Sticking to their side of the bargain admin November 28, 2011

Sticking to their side of the bargain

(or ‘The U.S. Debt Deal and Your Divorce’)

You come to an agreement with the other party but you don’t trust they will stick to it. How do you make sure they do?

Well, the U.S. debt negotiations broke down last week and there are some interesting lessons you can learn from the happenings.

Disaster averted

So, earlier this year, even the Eurozone crisis was overshadowed as the U.S. government came within a whisper of defaulting on its debts. Forget Greece, forget all of the PIIGS, a U.S. default would be big!

Negotiations saved the day. At the last hour, Republicans and Democrats came to an agreement to raise the legally-allowed debt ceiling, enabling the government to borrow more, but on the condition that further negotiations would find $1.2trn of savings over the next 10 years, to bring the overall amount of borrowing down.

Deal done.

However, what was the guarantee they would find those savings? Well, they did a very clever thing. The deal included a deadline of November 21st by which the savings had to be identified. If the “super-committee” appointed could not reach agreement on the details by then, a guillotine would fall – automatic spending cuts of $600bn from the defence budget and $600bn from social services such as Medicare.

Why was this so clever?

Both sides were now highly motivated to stick to the agreement. The Republicans were incentivised because almost anything would be better, from their point of view, than such slashing of the defence budget. Ditto the Democrats and their cherished Medicare.

What is more, it was like a Doomsday machine – once set in motion, once that deadline was passed, it could not be stopped. Neither side would risk triggering it.

What is the connection between Mutually Assured Destruction and your divorce?

Negotiations are based on trust but if there is no trust, what do you do? The solution found by the U.S. Congress was a trick stolen from game theory: you make sure everyone sticks to the agreement by having an alternative that neither side wants.

An example we have lived with for 50 years is in the conflict between the superpowers (America and Russia/Soviet Union, not X-Men and the Fantastic Four). Both sides kept to (relatively) peaceful behaviour because the threat of Mutually Assured Destruction was too awful to contemplate.

Or let’s take divorce, where emotions are high, the love is lost and with it trust.Some cases are smoother than others and these are usually successful because of a similar mechanism: settlements reached amicably because both partners are conscious of the alternative, a costly legal battle where neither side wins.

And if it is not the thought of transferring their life’s savings to their lawyers’ bank accounts which keeps their minds focussed, it is perhaps the effect on the children. Oh, the guilt if their cherished progeny were to end up a bankrobber or porn-star as a result of the breakdown between the parents.

(Hmm, if you really have come here for tips on your divorce settlement, here’s a top tip: don’t do it! Make up! It is much better that way – you will see).

Lesson to take home

So, if you are sadly involved in a divorce case and you are not too sure your partner will proceed amicably, focus their mind on the awfulness of the alternative.

Similarly, if you are involved in a national debt negotiation or a superpowers conflict.

Or, indeed, any negotiation where you do not fully trust the other party will stick to the agreement reached.

Disaster back on?

And yet, of course, the U.S. debt negotiations broke down. Which is not to say that the above technique does not work. The question is: when does it work and when does it not?

And that we will examine in a later blog.