With only a few days to go before Americans' tax rates rise and the U.S. federal government runs out of money, clearly the stakes in the "fiscal cliff" debacle are enormous. There may be an 11th-hour deal, but a more likely outcome is that Congress and the White House will continue their game of chicken, crash the economy, and then try to pick up the pieces as quickly as they can. Yet knowingly or otherwise, they are incurring a much greater risk than just short-term financial havoc.
As several commentators have already noted, the negotiations between President Obama and the Republicans in Congress have taken the form of the Prisoner's Dilemma from game theory. If either side gives in, it stands to lose a lot. If neither side gives in, the outcome will still be bad for both. If the two sides can find a way to cooperate, they'll both do pretty well. But paradoxically, whatever the opponent does, each side will always expect to do better by sticking to its guns.
Inevitably, game theory predicts an impasse: Neither side will compromise, and negotiations will fail. This is what Harry Reid, the majority leader in the Senate who has been stuck in the middle of the talks, predicted this week. But the game may not be a true Prisoner's Dilemma, since the White House may stand to gain more with no deal than with a cooperative outcome. Congress already has a measly approval rating of 18 percent, versus more than 50 percent for Obama. If the Republicans in the House and Senate take most of the blame for sending the nation over the cliff, the Democrats may be able to regain their majority in the House in 2014.
Either way, both sides in the political fight are acting in an outrageously self-serving manner. The Republicans don't want to seem weak, and they're hamstrung by absolutist pledges not to raise taxes. Obama wants to keep his electoral promise to raise taxes on high-income families, and Democrats are hoping to tighten their grip on power. Tragically, no one seems to be thinking about the economy and the millions of Americans who are still unemployed.
Yet they should be, even if only for selfish reasons. In reality, the quasi-Prisoner's Dilemma playing out in Washington is a game within a game. The bigger game, and by far the more important one, is between politicians and the American people.
In this game, politicians make the first move. They can reach a deal on the fiscal cliff, or not. If they don't, the American people will suffer, just as they suffered through the manufactured and unnecessary debt crisis in 2011. Markets will fall, spending in the private sector will drop, and the economic recovery will stall, or worse. Even if the politicians in Washington manage to cobble together a deal within a couple of weeks, plenty of damage will still be done. Volatility and a flurry of reactive buying and selling will add wasteful friction to the economy, and investors around the world will rightly see the United States as a riskier place to do business.
The next move will go to the American people: They will decide how much to trust their leaders and the political system as a whole. Of course, politicians aren't generally known as the most trustworthy folks. But for decades, Americans' trust in government -- and particularly the federal government -- has been falling. An event like this could reduce it even further, at least for several years.
That would be a shame, since trust in government does matter. For one thing, people who don't trust government are much more reluctant to pay taxes. This doesn't just mean they want lower tax rates; it means they will try harder to avoid taxes, whatever the rate may be. As a result, society will be able to afford fewer of the public goods that only government can purchase on its behalf, ranging from cancer research to the Coast Guard. There's no doubt that some spending by government is wasted, but these true public goods are essential for economic growth and high living standards.
Trust in government also affects how much people obey society's rules. If they don't respect their leaders, they won't necessarily respect the laws their leaders are sworn to uphold. In a society where politicians are seen as incompetent bumblers, people may feel that they have a right to set their own rules and act accordingly. This, too, can be a problem -- try it at a traffic light and see how it works out.
If the American people decide not to trust their leaders, politicians will have less power: less power to tax, less power to invest in the nation's future, and less power to legislate effectively. Even the most venal politician ought to realize that less power might not be so good for business. And with this in mind, the leaders on both sides of the aisle may wish to reconsider their uncompromising stances on the fiscal cliff.
Doing something -- even something that seems like capitulating in the short term -- may be far better in the long term than doing nothing. The alternative is simply one more small step toward anarchy.