Cogent analysis by James Surowiecki at New Yorker:
[P]olicymakers are seriously discussing a so-called Grexit—in which Greece would default on its debts and abandon the euro.
This isn’t an outcome that anyone wants. Even though a devalued currency would make Greece’s exports cheaper and attract tourists, it would do so at a terrible price, destroying huge amounts of wealth and seriously harming the country’s G.D.P. It would be costly for the rest of Europe, too. Greece owes almost half a trillion euros, and containing the damage would likely require the recapitalization of banks, continent-wide deposit insurance (to prevent bank runs), and more aid to Portugal, Spain, and Italy, which seem to be the next countries in line to default. That’s a very high price to pay for getting rid of Greece, and much more expensive than letting it stay……
But the catch is that Europe isn’t arguing just about what the most sensible economic policy is. It’s arguing about what is fair. German voters and politicians think it’s unfair to ask Germany to continue to foot the bill for countries that lived beyond their means and piled up huge debts they can’t repay. They think it’s unfair to expect Germany to make an open-ended commitment to support these countries in the absence of meaningful reform. But Greek voters are equally certain that it’s unfair for them to suffer years of slim government budgets and high unemployment in order to repay foreign banks and richer northern neighbors, which have reaped outsized benefits from closer European integration……
The basic problem is that we care so much about fairness that we are often willing to sacrifice economic well-being to enforce it…. a famous experiment known as the ultimatum game—one person offers another a cut of a sum of money and the second person decides whether or not to accept—shows that people will walk away from free money if they feel that an offer is unfair. Thus, even when there’s a solution that would leave everyone better off, a fixation on fairness can make agreement impossible.
Hart and Moore and Hart and Holmstrom have offered theories of centralization based on behavioral issues. I’m not familiar with the other work on behavioral contract theory. But my guess is there is plenty of room for interesting research in the area along lines implicit in this article.
Cheap Talk 
2 comments
Comments feed for this article
May 30, 2012 at 12:04 am
Emil
I wouldnt really call this tradeoff between fairness and efficiency “behavioral”. I think fairness is just a lay person’s way of talking about dynamic incentives. In a simplistic view of the world where the Euro crisis is a one-shot game, fairness at the expense of efficiency would indeed not make much sense. But, just as in the ultimatum game, if you thought this situation could potentially arise again in the future, you would rather not have your opponent convinced that you’d bail him out of trouble (or accept $0).
That’s why I think the model implicit in the article is as behavioral as the idea of repeated games (and perhaps also reputation?), i.e. not really.
June 5, 2012 at 9:20 am
Sean Crockett
I think dynamic incentives are just a theorist’s way of talking about lay persons’ fairness… Just kidding, to a point. Perhaps fairness has evolved in (great?) part as a heuristic device to allow people to conveniently cope with dynamic incentives; in the present circumstance it would appear they both could produce observationally equivalent paths. But I don’t think most Germans are really talking about dynamic incentives when they invoke fairness in this instance, I think they perceive the situation as a question of right and wrong more than one of dynamic optimality. Pure speculation on my part, to be sure.