving and presenting bills that fund everything, but delay Obamacare, is brilliant. It brings extreme clarity to voters. Similar to the Dem doves changing themselves into hawks on Syria, they refuse to fund their beautiful gov’t programs because it threatens the credibility of their Dear Leader. We all see this, and it harms the chances of Dem re-elections, not those of Reps. This Dem game-playing is backfiring with moderate Americans and can turn the Senate Rep.

Posted by sarkozyrocks | Report as abusive

A minority of fatcat knuckle-dragging toothless hillbillies is holding the nation for ransom and you think that there is room to let them save face when they should be in prison for treason? You’re kidding right? Ha haaaaa haaaaaa haaaaaa

Posted by lotuslandjoe | Report as abusive

Unfortunately, Mr. Kaletsky is not correct. Game theory would require that POTUS offer a small concession only if POTUS’s “win” were something other than no concessions in return for a clean CR. This is not a criticism of POTUS – only of Mr. Kaletsky’s analysis.

Posted by MrCommonSense | Report as abusive

“Republicans’ impossible demands to defund Obamacare”…

Please explain why these demands are “impossible”. You present this as an incontrovertible fact when in fact it is no such thing. The elimination of this socialist program set up by the naive fool in the White House and his band of black radicals seeking “reparations” under another guise (i.e. income redistribution by means of government hand outs and government jobs assigned solely under affirmative action pretenses) and their Jewish communist backers is just as possible as setting it up in the first place.

Posted by Mjolnir | Report as abusive

Actually, in reality the preferences of the negotiators
or representatives of the two parties,(for the two parties in a give-and-take situation of bargaining)after deducting the cost of agreement, vis-Ă -vis costs as well as benefits, determine the outcome of a situation, like the one, we are observing now. Mr. Kaletsky has overly emphasized the cost side. What is true in reality, is the melodrama created by the subjective elements!

Posted by jkgrope | Report as abusive

The game would be more interesting with the 14th Amendment’s invoked.
This is a constitutional crisis. It is not politics “as usual.”
The ACA is the law. If the House refuses to finance the law referring to the debt ceiling – it’s within the 14th Amendment.
Yes, it would be unprecedented. Yes, Obama doesn’t want to involve the Supreme Court.
However, if the divide continues, it would be the case for SCOTUS.
Boehner or Cantor – it doesn’t matter. We may observe the same situation for more years. Considering gerrymandering skillfully arranged by Republicans, we can assume that the mid-term election will not resolve the divide.
What is a constitutional crisis – if not what we see?

Posted by OUTPOST2012.NET | Report as abusive

Even the smallest concession under current circumstances would be a reward for Republicans’ extortionary tactics, and set an ugly precedent for the legal process.

Posted by brianpforbes | Report as abusive

Speaker is not a simple guy. The idea to raise the debt ceiling while keeping the government unfunded – is smart; I should admit.

The Senate and Obama will not buy it. But this way both sides can be harmed.

It is “the Republicans’ extortionary tactics.” Well said, brianforbes.

Posted by OUTPOST2012.NET | Report as abusive

I appreciate the approach of analysis by leveraging game theory. However both positions may not be fully presented.

The republicans who were elected to perform a specific task on a very fiscally conservative platform may either A) not run for re-election or B) lose their seat if they do not pursue this agenda (as many of their predecessors did).

There may also be gaps in the stance on the Senate (mostly Democrat) position. There are more entrenched, life-long, members of the Senate that have more to lose if their pet projects are no longer funded by the Federal government. If they lose the perceived “need” for these projects then the average voter may find they can live without as many Federal programs especially as it may relate to their tax burden.

For example, if there is a bridge (Federal program) that crosses a river in-between two other bridges (State and Local programs) and it is rarely used, will it be missed if torn down?

Posted by truetoform | Report as abusive

Shallow column – there is zero chance that a small concession would satisfy Republicans. By offering concessions he would merely validate yet again the Republican strategy of using leverage over must-pass legislation as a vehicle to pass a whole wish list of policy prescriptions. Review the Bush tax cut negotiations. It also is no accident that the “compromise” Republicans are likely to steer for would be really short-lived so that the whole process could be repeated yet again.

Posted by abrasket | Report as abusive

The market must worry enough to spook the Mad Hatter’s Tea Party (otherwise, the lack of market concern might be considered a partially self-inconsistent condition), but there’s another reason for the market effectively yawning: the extremists in Washington have been doing this for years. This shut-down was almost totally predictable, and already priced into the market to some degree (and more to the point: where else is anyone going to keep their money at the moment? In the bank, where we’re 100% guaranteed to lose money through “credit interest” at 2% below inflation?)

As much as the extremists can tank the market through intransigence, at least we can see a potential end-game to all of this now, in a newly emboldened Obama pressing his case and in the potential for a generational political castration of the uncompromising factions in Congress. The long nightmare might finally be almost over, or otherwise, might be about to get a whole lot worse, quite suddenly, in a way that will make it almost pointless to shift money OUT of the system. Wake up Congress: POLITICS = COMPROMISE! It’s supposed to be, by definition, a POLITE means of achieving the best compromise attainable. No one party can be right all of the time!

Posted by matthewslyman | Report as abusive

You say “While a government shutdown has theoretically been ordered, nothing much has really happened.”

800,000 families without a paycheck is nothing much? Thousands of foreign tourists, who have spent a small fortune to tour the US, are turned away from our parks, and that is nothing much?

Countries around the world are looking at our democracy, see basically that it isn’t working, is chaotic and unpredictable, and start wondering if democracy is really as valuable as we say it is. And that is “nothing much”?

China’s new president, after a smooth and efficient transfer of power, is touring Asiatic countries, offering economic trade agreements and our president canceled his trip and is sitting at home … and that is “nothing much”?

You have a strange view of “nothing much.”

Posted by Jeff9207 | Report as abusive

I think, Mr. Kaletsky, that you’re underestimating the intransigence of the Republicans. As you correctly referenced, those fueling this clown show live in safe, serpentine-gerrymandered districts. They will actually benefit from this. The nastier they are to Obama, the greater their fund raising prowess. A lot of their adherents would rather see the treasury default on our debt obligations then to see their Tea Party darling cry uncle to Obama, even if it had serious adverse consequences to our economy. Because if that happened, their Representative or Senator (in the case of Ted Cruz) would blame Obama and that would give those adherents a fresh new reason for hating Obama.

The sad thing is, they don’t really know why they hate Obama so much, but that’s what they’ve been taught to do. Ask them why they hate Obama and you’ll get a variety of vague, unsubstantiated reasons, like he goes around apologizing for America (I was actually given that answer) or that he’s trying to turn America socialist. (Heard that one, too.) (See Mjolnir’s comment above for a fine example of this. Boy, does he drive home my point.)

So I think the Tea Party jokers have nothing to lose. The challenge will be for the Republican, well, not moderates, but, the less extreme Republicans, have shown little willingness to stand up to the Tea Party. It’s all gotten out of control and now the Republicans seem to only care about keeping their seats, and they seem to be convinced that the safest strategy for doing that is to continue confronting Obama, who’s intent on forcing us to pay reparations to his band of black radicals. (Sorry, I couldn’t resist.) It could easily become a situation where no one wants to play the adult and so no one does. And off we go, over the cliff.

The ironic thing about all of this is that the Republicans claim to be about fiscal responsibility, and yet their behavior couldn’t be more economically irresponsible. Tea Party adherents don’t seem to understand the potential consequences of their actions. If we default it would be the biggest squandering of our economic resources since the Iraq War, also a brainchild of the fiscal responsible Republicans.

Posted by flashrooster | Report as abusive

I usually agree with Kaletsky, but not here.

I voted for Obama the first time around, but when he came out so strongly for mass immigration into the US, I came to see him (Obama) as an enemy to the American middle class. Immigration on such a large scale is unprecedented.

Now I am supporting the House Republicans. They are the only political group in America with the courage to question the current explosion in immigration that is flooding American labor markets, driving down wage rates. Immigration is flooding the American housing market, driving up housing costs and rents, destroying the careers of middle class America, and increasing the profits of wealthy corporate employers and landlords.

WHO STICKS UP FOR THE AMERICAN MIDDLE CLASS?
The President is a strong advocate for increasing immigration even more, stabbing the American people in the back. The Senate Democrats and Senate Republicans, bought off by the wealthy plutocrats, likewise advocate more immigration amnesties and more immigration.

It is only one courageous group alone, the HOUSE REPUBLICANS, who were loyal to the American people when the recent immigration amnesty bill was put before them, and they refused it.

That is why I, and many other people, look beyond this budget battle, and support the brave HOUSE REPUBLICANS. They are the only group who has not yet betrayed the American middle class to the globalist plutocrats.

The President, the Senate Democrats, the Senate Republicans, and the House Democrats, and even the US military, have all stabbed the American people in the back on immigration. Why is the military not protecting us from this invasion?

That’s why I gladly support the House Republicans in their brave struggle.

http://finance.yahoo.com/news/countries- most-immigrants-161952285.html

Posted by AdamSmith | Report as abusive

We are in this situation, because the Republican strategy to this “game” is being driven driven by people who haven’t played the game before and (like mediocre chess players) incorrectly use flashy surprise moves in a belief that they can prevail by psychologically intimidating a player with a better understanding of the game who is in an objectively superior strategic position.

Posted by Bob9999 | Report as abusive

Also, from a game theory point of view, the Democrats may be worse off over the long term if the Republicans end up with a resolution that allows them to save face. That is because this is not an isolated event but is, instead, one of a series of games. One game occurred in 1995 with the government shutdown then. Another game occurred in 2011 with the debt ceiling crisis. Any resolution the leaves the impression that it might be possible for the Republicans to prevail in the future by modifying this approach tactically will increase the likelihood that such a thing may happen. The best long-term strategy for the Democrats may be to get out of the temple, let Samson bring the roof down, and then pick up the pieces. That may not be the best approach for the country as a whole, but it is probably the best approach the Democratic party.

Posted by Bob9999 | Report as abusive

With their increasing support for GLOBALISM, the Democratic party has shown that they do not care for the American working class. They care only for the welfare class and the wealthy class. They care for the people of Mexico, Philippines, Indonesia, Nigeria and Somalia. But they don’t care about the American people.

Obama’s forceful push for a wider trade pact last week (further removal of American protective tariffs), and the Democratic controlled Senate’s overwhelming support for “immigration reform” (meaning amnesty and accelerated immigration and H1B Visas) last month demonstrate that the Democrats have become America’s worst enemy.

The House Republicans are fighting the Democrats and many people like me, who are definitely not Tea Party types, are behind the valiant HOUSE REPUBLICANS in this budget battle.

Unfettered globalism is quickly destroying America under the guidance of big money and big business. Obama is with them, and so are the Senate Republicans.

The House Republicans are the only group standing in the way of America’s destruction by the globalists, and this budget battle is their only available weapon.

That is why many people such as myself are supporting the House Republicans and John Boehner.

Posted by AdamSmith | Report as abusive

@satori: thanks for that bbc link! looks interesting.

#2. Have all of you bright netizens and Mr Kaletsky considered that this whole gov shutdown thing works beautifully for the Fed! The Fed is looking for a trigger to “let go” of interest rates. They need this game to be played out.

Thus it is in “strategic” interest of BOTH Tea Party/Repubs/and Democrats.

Really it amazes me how people swallow everything guv press releases dish out on face value. The game is much more cynical.

Posted by kiers | Report as abusive

Smartest move for the House Republicans is to insist on defending the American middle class.

The only way for the American people living today to have a decent future requires two things:

1. Stop welfare.
2. Stop immigration.

Posted by AdamSmith | Report as abusive

Our buddy AS sees all articles, regardless of topic, as another opportunity to tout his 19th century anti-immigration, anti-globalization, anti-trade stand.

Posted by jambrytay | Report as abusive