Failures of Capitalism: The Prisoners Dilemma

How a simple thought experiment demonstrates a deep problem with free markets.

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he prisoners dilemma is a simple game used to explain why participants in a market don’t always act in ways which are beneficial to society. It belongs to the field of game theory.

Simply told, two criminals are arrested and interrogated. Each criminal is contemplating whether to snitch on the other or keep silent. The trade-offs are these:

  • If you snitch on your partner and he stays silent you’ll go free and your partner will get 3 years of prison.
  • However if you are unlucky and he also snitches on you, you’ll both get 2 years of prison.
  • If both stay silent, each one will get 1 year of prison.
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How many years of prison each prisoner will get, depending on whether they snitch (betray) or stay silent and loyal to each other. Bottom right is the optimal choice.

For the two of them combined it is best to keep silent, as that will give them a total of 2 years in prison.

However that is not a safe strategy to follow when you can’t trust the other guy. The safe strategy is to snitch, as that avoids being stuck with 3 years of prison. The total prison time for both will however end up with 4 years, which is the worst total outcome.

The reason prisoners dilemma is useful in economics is because it explains why participants in a free market will on many occasions do things which are not good for any of them.

Real World Examples of Prisoners Dilemma

Whether dealing with political ads or ads for products, one ends up with a prisoners dilemma. For society it is no gain that enormous amounts of money e.g. is spent on political campaigns and it doesn’t really benefit the individuals running for office either.

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However if you spend minimal on advertisement and your opponent spends a lot, your opponent is likely to get an advantage over you.

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Cocoa Cola and Pepsi ads are a perfect example of prisoners dilemma. Both brands are already well known, so it is not like they need ads to make consumers aware of their brand. However the prisoners dilemma dictate that they must both engage in an ad’s arms race or see the competition gain marketshare.

Same goes for product sales. Some advertisement is needed to make your product known, but often far more money is spent on advertisement because otherwise the competitor using advertisement extensively, will sell significantly more.

Poverty and Pollution

It also explains why solving major problems such as pollution, high inequality or poverty is hard to achieve in a market.

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Factories have no strong incentive to clean up (apart from regulation and reputation), since they are marginally affected by pollution. Pollution affects everybody, but nobody wants to be the sucker taking responsibility while the rest freeloads on fresh air and water.

Even if everybody actually wanted to live in a society without pollution and poverty, people will be reluctant to contribute to that, as they don’t want to be the only ones making contributions, while the rest are freeloaders.

Employers and Employees

Employer and employees benefit from investment in training. The employer gets a more skilled employee who can do a better job, and the employee can get better pay.

However training costs money, which means money which could be spent on higher salary has to be spent on training. An employee has to remain in his job after training and not venture to a competing company offering higher salary. Otherwise offering job training would not be a beneficial arrangement for the employer.

The employee however might not want to remain loyal to the company if he cannot trust that the company won’t fire him or her at any suitable opportunity. In other words both employee and employer would benefit from mutual trust.

A good example of this is the extensive Germany vocational training programs. It gives employees solid skills which helps Germany retain excellence in manufacturing, yet it has been hard to reproduce in other countries as it depends more on trust, loyalty and tradition than pure free market principles.

Conclusion

While free market capitalism is a great system for producing many goods and services, the prisoners dilemma is one of several reasons I will cover, why certain goods and services are often provided through other means than the market. Health care, education, fire service, police, railroads, prisons etc are some examples of services which frequently is provided by public institutions, funded by tax payers.

Written by

Geek dad, living in Oslo, Norway with passion for UX, Julia programming, science, teaching, reading and writing.

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