Flexibility vs. Credibility in Strategy

Sometimes the key ingredient in equilibrium is trust.

One under appreciated aspect of the current administration is how much outcomes can change without policy change. The current dispute over the Obamacare CSR payments is an excellent case study – the Trump administration says it will continue to make the payments but vacillates between pledging to make them and threatening to withhold them as a lever for negotiation with Democrats.  This seems implausible, since a lot of people would lose health insurance and the Administration would rightly be blamed.  It’s a bit of a dead man’s switch.  The actual desired end state – what the Administration wants to happen with the payments – is totally unclear.

So – if you’re an insurer whose profitability depends on the payments coming in, what would you do?  You certainly can’t count on the payments coming in, certainly.  If the payments are large enough to present a very substantial upside or a major part of your business, you might gamble – but if the downside risk is high you’d get out and not expose yourself to an unquantifiable uncertainty.  The last thing an insurance CEO wants to tell her shareholders is that she incurred major losses due to a Republican President cutting Obamacare subsidies; after all, what else would she expect?  And so while the policy remains in place, the outcome changes.

Trump says that he likes to be unpredictable – and this has some upsides.  He has a genuine point that his complete unpredictability and lack of ideological commitment offers a lot of flexibility.  By constantly changing his positions on policy issues, it allows him the freedom to do whatever seems most advantageous today without worrying too much about path dependence in the future.  This is a big strength for obtaining his goals, particularly if they change over time. However, he makes a grave mistake when he says that it offers him total flexibility.

There are many policy outcomes that can only be obtained with a credible commitment – the CSR payments are one, and NATO is another.  Even though the NATO policy is currently nominally the same as under Obama, Trump’s lack of credibility on the issue substantially weakened the deterrence value of the alliance.  Constant ambiguity on the issue doesn’t offer the US the choice between “no NATO commitments” vs. “a strong NATO deterrent”, it offers the US the choice between “No NATO commitments” vs. “a weak NATO deterrent”.

Total lack of credibility is not a completely insane choice, but requires the principal to put a very high value on the option value vs. a less-flexible choice with higher expected value.  It’s certainly notable that no other US President has ever gone this route, as it has a lower payoff than picking choices and sticking with it – but that is under the assumption that the principal’s utility function is the same from day to day.  If you don’t know what outcomes you’ll favor tomorrow, chaos might be a rational choice!

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