Auction stations

A few days ago I heard someone describe the Brexit process in terms of the dollar auction problem and was immediately struck by how accurately it described the current state of affairs. The dollar auction problem was formulated by the late economist Martin Shubik, as a non-zero sum sequential game to illustrate how a series of rational choices can still lead to irrational outcomes.

In the original thought experiment, an auctioneer sells a dollar bill with two participants engaged in the bidding process. The caveat is that the person making the second highest bid must pay a penalty equivalent to the amount that they bid – unlike a real auction where there is no penalty for a failed bid. Suppose that bids increase in increments of 5 cents. If the first participant bids 5 cents for the dollar bill, a discount of 95% relative to the face value, the second person has an incentive to raise the bid to 10 cents because they still obtain the banknote at a 90% discount. Player One rebids because they can still make a significant notional gain and so it goes on. By the time Player One bids 95 cents, Player Two has to raise their bid to the face value of the dollar bill. They clearly make no profit but at least they avoid the 90 cents penalty from their failed bid. But Player One is facing a 95 cents penalty so it is in their interests to raise their bid to 105 on the basis that if they win, they will only lose 5 cents versus 95 cents if they do not bid. But Player Two has an incentive to bid again and the bidding round continues. In theory, it could continue forever so long as both players remain committed to winning.

Shubik designed this game to demonstrate how people can become obsessed with the idea of avoiding losing, even though the cost of winning can be so great as to leave them worse off – in effect, they lose whatever happens. This strikes me as a brilliant exposition of the underlying problems facing the two sides in the Brexit debate. We can think of the EU27 as the auctioneer determining the nature of the UK’s relationship with the EU, whilst the Leavers and Remainers bid against each other to ensure that their plan is accepted. Just as the bidding actions in the dollar auction game are determined by the action of the previous bidder, so the Leavers and Remainers have reacted to the plans made by the other side over the past two years.

We are now at the stage where Theresa May’s Chequers Plan represents the one dollar bid. It will not make the UK any better off but it will minimise the damage to the UK if accepted. But so committed are the Brexiteers to not losing the right to “take back control” that they are prepared to vote down any such plan. In their eyes, the economic losses are offset by the right (in the words of Dominic Raab) to take back control of “our borders, our money and our laws.”

Over the coming days and weeks, we will see whether the prime minister is willing to amend her plan in order to satisfy  the auctioneer’s requirement that a solution be found to the Irish border problem. Latest leaked reports suggest the government is prepared to back down on its opposition to new checks on goods moving between the British mainland and Northern Ireland. In exchange, May’s team would ask the EU to permit the whole of the UK including Northern Ireland to stay in the bloc’s customs regime (as I suggested here). At that point the Brexiteers may respond with another crazy bid, arguing that remaining in the customs union is to ignore the “will of the people” (it isn’t!)

The dollar auction game teaches us three lessons about escalation strategies: 

1. Perhaps the most obvious lesson is not to enter in the first place. But if you do, make sure you cut your losses early (too late for that I fear). 
2. It is possible to game the auction via cooperation. In the dollar auction,  the best outcome is derived if one person bids 5 cents and the second player refrains from bidding on the understanding that they will receive an equal share of the profits, in which case both end up better off. Again, it might be possible to achieve a smooth Brexit if all sides are prepared to compromise. 
3. The auctioneer is the only winner, especially as the stakes are raised.

Unfortunately, the dollar auction game can go on forever but the Brexit auction game can now only run for less than six months. Time, perhaps, to look again at option (2)
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