Tuesday, April 3, 2012

Class #17 Highlights

In this class, we debriefed the OPEC game. Several key points emerged from the discussion. First, in the initial summit, it is especially important to agree on thresholds where punishment will occur and the exact punishment that will be undertaken. The threatened punishment must be credible, so threats to punish forever will rarely be successful.

One problem with designing punishment is the tradeoff between being forgiving and inviting individuals to cheat. By building in a cheating "buffer" market A undercut the power of their punishment strategy by inviting cheating up to the buffer.

After the summit, communicating is crucial. Even if the lines of communication are open, without constant attention given to this channel, mistrust can build. Here, there was a significant difference between the two markets. Communication proved key to success.

What motivates people to cooperate? Part of it is financial interest in doing so, but another part, which is very important, is the power of relationships, honor, and trust. Appeals are most successful when they align the financial interests with intangibles. Much like GE's unilateral disarmament strategy in its dealings with Westinghouse, Saudi B's strategy of publicly vowing never to punish worked well in sharpening its appeal to honor and other intangibles. Thus, it gave up power using financial instruments to gain it through moral instruments.

Key Takeaways

  • Coordination works best when good behavior and bed behavior are well defined and known to all. Punishments need to be swift, forgiving, and credible.
  • Forgiveness works best in terms of the punishment, not in terms of waffling about what constitutes bad behavior. The latter simply invites cheating.
  • Use all the tools available to achieve coordination, including non-pecuniary tools. Appeals to honor, integrity, and other moral attributes, with punishments denominated in these same terms, can be powerful means of aligning incentives.

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