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Bulletin of the ERI, 2009/10 no. 2

Contents: March 2010

Channelling Schelling: Thoughts on parenting, governing, and credibility 50 years after The Strategy of Conflict

Credibility is a powerful and compelling notion. An amalgam of trust and believability, it provides a lens for examining and understanding economic, social, and political situations arising in many arenas, as two divergent but related situations that have come to my attention of late suggest.

Consider the following interaction between a father, Abhinay, and his daughter, Aruna. Abhinay says to Aruna that if in future she loses her mobile phone, he will not buy her another one for at least six months. The purpose of such a statement is to give Aruna the incentive to take good care of her mobile phone. However, she may choose not to incur the costs that come with keeping track of a mobile phone if her father’s statement, or threat, is not credible. That is, perhaps Aruna believes her father will capitulate if she loses her mobile phone, and is thus unable to communicate with her family when she is out and about, causing him considerable worry! This is but one small example illustrating the difficulty that parents face in establishing credibility with their children.

Then, consider an example of a similar credibility problem, one faced by many governments. Political leaders say they will act prudently in the future when influencing the setting of interest rates. But when that future arrives, and times are bad, they then behave quite differently in order to protect their electoral objectives. This rightly perceived lack of credibility impacts on the current behaviours of firms, consumers, and other economic actors. And that, in turn, adversely affects economic outcomes.

For instance, a commitment to the setting of interest rates independent of government politics was a fundamental rationale for the creation of the now famous Monetary Policy Committee (MPC) of the Bank of England by the Labour government in 1997. Indeed, creating this institutional mechanism was one of the party’s very first acts upon gaining power after around two decades in opposition. The goal was to establish government credibility in this critical policy arena.

In various forms, the same dramas, all matters in which credibility lies at the heart of the matter, are now in the world spotlight. As the United States debates whether it will fashion a new health care plan, one question concerns the credibility of the threat to require citizens to have insurance. As nations worry about Iran’s nuclear weapons capabilities, questions emerge about what possible sanctions will be credible enough to serve as deterrents. Then, too, credibility is at stake in the financial markets as the crisis over the Greek government’s debt situation confronts the European Union.

As these varied events illustrate, establishing and maintaining credibility is not easy. Credibility, or a lack of it, underlies interactions among institutions – governments, markets, businesses - and among humans – family, friends, and colleagues.

At times such as these, one may seek useful insights from timeless sources. Thomas Schelling’s classic treatise The Strategy of Conflict, still offers fresh insight half a century after it was published. The seminal book on bargaining and strategic behaviour by the Nobel laureate underscores the relevance of economic research and game theory in so many current world situations in which credibility is a key element. In reading it, one is reminded of the critical similarities that underlie seemingly unrelated events, such as deterring the proliferation of nuclear arms, crafting beneficial monetary policies, and the raising of one’s children.

Good luck in establishing your credibility!

Abhinay Muthoo

Abhinay Muthoo is director of the Economic Research Institute and chair of the Department of Economics.