A decision-tree framework for thinking about the Greek – Troika negotiations

This is a short post to update you on Greece. I continue to believe a deal can get done. Recent events demonstrate this is so. Nevertheless, the potential for policy error remains high. Brief thoughts below using a decision tree model framework

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This is a short post to update you on Greece. I continue to believe a deal can get done. Recent events demonstrate this is so. Nevertheless, the potential for policy error remains high. Brief thoughts below using a decision tree model framework

On a few occasions in the past, when I have discussed political negotiations, I have used the decision tree framework, most recently on Ukraine. And I think it is useful here for thinking about outcomes in the context of the consistency anchoring model I outlined last week.

Here is the brief synopsis. Implicitly, we do a mental calculus for every decision we take. We’re thinking quickly to ourselves that if I do this, the outcome is on net likely to favourable. But if I do that, the outcome on net looks less favourable. I’m in the grocery store and see five lines and I look quickly at how much each person has in her basket and how long the line is and make a lightning on the spot calculus as to which line will get me to the register the quickest. We do these kinds of calculations every day, all the time, without even noticing.

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It’s the same in the political world. The caveat here is that politicians need to get elected. As a result, they need to calculate how their political decisions will be perceived by the electorate. Think of any specific political decision as yielding a set of possible political and economic outcomes, some of which are good for an incumbent politician and some of which are bad.  Now, we have short cuts, heuristics, we use to reduce the complexity of decision-making, allowing us to make decisions rapidly – and that means errors creep in. But, we are weighing the pros and cons. In making these calculations, a long-standing incumbent politician is risk-averse. She will almost always look to avoid uncertainty because uncertainty is another way of saying “choices have just multiplied exponentially and I am so overwhelmed that I can’t compute what’s best to do”. This is when policy errors happen, ones that lead to negative outcomes, sometimes to negative outliers – i.e. black swans. And that’s what gets you booted out of office.

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So, in negotiation, despite bluster and posturing, we can assume most incumbent politicians will look to eliminate uncertainty by avoiding decision tree nodes that explode the potential number of outcomes. It’s like Chess: there are standard moves that yield standard responses because it is clear what the best move is. That’s why Chess openings are studied and memorized by students of the game. But in any Chess match, you can get to a specific move where you have multiple choices, some that open you up to an incalculable number of moves and counter-moves, increasing the risk of error and others that have a more well defined and limited set of potential outcomes. The defensive and risk-averse strategy is to play to reduce uncertainty, to reduce outcomes. That’s because in a situation in which an incumbent chooses the risky node, outlier situations increase in probability and black swan events can occur. Think Lehman Brothers for example.

Also think of the distribution of outcomes as having fat tails. So, choosing the wrong decision node means moving from a more stable if unsatisfactory point with a limited range of outcomes to a less stable and less predictable point where catastrophic outcomes increase markedly. Greek Finance Minister Yanis Varoufakis knows this. And given that he is not the ‘incumbent’ in negotiations, his strategy must be to force the Troika’s incumbents to choose between the unlimited outcome node and the suboptimal but safer node, betting that they will eventually go with the safe option.

Varoufakis’ red line Op-Ed in the NYTimes accomplishes this goal by putting the ball in the Troika’s court. Believing that Varoufakis is serious, the Troika must now deal with the consequences of Greece running out of money and defaulting or choose the safer option of making an interim loan agreement and battling over the longer-term agreement over a much longer time-frame. I believe the Troika will go with the safer option because the other one is so reckless. Greece must believe this as well because it is tabling a draft agreement suggested by EC economics commissioner Pierre Moscovici that is very much not in alignment with what the Eurogroup finance ministers are looking for. 

I believe this Moscovici option, which is basically a 4 to 6-month bridge loan without a clear commitment to a Troika program, will now anchor further discussion and the Eurogroup finance ministers will be forced to take it with minor caveats or risk the fallout of Greek default. I don’t think the language I am hearing from the Troika says they have backed themselves into a rhetorical corner. There is wiggle room for a deal that is consistent with past policy stances on both sides. Only if the Troika can convince themselves that black swan events are almost certain not to occur if Greece defaults will we see them reject a deal with Greece. Otherwise, a deal remains the base case outcome.

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