Monday, August 22, 2011

Privatizing Keynes: Using Game Theory to Fight the Recession

According to neo-Keynesian economists, the problem with the economy is that people and businesses are hanging onto their money rather than spending it. There's a vicious cycle that needs to be broken: people aren't spending any money, because businesses are afraid to hire since demand is weak, so people either don't have jobs or are afraid of losing them, which leads them to spend less . . . The classic Keynesian solution is for the government to make up for the spending gap. But there's another, more private sector approach that could also work.

From this perspective, the recession is a collective action problem. Paul Krugman has a really nice parable about a babysitting coop in which everyone decides to babysit more to earn credits for future evenings out, but the result is that no one can get any credits because no one is going out, which the coop solves by issuing extra credits. If businesses could agree to hire, demand would be stimulated, and they would all be better off. But for any one business to act independently makes no sense since little of the increased demand from its own workers will be for its products. The problem is that solving the problem requires coordination.

Consider the following game. In step one, businesses make pledges to increase their workforce by an agreed amount, conditioned on a critical mass of other businesses doing the same. The pledges are not announced until the end of the commitment period. An equilibrium strategy is for everyone to pledge -- it costs nothing unless the critical mass is reached, but pays off in the form of increased sales otherwise. Moreover, if everyone else signs up, you're going to want to hire more people in order to deal with the increased demand. (Thus, this is a coordination game rather than a prisoner's dilemma). An added wrinkle, by the way, would be for the Fed to pledge to help finance all of this by buying corporate paper from companies that participate.

Once the pledges are made, what are the incentives to follow through with the hiring? One could be reputational. Firms that hire could advertise themselves as "Put America Back to Work" companies promised to hire but failed to do so would face unhappy consumers for their lack of patriotism. Another possible sanction is legal. There is some argument that the pledges are all made in consideration of each other, along the lines of the New York rules for charitable pledges established by Justice Cardozo.

This resembles some proposals that have recently been made by Joe Nocera and Marc Groz, but with some differences. They would make the commitment conditional on agreement by other firms in the same industry, which seems to me like an invitation to antitrust problems. Also, they are asking businesses to be public spirited whereas I'm focusing on the fact that a successful program will boost their sales.

This proposal is out in left field and implausible -- until the day it isn't. What makes it implausible is that it doesn't have enough credibility to be taken seriously, so it's not plausible for businesses to participate. But as soon as enough people take it seriously, then it becomes a live prospect because the likelihood of getting enough pledges becomes big enough to take seriously. (A bit like Tinker Bell, this proposal needs a critical mass of belief in order to be viable.)

How could this program get the credibility it needs to work? The President could put his weight behind it, or failing that, it could get some major employer like Walmart to back it. Neither is likely to happen until the idea has already begun to gain some public plausibility -- but that could happen from a bottom-up process, through social networks, blog posts, etc.

The classic remedies for recession make a lot of sense to me: increase the money supply and use government spending to stimulate the economy. But for political reasons if nothing else, those remedies are questionable now. So why not take the plunge and try something new?



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