Analysis of the Prisoner's Dilemma

on Thursday, March 3, 2011

"The "public interest" is regarded as a valid principle to guide legislation... [but] there is no such entity as “the public,” since the public is merely a number of individuals. The idea that the public interest supersedes private interests can have but one meaning: that the interests of some individuals take precedence over the rights of others."
-Ayn Rand

This seems like a brilliant observation, but on second thought, it isn't necessarily true, especially in "Prisoner's Dilemma" situations. For example, imagine you and I are fishermen. We know that over-fishing our lake will harm us and the other man. If we don't agree to fish at a certain acceptable rate, both of us will calculate that the other man will over-fish, and that we may as well over-fish until the lake is harvested to zero. In this case the "public" interest is synonymous with our mutual interestl. This can also be seen in "tragedy of the commons" situations, where public land is abused because no one owns it.

Both situations are solved when someone owns the lake or the land, and both would be solved if all fishermen or land users came to a mutual agreement on fishing or grazing rates, which is an agreement to protect the mutual interests of all parties. The easy solution is private ownership of everything; the problems only arise when ownership is split amongst many people, none of whom hold a strong interest in the property. The harm from each person in a tragedy of the commons is small, but results in a devastated common area. The best solution is to have private ownership of that previously common land, second best would be direct ownership by government (land managed badly at great expense), and worst is to allow it to remain common land (land is destroyed).

Prisoner's dilemmas do not need to involve idiots. All parties can be rational, and that's why they are so interesting. It's a situation where each person thinks "the other guy might confess, so I will confess first." It becomes too high-risk to trust the other person, so confessing is more optimal. In the same way, two rational fishermen will think "he's going to over-fish and take all the fish, so I will harvest fish as fast as possible." It becomes a race to get all the fish out first. Both fishermen know that if they make an agreement that is enforceable, they will both be better off in the long run, and that is why many people feel that enforcing contracts and maintaing courts of law is part of government's legitimate purpose.

However, the Prisoner's Dilemma is not the fundamental game theory problem it appears to be. It is no mystery why two men fail to cooperate even when it is in each man's best interest to do so. It is not paradoxical at all. The men fail to cooperate because they have no ability to make an effective and binding agreement. It is a dilemma only because there is no rule of law (they cannot create an enforceable contract), so the worst possible outcome for each man is the result (both confess). Prisoner's Dilemma situations only occur when parties are forced to negotiate an exchange without mutual trust, and are easily resolved when trust is introduced. Rule of law is one method for encouraging trust.  If both men know they will be arrested for theft or fraud, they trust the other party to avoid theft and fraud.

Prison in Leoben, Austria
Trust can happen naturally, without the threat of force from government, if both men trust each other or have a reputation to uphold in their community. If they value their reputation, they keep agreements to protect it. We can see a great example of this in eBay. It began with a bunch of people who didn't know each other trading small items through the mail. As sellers and buyers gained reputations (through feedback ratings), the volume of trade gradually increased, and the value of items traded increased. Today, eBay merchants with a long history of reliability and trustworthiness are able to sell items worth tens of thousands of dollars to people they have never met on the basis of reputation alone, and this happened without active enforcement of contracts by eBay. In the beginning, if you sent a payment and did not receive your merchandise, your only real option was to leave negative feedback. To this day, eBay is still largely ineffective as an enforcer of contracts, they have no courts, no police and no real power to settle disputes. Trade is facilitated because buyers and sellers have developed reputations they wish to protect. Members new to eBay are regarded with suspicion and are generally limited in their ability to buy or sell because they have no reputation to damage.  Experienced users have long histories that would be dramatically damaged by negative feedback by other users, which is posted publicly and permanently.

This is how merchants were able to trade in the past, even without rule of law in all areas that the merchant might operate. He "enforced" contracts simply by developing relationships with other traders, maintaining his own reputation, and depending on good reputations instead of the courts. He avoided the need for courts by dealing with trustworthy merchants who were able to maintain good reputations in same way as eBay users, and gradually developing relationships (small trades at first) with new merchants.

It is an illusion to think that the men are behaving paradoxically in prisoner's dilemma situations, and it is erroneous to assume that government is necessary to enforce contracts. If anything, government is likely reducing the benefits of trade by implying that they will resolve disputes efficiently. Courts are extremely slow and expensive, and it is likely more efficient for merchants to develop trusted relationships than to wildly trade with anyone and depend on the courts if an agreement is broken.

In school, many were presented with the prisoners dilemma as an example of selfishness leading to bad outcomes for everyone, which is ironic because it's actually a wonderful example of what happens between rational (selfish?) parties when property rights and rule of law are removed, and the hidden benefits of a society that respects private property and has an effective dispute settlement system.