Prediction: How to See and Shape the Future with Game Theory

by Bruce Bueno de Mesquita

This produces the dilemma. If both crooks kept quiet they would each get a fairly light sentence and be better off than if both confessed (five years each versus fifteen). The problem is that neither one benefits from taking a chance, knowing that it’s always in the other guy’s interest to talk. As a consequence, Chris’s and Pat’s promises to each other notwithstanding, they can’t really commit to remaining silent when the police interrogate them separately.

Nash defined a game’s equilibrium as the planned choice of actions—the strategy—of each player, requiring that the plan of action is designed so that no player has any incentive to take an action not included in the strategy.

The central characteristic of any game’s solution is that each and every player expects to be worse off by choosing differently from the way they did. They’ve pondered the counterfactual—what would my world look like if I did this or I did that?—and did whatever they believed would lead to the best result for them personally.

Part of my task as a consultant is to work out how to get players to select strategies that are more beneficial for my client than some other way of playing the game. That’s where trying to shape information, beliefs, and even the game itself become crucial, and in this next section I’d like to show you just what I mean.

Using strategies that involve mixing up moves to create a change in expectations is something that comes up all the time. Although applied game theorists often like to ignore these complicated “mixed strategy” approaches to problems, they do so at their own peril. Rolling the dice can really make a difference in how things turn out.

After some clever give-and-take, Gutman retorts, “As you know, sir, men are likely to forget in the heat of action where their best interests lie and let their emotions carry them away.”

In this brief exchange we see three lovely principles of game theory at work: the question of credible commitment; the use of playing probabilistically to alter how others look at the situation; and the pretense of irrationality (the heat of the moment) for strategic advantage.

This scenario looks at trade-offs between U.S. political and economic concessions in exchange for North Korean concessions on the nuclear front.

First, the facts. In my experience, all that is necessary to make a reliable prediction is to: Identify every individual or group with a meaningful interest in trying to influence the outcome. Don’t just pay attention to the final decision makers. Estimate as accurately as possible with available information what policy each of the players identified in point 1 is advocating when they talk in private to each other—that is, what do they say they want. Approximate how big an issue this is for each of the players—that is, how salient is it to them. Are they so concerned that they would drop whatever they’re doing to address this problem when it comes up, or are they likely to want to postpone discussions while they deal with more pressing matters? Relative to all of the other players, how influential can each player be in persuading others to change their position on the issue? That’s all you need to know. That’s all? you might ask. What about history? What about culture? What about personality traits? What about almost everything else that most people think is important to know?

Experts have invested years in learning a place’s culture, language, and history. They follow the intimate political details that go on in the area they study. If anyone knows who will try to shape decisions, how influential those people can be, where they stand, and how much they care about an issue, it is the experts. Come to think of it, isn’t knowing this information what it means to be an expert?

It’s important to remember that experts alone do not do nearly as well at anticipating developments as do experts combined with a good model of how people think. A declassified CIA study reports that my forecasting model has hit the bull’s-eye about twice as often as the government’s experts who provided me with data.1

Consider the computer’s advantage. Suppose we were examining the North Korean nuclear problem in 2004, as I was, and suppose we simplified it (which I didn’t) to consider just five players: George W. Bush, Kim Jong Il, Russia’s Vladimir Putin, China’s Hu Jintao, and South Korea’s Roh Moo Hyun (ignoring Japan for the moment). How many conversations among the parties to the talks might each of those five decision makers want to know about?

Those 120 possible exchanges of points of view and beliefs about such exchanges are what can happen in a single round of bargaining with just five stakeholders.

Say you and some friends are trying to choose between two movies. Anyone who really truly wants to see The Sound of Music (or fill in whatever first-run movie might grab your fancy) gets a value of 100, and anyone really committed to seeing A Clockwork Orange (another great old film) gets a 0. Then you should be able to rate how strongly each friend leans toward one movie or the other. Any who are truly indifferent get a 50; anyone leaning slightly toward A Clockwork Orange might be close to 50, say at 40 or 45, and so on. You or the “expert” you are interviewing need to calibrate their strength of feeling as accurately as possible. This way, movie preferences are turned into one value for each chooser—that is, each family member and/or friend involved in shaping the decision. The process is exactly the same, although the choices may be more complex, whether deciding what movie to see or addressing North Korea’s nuclear choices. Sure, the stakes differ, but once the essential facts are extracted, the process of turning stated objectives into a predicted outcome is the same.

If you think a family member will drop what he or she is doing to discuss the movie to see, rate that person’s “salience” (variable 3 on my list) close to 100 (no one is ever really at 100). The less focused you think someone is on the movie choice, the lower the salience score.

Finally, figure out who you think has the most influence among your friends or family members if you assume that everyone thinks the choice is equally important.

In fact, the CIA has checked out the risk that different experts give greatly different answers leading to greatly different predictions. They found little variation in the predictive results from the sort of modeling I do, even when the people asked had dramatically different access to information.

William Casey, then Ronald Reagan’s director of intelligence, asked me to study this problem, and I was locked in a (cold) lead-lined vault at CIA headquarters to do it. I had access to classified information, but was not even allowed to read my own report when it was finished. The report was for the eyes of only the president, the vice president, the secretaries of state and defense, the national security adviser, and a few others. Meanwhile, my students worked on the same problem and were given access to the computer program I had developed to help solve such problems. They extracted the required information from magazines such as The Economist and newspapers such as The New York Times and fed their data into the computer. Ninety percent of them arrived at the same conclusions I reached in the lead-lined vault, and those conclusions about strategy proved to work rather well.

It should also tell us that a lot of classified information is easily reproduced from open, public sources for those who are willing to work at it.

One thing they want is a decision that is as close as possible to the choice they advocate. The second thing they want is glory—the ego satisfaction that comes from the recognition by others that they played an important part in putting a deal together.

We can extract two insights from figure 4.2 that can help us predict if we are looking at a purely international political decision (which we are not). First, there really isn’t that much clout supporting North Korea’s nuclear program. None of the positions that favor North Korea’s keeping a nuclear program are backed by a really large amount of power. Second, piling the mountains of power one on top of the other as we move across the spectrum of choices, we discover that the pile does not reach a majority of all the power until we get to the position designated as “Eliminate Nuclear Programs / U.S. Concessions.”

Kim Jong Il knows what it takes to retain the loyalty of his military leaders and to keep rivals at bay for years on end. He knows whom to antagonize and whom to placate. He certainly understands that he couldn’t defeat a concerted effort by the United States or South Korean governments to overrun North Korea and overthrow his government. But he also understands that he could raise the price of an invasion sufficiently that such an effort would be too costly to consider. In that case, by building a nuclear weapons capability he diminishes or even eliminates the most significant foreign threat to his political survival, freeing himself to concentrate on managing relations with his military leaders, party elites, family members, and senior civil servants. They, of course, could form various coalitions that might threaten his hold on power. Keeping them happy must be a primary concern for Kim Jong Il.

In practical terms this meant that the United States directly, or through third parties, needed to guarantee, and I mean really guarantee, not to invade North Korea. The United States also needed to guarantee a sufficient flow of money—we will call it foreign aid—so that Kim Jong Il’s key domestic backers would be assured of receiving substantial personal, private rewards from him.

I want to emphasize here that I have said “a verifiable means of ensuring that its nuclear weapons program stopped.” I have not suggested that North Korea’s nuclear weapons program and enrichment facilities be eliminated (positions 80 and above on the issue scale in figure 4.1) or dismantled. This is of fundamental strategic importance in making an agreement credible from both sides—so let me explain what I had in mind.

If he dismantled his nuclear capabilities, he would no longer have a credible threat of restarting his weapons program quickly in the event the international community—especially the United States—reneged on its promises.

So we can see that money and security guarantees for disabling, but not dismantling, Kim Jong Il’s nuclear program create a self-enforcing mechanism. Neither side would have an incentive to renege on its part of the bargain. It is a deal that reinforces each side’s interests. It is the deal that was struck and that, with minor tweaking and continuous jockeying for position, is likely to succeed.

For me, answering a question like “How can we make peace in the Middle East?” involves breaking this question down to specific issues, to specific choices that must be made. Therein lies the key. Questions need to be about actual choices confronting decision makers rather than about abstract ideas like winning or getting ahead.

Several years ago I worked with an international team of analysts on a major effort to create a unified defense industry across Europe, one that could compete with the American defense industry. We looked at virtually every possible combination of defense firms in Britain, France, and Germany, as well as several possible combinations that would have included defense firms in Italy, Spain, or Sweden. The question put to us was “Can we do these mergers?” To answer that question, my team needed to examine approximately seven different issues for each possible combination of firms for a total of more than seventy individual issues, each representing a decision that could make or break a multibillion-dollar deal.

The game structure I use looks at choices as sometimes involving cooperation, sometimes competition, and sometimes coercion.

The fraud model does not think of executives as altruists who lose sleep trying to think up ways to make shareholders better off. They commit fraud to protect their jobs in the face of poor performance rather than as a result of a desire to defraud investors per se. That means we can use public records to link the likelihood of fraud to any publicly traded corporation’s reported performance, ownership oversight, and governance-induced incentives to manage the firm truthfully.

In the fraud years, senior management receive less compensation—you read that right, less compensation, not more—than expected given their corporate governance structure and reported corporate performance. Dividends typically also fall short of expectations.

Why these patterns? CEOs always have incentives to take actions that protect their jobs.

If revenues are exaggerated or costs are understated, then senior executives can temporarily lead the marketplace to misjudge the true worth of a company, making the company appear (falsely) to have met or exceeded expectations. This, the model suggests, is the essential motivation behind corporate fraud.

What, then, are the right and wrong incentives? Why do some companies commit fraud while others—the vast majority of firms—even in dire circumstances do not? In answering these questions we can gain insight into how to alter incentives appropriately and how to anticipate who has the wrong incentives and is at serious risk of committing fraud.

Government regulators and boards of directors could do a better job of protecting shareholders and employees from the risk of fraud. To do so, the focus needs to be more squarely placed on the incentives executives have to monitor themselves and their colleagues in the face of declining business performance.

DIPLOMATS ARE CONVINCED that a country’s name is an important variable that helps explain behavior. That’s why the Department of State is organized around country desks, just as the intelligence community is organized around geographic regions.

That seems eminently reasonable and right. Yet it is only partly right and terribly inadequate for solving most problems, or, as I see it, for engineering the future.

As valuable as area studies is, it is by itself a poor substitute for the marriage of expertise about places and the expertise of applied game theorists about how people decide.

Country expertise is no substitute for understanding the principles that govern human decision making, and it should be subordinate to them, working in tandem to provide nuance as we actively seek to engineer a better future.

I’ve advised on cases where my client spent tens of millions more on lawyers than they paid in settlement.

Armies are the diplomat’s analog to the prodigious spending on lawsuits. Having more and bigger guns discourages others from picking fights with the well-armed. Deterrence works much of the time, but sometimes, just as with the deterrent threat of costly litigation, arms fail to protect the peace—and war results.

One reason that diplomats and attorneys do not avoid the huge costs of their pre-settlement minuets is that they simply don’t know bargaining theory.

The merits of the case don’t matter very much once negotiations begin—the merits are inherent in the impasse.

How can this be? Remember the information we seek in expert interviews. None of it is about how meritorious anyone’s position is. It’s all about calculating how much they care about the result and ferreting out how much they care about getting personal credit.

Justice requires that we distinguish between bad outcomes and bad intentions or willful ignorance. I don’t believe it’s fair to blame people when things turn out badly unless there is proof (and not just innuendo) that they intentionally chose actions or inaction when a reasonable person could foresee the bad consequences of their decision. It is best to judge people based on what they reasonably could know and expect before they did things, not based on what we know later, after the situation has played itself out.

No one should blindly follow a model. It is, after all, just a bundle of equations. But neither should people dismiss a model’s results out of hand just because its implications and their personal opinions differ.

Land for peace and peace for land are two formulas that are doomed to failure, whether in the Middle East or anywhere else.

All land-for-peace or peace-for-land deals by themselves will do the same. They are no way to end violence, because neither assures either side that the other is making a lasting promise, a credible commitment.

In fact, Israeli settlements almost always occupy the high ground surrounding Palestinian villages, making it all but impossible for Palestinians to enjoy a sense of security within their own homes. And even more troubling, Israel for decades restricted the movement of Palestinians into and out of Israel, just as they had done within Israel to Israeli citizens of Palestinian extraction. The upshot is that the Israeli government prevented Palestinians from following a peaceful road to independence by restricting their freedom of assembly. When Israel had the opportunity to promote peace with Palestinians after the 1967 war, it fell short, just as the Palestinians have fallen short in efforts to promote peace with the Israelis.

One way to change the game is to make costs and benefits change directly and automatically in response to the actions chosen by each player. A self-enforcing strategy solves this problem and can help promote peace and prosperity for each side. Here I would like to use the power of game-theory thinking to propose an important step toward peace between Palestinians and Israelis. It is not a comprehensive peace plan, but it is a way to make peace more likely. What I will say follows logically from game-theory reasoning, but it is not a mere assessment of what is likely to happen. It is a statement of logic in support of a way to end violence. It is a prescription for progress.