A fantastic editorial in the August 8-14 Bloomberg Business Week describes the debt ceiling negotiations using game theory. Anyone familiar with the prisoner’s dilemma will recognize how it relates. Both sides can compromise, both sides can hold out, or one side can give in to the other. The problem is that you don’t know ahead of time what the other side will do. If you hold out and the other side caves, you get the best result. But if you hold out and so does the other side, then you get economic calamity. So it is best for both sides to compromise. But in this case, we had a third side, the Tea Party, which made it quite clear that they were not going to compromise, which forced both other sides to give in to avoid the economic calamity.
The other major point that the editors make is that the constant election cycle and campaigning has made politics into a non-cooperative game. Holding out becomes a better way to get re-elected than compromising. So there is incentive for both sides to hold out and end up with the worst possible result. Unless something really fundamental changes about our system, this will continue to be the case.