Noel P. De Guzman
THE late American microeconomist, Jack Hirshleifer, once delivered a speech, entitled “The Dark Side of the Force”. In this speech, he calls the attention of economists to the important issues of “war, crime and politics” that are seldom tackled in conventional economic discourse. He points out that humans have two basic economic functions: the productive and the appropriative. And while much of mainstream economics deals with the first (as demonstrated by the profession’s obsession with issues of efficiency and economic growth), the second—the propensity for conflict—lies submerged.
Quoting Hirshleifer:
“The appropriative struggle can also take more energetic forms, for example strikes and lockouts, bank robbery, revolutionary warfare, and international confrontations. In short, the dark side is no mere outlying peninsula but rather an intellectual continent on the map of economic activity.”
and
“The bottom line is that nations with wealth-enhancing laws and institutions will not be able to enjoy the fruits thereof, unless, when challenged, they can put up a tough fight.”
These passages ring true today in the Philippines. Indeed, our government continues to face a sequence of potential and actual conflict situations: the territorial dispute with China, confrontations with local militant groups, such as Kadamay, and the ongoing crisis in Marawi City. As the most powerful entity in any nation, a government’s response to any security challenge is crucial.
Economics, and in particular, industrial organization and game theory can offer some insights. First, the government is the only institution in any nation that has a monopoly on the legitimate use of force. As “customers”, citizens pay taxes to ensure their protection from crime and invading armies. A government is therefore, first and foremost, a monopolist in the “protection industry”. However, over the years, governments have evolved and taken on multiple roles, such as the provision of public services, macroeconomic policy, disaster assistance and others. Hence, the government is also like a multiproduct firm that practices “bundling”. In addition, a government also practices price discrimination when it levies different tax rates to different citizens. There is, however, one other parallel that is quite relevant today: strategic entry deterrence.
China, the Maute Group and Kadamay all represent challenges to the present Philippine government, albeit in varying degrees. They all have appropriative motives and such cannot be realized unless the government surrenders some of its monopoly power over the use of force. In each situation, the government basically has two options: fight (or deter “entry”) or accommodate. The theory of strategic entry deterrence from industrial organization describes why an incumbent monopolist may choose one or the other of the two actions.
In the language of game theory, the present government seems to be involved in what is called the “chain-store game”. Introduced into economics by Nobel Prize-winning game theorist Reinhard Selten, the chain-store game gives rise to a celebrated paradox. In the game, an incumbent monopolist faces a sequence of competitors in different markets. The number of competitors is finite and the monopolist must devise a strategy that maximizes its welfare. The so-called chain-store paradox arises because the rational solution via backward induction (also known as the subgame perfect equilibrium) is for the monopolist to accommodate entry all the time. The simple logic is that when the monopolist decides whether to fight or accommodate in the last market, it chooses to accommodate since there is no more reputational gain to be had and fighting is costly. However, this situation is repeated in the second-to-the-last market if it is common knowledge that the monopolist accommodates in the last market. The game unravels backward until it doesn’t pay to fight any competitor.
The paradox is that choosing not to fight all the time does not seem natural. Looking at the Philippine government’s actions in recent months, it chooses to accommodate when it comes to China, fight the Maute Group and accommodate Kadamay. What explains this pattern of behavior? There have been several attempts to provide resolution of the chain-store paradox, including the roles played by uncertainty and asymmetric information. For example, economists, such as Kreps and Wilson, and Milgrom and Roberts, break the paradox by assuming that the competitor faces uncertainty about the strength and/ or preferences of the incumbent. This uncertainty allows entry deterrence (or occasional display of aggressiveness) to be rational even if, in fact, the monopolist is weak. It is also possible for a government to randomize its actions (i.e., play a mixed strategy) to gain advantage. Whatever the case may be, establishing a reputation for toughness (whether real or imagined) should take top priority.
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