Never thought about it before in those terms, but it does make some sense. The Prisoner’s Dilemma is, of course, the classic scenario used in Game Theory, usually taught in economics or political economy classes, involving two people in police custody following the commission of a crime. The model is used in introductory level classes to introduce how one can quantify outcomes (“payoffs”), what are optimum results, and how cooperation can have dramatic effects on the results.

In a column responding to Paul Krugman’s call for more aggressive action from the U.S. government on the RMB valuation issue, Professor Huang Yiping from Peking University invokes the Prisoner’s Dilemma in describing the scenario facing the U.S. and China on this issue:

The China-US policy game on the renminbi exchange rate can be best characterised as a ‘prisoners’ dilemma’. It is important to keep in mind that, like American politicians, Chinese leaders also have to entertain domestic political pressure. And to be seen as giving in to American pressure can substantially weaken the leaders’ political standing and capacity to act in everyone’s best interests. China is more likely to move ahead quickly if the US maintains a calm and rational stance.

I’m not sure the reference is entirely appropriate, but it is thought-provoking. Most people like to invoke the Prisoner’s Dilemma when pushing for a cooperative solution. I suspect that this is Professor Huang’s point as well since his explanation focuses on unilateral action versus cooperative resolution.

I’m generally in agreement with Professor Huang that cooperative action is preferable. Certainly a unilateral act by the U.S., such as a tariff on PRC goods, would lead to some disastrous results on the trade front, hurting both countries. Moreover, it would most likely lead to further entrenchment by Beijing on revaluation.

The only reason why I think that the reference to the Prisoner’s Dilemma is slightly off is the political context. Professor Huang is probably right (and quite astute, I might add) in pointing out that some U.S. politicians are quite happy having China to kick around on this issue, while others would no doubt take credit if Beijing went ahead with a revaluation.

However, using the classic scenario, the U.S. would have two options: punitive action or cooperative solution. I believe that there are some in Washington, and this may also be Krugman’s position, that see a third option. Call it the Game of RMB Chicken.

This is another classic game, but one of international diplomacy. You let Congress rattle their sabres, threaten retaliation, and perhaps even allow the Treasury Department to label China a currency manipulator, but you don’t go so far as fomenting a trade war via punitive legislation. The hope is that the other side (China) will blink and eventually revalue.

If this third option, which I don’t like by the way, is the one being taken by Washington, then the Prisoner’s Dilemma analogy doesn’t quite fit. It also means a heightened possibility that the two sides will misinterpret each other’s positions.

I always found game theory to be too simplistic when applied to political situations. I think this is another good example. I do recommend Professor Huang’s column, though, which is an excellent rundown of the issue and the probable result of several “what if” scenarios on both sides.