The role of subsidies in coordination games with interconnected risk

Min Gong, Geoffrey Heal, David Krantz, Howard Kunreuther, Elke Weber
Project Complete

Subsidy and tax are commonly applied to promote socially optimal behavior in environmental decisions. Even though most environmental problems, such as climate change, are probabilistic in nature, researchers have focused primarily on problems with deterministic outcomes. Acknowledging uncertainty allows us to model decision processes more realistically, thus helping us to design more appropriate policies. We studied subsidy effects in coordination games with both stochastic and deterministic payoffs. In the stochastic game, players coordinated to reduce uncertain losses. A real-life example is to coordinate to reduce environmental risks. In the deterministic game, players coordinated to reduce certain losses. The payoffs in the deterministic game equaled the expected payoffs in the stochastic game.

Major Findings

• We found that partially subsidizing the cooperative actions for 2 out of 6 players in a laboratory coordination game usually produced better coordination and higher total social welfare both with deterministic and stochastic payoffs. Not only were the subsidized players more likely to cooperate (choose the Pareto-optimum action), but the unsubsidized players increased their expectations on how likely others would cooperate and they cooperated more frequently themselves.
•  After removal of the subsidy, high levels of coordination continued in most groups with stochastic payoffs, but declined in deterministic ones. This carry over disparity between the deterministic and stochastic setting was consistent with the economic theories that agents were more likely to keep the status quo option under uncertainty than without uncertainty.
• Hence, players with stochastic payoffs were more likely to keep the high coordination level (status quo) brought by the subsidy in the previous subsidy session. A post-game survey also indicated that with stochastic payoffs, players focused on risk reduction. Temporary subsidies promoted lasting coordination because even after subsidy was removed, players still assumed that others players would prefer reduced risks from cooperation.
• With deterministic payoffs, however, the subsidy might crowd out other rationales for coordination, with many players indicating that the subsidy was the only reason for anyone to cooperate. Hence, the coordination level dropped when the subsidy was removed.
• Under revisions for the Journal of Behavioral Decision Making.

CRED2 Award (2010-2015): Funding was provided under the cooperative agreement NSF SES-0951516 awarded to the Center for Research on Environmental Decisions.