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irrational behavior

Greek Game Theory

Smooth operator.

Smooth operator.

Game theory suggests that it’s sometimes rational to behave irrationally. Case in point: Yanis Varoufakis, the Greek finance minister.

Varoufakis’ country is nearly bankrupt and other European community nations – especially Germany – hold the keys to any bailout. So you might expect Varoufakis to behave contritely toward his potential saviors. Far from it. Instead, he seems determined to make his opponents recoil in disgust and horror.

Varoufakis wears a black leather jacket (gasp!) to high-level ministerial meetings and lectures and hectors his fellow finance ministers. He’s rude, he shows up late, and his behavior borders on the bizarre. He alienates the very people who are poised to bail him out. In other words, he’s a very shrewd negotiator.

A Greek exit (Grexit) from the euro would create hardships for Greece and every other country in Europe (and perhaps far beyond). The European finance ministers claim that a Grexit would be much more “contained” than it would have been three years ago. But nobody knows for sure. It could spark a widespread panic.

Nobody wants a Grexit. But nobody can afford to give in either. Greece wants the bailout as long as it doesn’t include onerous conditions related to austerity and labor reform. Germany and the rest of the EC want to bail out Greece as long as they can claim that they’ve forced reforms on their wayward neighbor so that it will never happen again. Nobody wants a Grexit but both sides want a certain amount of theater.

An avid game theorist, Varoufakis knows that behaving irrationally is the best card he has to play. He needs to convince his opponents that he’s crazy. He wants them to think, “This man is just crazy enough to push the exit button. We can’t let that happen. We better not push too hard.”

As we learned the other day, behaving irrationally can cause the opposition to restrict their thinking and forego some options that might otherwise be perfectly acceptable. This is exactly what Varoufakis wants.

On the other side, the German finance minister, Wolfgang Schäuble, seems to be the designated “humiliator”. He’s taking a hard line and lectures Greece publicly and privately. He repeatedly reminds the Greeks that it’s time to clean up their act. Everyone knows that Germany is key to any compromise. By positioning the German finance minister (as opposed to say the Belgian finance minister) as Dr. No, the EC is trying to plant a simple thought in Greece: “These people really hate us. They might just pull the plug and force us out. We can’t let that happen. We better not push too hard.”

Both sides want to push the issue to the brink so they can tell their voters that they got the best deal possible. I expect two more weeks of theater followed by a compromise that no one likes but everyone can live with. In theory, it’s just a game.

When Irrational Behavior Is Rational

We can teach you international finance.

We can teach you international finance.

Not long ago, I drove to my doctor’s office for a 10:00 AM appointment. To get there, I drove past the University of Denver and a local elementary school.

The university students were ambling off to their ten o’clock classes. They ambled randomly, crossing the street from different locations and at different angles. Rather then using the cross walks, they often stepped out from behind parked cars. I couldn’t guess where or when they might emerge from hiding and step directly into the path of my car.

The elementary students were also on a break but they were formed up in neat lines. The younger ones held hands in well-organized two-by-two columns. Teachers were in control and the kids only moved when directed by adults. Then they moved only in predictable fashion in predictable directions.

I thought, “Huh … the school kids are much better behaved than the college kids. The college kids should behave like the school kids, not the other way round. The college kids may be learning advanced, abstract concepts but they need to get back to the basics.”

A few days later, I had another think and asked a different question: Which set of kids induced better, safer behavior in me? Clearly, it was the college kids.

Here’s how it works. When I drove past the elementary school, I was aware that school was in session. I drove slowly and paid close attention to my surroundings. At the same time, however, it was clear that the kids were well behaved and under control. I could predict their behavior and I predicted that they would behave safely. I was aware of the situation but not overly concerned.

With the college students, on the other hand, I had no idea what they would do. They were behaving irrationally. Anything could happen. By the elementary school, I was aware. By the university, I was hyper-aware. I drove even more cautiously by the university than by the elementary school.

The college kids influenced my behavior by acting irrationally. As it happens, that’s a key element of game theory – as formulated by John Nash, the brilliant mathematician who was also haunted by mental illness (and who died recently in a traffic accident).

In game theory, if you don’t know what your opponent will do, you may circumscribe your own behavior. I didn’t know what the college students would do, so I drove extra carefully. I ruled out options that I might have considered if the college students were behaving more rationally and predictably.

In other words, acting irrationally is often a perfectly rational thing to do. I’m sure the college students didn’t consciously choose to act irrationally. But a crafty actor might well behave irrationally on purpose to limit her opponent’s options.

In fact, I think this school example perfectly explains the behavior of the finance ministers in the current Greek financial crisis. More on that tomorrow.

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