Editors' note: This column is part of the Vox debate on the economic consequences of war.
Several economic experts have called for more intensive measures on behalf of Germany and the EU to reduce ongoing oil and gas imports from Russia (e.g. Chepeliev et al. 2022, Chaney et al. 2022a), as these contribute significantly to financing the Russian state and the current war. Over 500 professionals have signed a petition calling for an oil embargo and tariffs on gas imports (Chaney et al. 2022b). Moreover, a broad group of German economists have shown only moderate negative impacts from a full embargo on Russian oil and gas imports for Germany based on extensive macroeconomic modelling (Bachmann et al. 2022). At the same time, a series of publications has highlighted that setting punitive tariffs on Russian oil and gas imports could be beneficial as a significant burden of their costs would fall on Russia (Hausmann 2022, Gros 2022, Sturm 2022). Taking this research further, we apply non-cooperative game-theoretic and negotiation analysis to show that these means are not just meaningful from a macro-economic and trade theory perspective but also to effectively push for faster conflict resolution.
Game theory had its first boom period in the 1950s to analyse conflict strategies in the Cold War between the US and the Soviet Union. As the current Russia-Ukraine-Europe/NATO conflict has some similarities, it is helpful to understand these findings. Some of the most important outcomes from this research period are summarised by Nobel laureate T C Schelling in his famous phrase “The power to constrain an adversary rests on the power to bind oneself ” (Schelling 1960). Its application is demonstrated by the many Ukrainians who have bound themselves to risking their lives apparently much more than Putin had anticipated. At the same time, and over the same conflict, Putin is negotiating with the West about further expansion options of NATO. In this negotiation, however, important members like Germany are still quite hesitant to formally bind themselves to a clear path of reducing oil and gas dependency from Russia. In this way, Germany's hesitation is strengthening Putin’s position in the overall conflict.
The debate amongst German economists so far has been centred around a pure cost-benefit debate. How much would it cost Germany? How much would it stop the war? In this dichotomy, the scientific debate unfortunately ignores the crucial strategic and tactical elements of the willingness to take on costs and risks in strategic conflicts.
Game theory is extremely abstract and often formalised and limited. However, in the current conflict it is helpful to understand how decisions and actions can influence the overall conflict and the decision making of the parties involved. As such, we can use non-cooperative game theory and findings from the extensive analysis of bargaining and negotiations to understand meaningful steps and counterproductive measures.
Key game theory findings and the resulting recommendations
Game theorists have modelled ‘wars of attrition’ (e.g. Kennan and Wilson 1990), and it looks very much today that the situation on the battlefield may turn into a stalemate with ‘war of attrition’ characteristics. Similarly to Schelling’s analysis, signalling plays a crucial role. In this situation, it is relevant to understand which party has more resources to stand a longer phase of attrition. In that sense, all weapon and food supplies to Ukraine, as well as refugee relief, is simply supporting the Ukrainian position. Cutting off Russia from technology and a supply of dollars is making it harder for Russia to maintain the aggression. Limiting Russian oil and gas revenues is hence essential to end the conflict.
One of the most relevant concepts of bargaining models was developed by Ariel Rubinstein (Rubinstein 1987). He introduced the concept of time and sequential bargaining models, with a simple and intuitive result: “if one side suffers bigger time pressure to come to a result it will make bigger concessions in the negotiation than the other side”. This finding is essential both for the ongoing war as well as for potential extended peace negotiations. It has been shown that further restrictions by Europe on Russian coal, oil, and gas exports would limit the inflow of foreign exchange to Russia and increase time pressure on political decision makers in the country (Kennedy 2022).
Another crucial finding of bargaining theory considers the impact of risk aversion on bargaining (Roth 1985). The outcome is robust across different settings and shows that the more risk-averse party is always at a disadvantage. This result is relevant especially to politicians in Germany, who in their communications often stress concerns about the German economy much more than their willingness to take on risks and costs to support Ukraine. With this approach, Germany is strengthening Putin's position against the West.
A very relevant but disappointing finding of game theory is hidden in the Myerson-Satterthwaite theorem (Myerson and Satterthwaite 1983). It states that, in a non-cooperative negotiation game with double-sided asymmetric information, no efficient mechanism exists to ensure a deal. In a nutshell, when both parties do not fully know how much the other side values the negotiation subject, there is always a risk of a negotiation breakdown, even if there is in fact room for an agreement. In practice, even though there would be a possibility for a negotiated agreement for peace between Ukraine and Russia that is fully acceptable for both parties, we cannot expect it will happen. This means it is worthwhile considering a broader set-up for peace negotiations where, alongside NATO and EU representatives, other parties with an interest in a solution, such as China, are involved.
Options for Europe and Germany from a negotiation analysis perspective
Negotiation analysis has been established mostly by Howard Raiffa to include behavioural analysis and expand the use of game-theoretic reasoning to more practical applications in negotiations (Eichstädt et al. 2016). So, how can Europe and Germany maximise the effectiveness of their actions around economic sanctions on Russia to make a fast peace agreement more attractive to the Putin administration?
For this, we will build upon the game-theoretic findings above and a further key finding of Schelling on the application of threats in conflicts. A threat can influence the expected outcome of any negotiation or conflict if the other party expects the threat to be realised. Hence it becomes essential for either conflict party to be credible in implementing threats. Germany has so far refrained from sanctioning Russians oil and gas imports as German policymakers are not convinced that the country would be able to maintain such sanctions, especially on Russian natural gas, over a longer period. Hence, they view such a threat as not credible, which strengthens the Russian position.
Schelling, in contrast, suggests that ideally, threats are split up into separate steps, where the first steps can be taken more easily but at the same time increase the credibility that further threatening and damaging steps will be imposed in the future. This mechanism is indeed quite often applied by professional negotiators to ensure credibility and at the same time allow for further escalations in case the overall conflict escalates. In the German automotive industry, for example, procurement organisations have a clearly defined path of escalating threats to be applied in conflict negotiations with their suppliers.
If Germany and Europe want to improve their position at the virtual negotiating table with Putin and exert pressure for peace in Ukraine, they therefore must develop a system of credible threats that can be implemented in a step-by-step way. For this, they should define and communicate a very clear path of decreasing oil and gas imports based on a determined and verifiable step-by-step approach. As soon as Russia can observe that first steps are being taken, this increases the overall credibility of Europe and Germany acting decisively. Hence, they should start to impose punitive tariffs on oil and gas imports at measurable levels of around 20–30% of sales prices for oil and, due to the higher dependency, at a lower level of just 5–10% for gas initially. It is important that these steps are observable and realised accordingly. On top of this, they can establish clear rules of increasing the tariffs if the war is escalated using weapons of mass destruction or Russian offensives expand into other countries such as Georgia or Moldova. It is essential for this mechanism that the approach is communicated upfront and openly, and that progress is measurable and can be observed over time. Additionally, the tax can also be imposed for extended periods – in the beginning only for one year, later for two years, up to five or ten years.
Such an approach would not just maximise the credibility of threats, it would also increase the time pressure on Russia to come to a negotiated agreement and signal reduced risk aversion among Europeans (or at least Germans). Obviously, all these measures will also come with disadvantages and costs to Europeans, Germans, and their businesses. However, tariff revenues could be used to compensate consumers, reduce existing energy taxes, or finance support for Ukraine.
References
Bachmann, R, D Baqaee, C Bayer, M Kuhn, B Moll, A Peichl, K Pittel and M Schularick (2022), “What if Germany is cut off from Russian energy?”, VoxEU.org, 25 March.
Chaney, E, C Gollier, T Philippon and R Portes (2022a), “Economics and politics of measures to stop financing Russian aggression against Ukraine”, VoxEU.org, 22 March.
Chaney, E, C Gollier, T Philippon and R Portes (2022b), “Stop financing Russian aggression against Ukraine”, stopfinancingwar.com.
Chepeliev, M, H Hertel and D van der Mensbrugghe (2022), “Cutting Russia’s fossil fuel exports: Short-term pain for long-term gain”, VoxEU.org, 9 March.
Eichstädt, T, A Hotait and N Dahlen (2016), “Bargaining power–measuring its drivers and consequences in negotiations”, in International Conference on Group Decision and Negotiation, Springer, Cham, 89-100
Gros, D (2022), “Optimal tariff versus optimal sanction: The case of European gas imports from Russia”, CEPS.
Hausmann, R (2022), “The Case for a Punitive Tax on Russian Oil”, Project Syndicate.
Kennan, J and R B Wilson (1990), “Theories of Bargaining Delays”, Science 249(4973): 1124-28.
Kennedy, C (2022), Russian Oil's Achilles Heel, Navigating Russia.
Myerson, R B and M Satterthwaite (1983), "Efficient Mechanisms for Bilateral Trading", Journal of Economic Theory 29: 265-281.
Roth, A (1985), "A Note on Risk Aversion in a Perfect Equilibrium Model of Bargaining", Econometrica 53(1): 207-21.
Schelling, T C (1960), The Strategy of Conflict, Harvard University Press.
Sturm, J (2022), “The Simple Economics of Trade Sanctions on Russia: A Policymaker’s Guide", Working Paper.
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