Crimea Through a Game-Theory Lens

MARCH 15, 2014 

Economic View

By TYLER COWEN

In 1997, soldiers prepared to destroy a missile housed at a former Soviet base in Ukraine. After the Soviet Union’s breakup, Ukraine gave up its portion of the old Soviet nuclear arsenal.CreditAssociated Press

A Russian occupation of Crimea raises the specter of the Cold War, in which the nuclear stalemate between the United States and the Soviet Union devolved into regional disputes around the world.

While military and political frictions made the biggest headlines, the Cold War couldn’t be well understood without using economic theory — specifically, game theory, which analyzes the strategic logic of threats, credibility and conflict.

NUCLEAR DETERRENCE From the standpoint of game theory as developed by Thomas C. Schelling, a 2005 Nobel laureate in economic science, the conflict can be seen as a case study in nuclear deterrence. That’s because, after the Soviet Union split into many pieces in the 1990s, a newly independent Ukraine gave up its portion of the old Soviet nuclear arsenal. In part, it did so in exchange for a memorandum supporting its territorial integrity, signed by both Russiaand the United States.

Eliminating its nuclear weapons may have seemed a good deal for Ukraine at the time, and it can be argued that the world became a safer place. Yet if Ukraine were a nuclear power today, it would surely have a far greater ability to deter Russian military action.

TIPPING POINTS Long before Malcolm Gladwell popularized the concept, Mr. Schelling created an elegant model of tipping points in his groundbreaking work “Micromotives and Macrobehavior.” The theory applies to war, as well as to marketing, neighborhood segregation and other domestic issues. In this case, the idea of negotiated settlements to political conflicts may be fraying, and the trouble in Crimea may disturb it further, moving the world toward a very dangerous tipping point.

First, some background: With notable exceptions in the former Yugoslavia and in disputed territories in parts of Russia and places like Georgia, the shift to new governments after the breakup of the Soviet Union was mostly peaceful. Borders were redrawn in an orderly way, and political deals were made by leaders assessing their rational self-interest.

In a recent blog post, Jay Ulfelder, a political scientist, noted that for the last 25 years the world has seen less violent conflict than might have been expected, given local conditions. Lately, though, peaceful settlements have been harder to find. This change may just reflect random noise in the data, but a more disturbing alternative is that conflict is now more likely.

Why? The point from game theory is this: The more peacefully that disputes are resolved, the more that peaceful resolution is expected. That expectation, in turn, makes peace easier to achieve and maintain. But the reverse is also true: As peaceful settlement becomes less common, trust declines, international norms shift and conflict becomes more likely. So there is an unfavorable tipping point.

In the formal terminology of game theory, there are “multiple equilibria” (peaceful expectations versus expectations of conflict), and each event in a conflict raises the risk that peaceful situations can unravel. We’ve seen this periodically in history, as in the time leading up to World War I. There is a significant possibility that we are seeing a tipping point away from peaceful conflict resolution now.

MARKET DETERRENCE A more reassuring kind of deterrence has to do with the response of Russian markets to the crisis. Russia is a far more globalized economy than it was during the Soviet era. On the first market day after the Crimean takeover, the reaction was a plunging ruble, and a decline in the Russian stock market of more than 10 percent. Russia’s central bank raised interest rates to 7 percent from 5.5 percent to protect the ruble’s value. Such market reactions penalize Russian decision makers, who also know that a broader conflict would endanger Russia’s oil and gas revenue, which makes up about 70 percent of its export income.

In this case, market forces provide a relatively safe form of deterrence. Unlike governmental sanctions, market-led penalties limit the risk of direct political retaliation, making it harder for the Russian government to turn falling market prices into a story of victimization by outside powers.

CREDIBILITY AND CONSEQUENCES How much credibility will the United States lose if it doesn’t respond forcefully to Russian action? This, too, is a problem of game theory.

A commitment by a sovereign state is credible only when that state’s self-interest dictates honoring it. Previous American pledges to help or protect Ukraine were not all that credible to begin with, given the greater power and historical influence of Russia in the region. Failing to protect Crimea therefore doesn’t automatically lead to a big shift in the world’s perception of American willingness to honor commitments where the nation’s loyalties and interests are more certain. Daryl G. Press, a professor of government at Dartmouth, articulates a general version of that argument in his book “Calculating Credibility.”

Still, there may be a net loss of credibility, perhaps a serious one, when the world is uncertain where American self-interest lies. For instance, how dedicated is the United States to protecting various disputed small Asian islands from Chinese domination or conquest? How much does America care about the de facto independence of Taiwan these days, or about limiting China’s influence in the South China Sea? The answers may not be obvious, especially in a diverse democracy like ours.

But for strategists in China and elsewhere in Asia seeking clues to American behavior, it’s possible that the effectiveness of the United States response on Crimea will matter a great deal. For actual deterrence, the United States would mainly need to create negative consequences for Russia, not just engage in posturing.

In any case, it is unlikely that Russia will happily reverse course and hand back Crimea, and so we may well see some careful calculations on how negative those longer-term consequences will be. In this sense, economics — through the medium of game theory — is again earning its moniker as the dismal science.