Bruce Riedel who ran President Obama’s AfPak review now favors containment over engagement with Pakistan as I mentioned in Part 1.  He thinks military aid should be reduced sharply and substituted with reduced tariffs and the like.  How is the Pakistani army going to respond?  In the past, scientist A Q Khan sold nuclear secrets to countries that are hostile to the United States.  Was the Pakistani Army complicit in the nuclear trade?  That information is not in the public domain.

What is to stop the Pakistani Army employing or reverting to nuclear trade under containment?  Again, thinking of the United States as the Principal and the Pakistani Army as the Agent, the principal has to come up with some way to give incentives to the agent.  With commitment, the obvious instrument is a threat, e.g. the United States will attack/invade Pakistan if they observe a sign of nuclear trade. If the threat is credible, the Pakistani Army will not engage in nuclear trade and the United States will not have to carry out its threat.  But the threatened action is costly and it is impossible to commit to carry out the threat in the scenario where it is meant to be implemented. Hence, there would be a credibility issue even if Pakistan were not nuclear.  The fact they are nuclear makes the threat incredible.  Indeed, it is hard to see any “stick” that can credibly be used to give incentives.

That leaves “carrots”.  The United States can make a transfer to the Pakistani Army if and only if there is no sign they are engaging in nuclear trade.  It is credible to take the carrot away if there is a sign of trade. If there is no sign of nuclear trade, it is credible to make the transfer because the Pakistani Army has a credible threat of start nuclear trade if a transfer is not forthcoming – after all they get surplus from nuclear trade.  If the transfer is large enough and signals of nuclear trade are more likely if nuclear trade actually occurs, the Pakistani Army will play along with its part in the equilibrium too.

This logic is familiar from the efficiency wage model of Shapiro and Stiglitz – if the principal cannot use sticks, she must use carrots and ends up giving surplus to the agent.  But here I only want to point out an irony: under the old regime of engagement, the United States paid the Pakistani Army to take a costly effort and hunt down terrorists; in the (possible) new regime of containment, the Unites States pays the Pakistani Army not to go take the profitable action of engaging in nuclear trade.  Either way, a transfer is made.