Couldn’t they have predicted that?


I am following up, smoothly, on my last update in French, namely « Quel rapport avec l’incertitude comportementale ? », and so I give a little prod to the path of scientific research possible do develop around my work on the EneFin project. I am focusing on the practical assumptions of the project itself, and I am translating them into science. There is one notable difference between business planning and science (I mean, there is more than one, but this one is the one I feel like moaning about a little). In business, when you make bold assumptions, you can make people cautious or enthusiastic, it depends, really. In science, bold assumptions are what Agatha Christie’s characters used to describe as ‘a particularly laborious way to commit suicide’. Bold assumptions, in a scientific publication, are like feebly guarded doors to a vault full of gold: it is just a matter of time before someone tries and breaks in.

Thus, I am translating my bold assumptions from the business plan into weak scientific assumptions. A weak scientific assumption is the one which does not really assume a lot. The less is being assumed, the weaker is the assumption, hence the stronger it is against criticism. Sounds crazy, but what do you want, that’s science.

Anyway, the whole idea of EneFinc came to my mind as I was comparing two types of end-user, retail prices in the European market of electricity: those offered to small users, like households, and those, noticeably lower, reserved for the big, institutional customers. EeFin is a scheme, which allows small users of electricity to get it at the actual low price for big customers, and, in the same time, still allows the suppliers to benefit from the surplus between the small-customer prices, and the big-customer ones, only in the form of equity, not sales as such.

There are markets, thus, where, at a moment t, there is a difference between the price of electricity for small users PESU(t), and that for the big ones: PEBU(t). Formally, I express it as PESU(t) > PEBU(t) or as PESU(t) – PEBU(t) > 0. The difference PESU(t) > PEBU(t) comes from different levels of consumption (Q) per user, thus from QSU(t) < QBU(t).

Now, I further (weakly) assume that the difference PESU(t) – PEBU(t) > 0 can make a behavioural incentive for the small users to migrate towards suppliers, who minimize that gap. Alternatively, a supplier can offer additional economic utility ‘U’ to the user, on the top of the energy supplied. I imagine two different markets of energy, with two different games being played. In the market A, small users migrate between suppliers so minimize the differential in prices, and the desired outcome of the game is min[PESU(t) – PEBU(t)]. In the market B, a similar type of migration occurs, just with a different prize in view, namely maximizing the additional economic utility offered by the suppliers of energy to compensate the PESU(t) – PEBU(t) gap. In other words, in the market B, the desired outcome of the game is max{U = f[PESU(t) – PEBU(t)]}. That utility can consist, for example, of claims on the equity of the suppliers, just as in my EneFin concept. Still, we experience the same type of scheme from the part of our usual suppliers. As an example, I can give the contractual scheme that my current supplier, the Polish company Tauron, uses to secure the loyalty of customers. The thing is called ‘Professional 24’ and is a 24/24 emergency service for all that touches to electrical and/or mechanical maintenance in the user’s house. If my dishwasher breaks down, I have the option to call ‘Professional 24’ and they will fix the thing at the cost of spare parts, no labour compensation. All I have to do in order to benefit from that wonder scheme is to sign a fixed-term contract for 2 years. In other words, I pay that high price for small users, and thus I pay a really juicy surplus over the price paid by big users, and in exchange Tauron gives me the opportunity to use those maintenance services at no cost of labour.

Now, I assume that both markets, namely A and B, and their corresponding games can overlap in the same physical market. Thus, there are two games being played in parallel, the min[PESU(t) – PEBU(t)] and the max{U = f[PESU(t) – PEBU(t)]} one. Both are being played by a population of users NU, and that of suppliers MS. A third game, that of status quo, is hanging around as well. The general theoretical questions I ask is the following: « Under what conditions can each of the three games – the min[PESU(t) – PEBU(t)], the max{U = f[PESU(t) – PEBU(t)]}, or the status quo – prevail in the market, and what can be the long-term implications of such prevalence? Should the max{U = f[PESU(t) – PEBU(t)]} game prevail, under what conditions can the U = f[PESU(t) – PEBU(t)] utility find its expression in claims on the equity of suppliers?   ».

The next step consists in translating those general questions into hypotheses, which, in turn, should have two basic attributes. In the first place, a good hypothesis is simple and coherent enough to enable rational classification of all the observable phenomena into two subsets: those conform to the hypothesis, on the one hand, and those which make that hypothesis sound false, on the other hand. Secondly, a good hypothesis is empirically verifiable, i.e. I can devise and apply a rational method of empirical research to check the veracity of what I have hypothesised.

Intuitively, I turn towards one of the most fundamental economic concepts, i.e. that of equilibrium. I hypothesise that there is an equilibrium point, where the outcomes of the min[PESU(t) – PEBU(t)] game are equal to those of the max{U = f[PESU(t) – PEBU(t)]} game, thus min[PESU(t) – PEBU(t)] = max{U = f[PESU(t) – PEBU(t)]}. This is my hypothesis #1. Postulating the existence of an equilibrium is sort of handy, as it gives all the freedom to explore the neighbourhood of that equilibrium.

My second hypothesis goes a bit more in depth of the avenue I am following in my EneFin concept. I assume that the max{U = f[PESU(t) – PEBU(t)]} game makes sort of a framework, within which distinct subgames emerge, oriented on different kinds of that utility ‘U’, like U = {U1, U2, …, Uk}. In that set of utilities, one item is made of claims on the equity of suppliers. I call it Ueq. From there, I can hypothesise in two directions. One way is to postulate a hierarchy inside the U = {U1, U2, …, Uk} set, and Ueq maxing out in that hierarchy, so as Ue  = max{U = f[PESU(t) – PEBU(t)]}.

The other way is to open up, once again, with the concept of equilibrium, and postulate that although, basically, we have U1 ≠ U2 ≠ … ≠ Uk in the U = {U1, U2, …, Uk} set, there is a set of equilibriums, where Ueq = Ui. Going into the equilibrium department, instead of the hierarchy one, is just simpler. I can make like the function of Ueq, as an equation, put it at equality with any other function, and, as long as those identities are solvable at all, Bob’s my uncle, essentially. In that sense, equilibrium, or the absence thereof, is almost self-explanatory. On the other hand, hierarchies need a structuring function, more complex than that of an equilibrium. A structuring function is a set of conditions expressed as inequalities, and I need to nail down quite specifically the conditions for those inequalities being real inequalities. Seen from this perspective, the hypothesis with equilibrium is sort of conducive towards the one with hierarchy.

My mind makes a leap, now, towards that thing of political systems. Playing a game means winning or losing, and one of the biggest prizes to win or lose is a country, i.e. the controlling package of political power in said country. I teach a few curriculums which involve the understanding of political systems, and I did quite a bit of research in that field. Anyway, the hot topic I want to refer to is Brexit, and more exactly the policy paper entitled ‘The future relationship between the United Kingdom and the European Union’, issued by Her Majesty’s Department for Exiting the European Union. The leap I am doing, from that model of the energy market towards Brexit, I am doing it with some method. I started developing on the theory of games, and politics are probably one of the most obvious and straightforward applications thereof.

My students frequently ask me questions like: ‘Why this stupid government does things this way? Couldn’t they be more rational?’. The first thing I am trying to get across as I attempt to answer those questions is that in public governance some strategies just work, and some others just don’t, with little margin of manoeuvre in between. Policies are like complex patterns of behaviour, manifest in complex, intelligent entities called ‘political systems’. In the case of Brexit, the initial game played by the Her Majesty’s government was akin the strategy used by the government of the United States. The United States are signatory member to multilateral, international agreements like the GATT (General Agreement on Tariffs and Trade), or the NAFTA. Still, the dominant institutional contrivance that the US Federal Government uses to design their international economic relations is the bilateral agreement. The logic is simple: in any bilateral agreement, the US are the dominant party to the contract, and they can dictate the conditions. In multilateral schemes, they can be outvoted, and you don’t like being outvoted when you know you have a bigger button than anyone else.

Before I go further, there is an important distinction to grasp, namely that between an international agreement, and a treaty. An agreement is essentially made by executives – usually ministers or Prime Ministers – who sign it on behalf of their respective governments. Parliaments do not need to ratify signed agreements; neither do such agreements require to run a referendum. Agreements remain essentially executive acts, and, as such, they are flexible. Countries can easily back off from those schemes. The easiest way to do it sort of respectably is to vote non-confidence regarding a Prime Minister, and to label what they had done as a series of mistakes. Treaties, on the other hand, are being ratified. Parliaments, presidents, monarchs, and, in the case of the European Union, whole nations voting in referendums, give their final fiat to the signature of an executive. It is bloody hard to pull out of a treaty, as it essentially requires to walk back on your tracks, i.e. to revert the whole sequence of ratifying decisions.

The Britons seem to have bet on a similar horse. They decided to pull out of the European Union – a multilateral treaty, bloody limiting and clumsy to renegotiate – and to govern their economic relations with other countries with a set of bilateral agreements. Each of those bilateral agreements was supposed to be sort of tailored for the specific economic relations between Britain and the given country. Being an agreement, and not a treaty, each such understanding was supposed to be much more manœuvrable than a multilateral treaty.

Mind you, the game was worth playing, as I see it, and still there was a risk. The prize to win was a lot of local business deals, impossible or very hard to achieve under the common rules of the European Union. The big hurdle to jump over, on the way, was the specific geopolitical structure of the EU. If you want to replace your multilateral relations with a set of countries by a range of bilateral relations, you need to look at the hierarchy of the whole tribe. In the European village, we have two big blokes: France and Germany. Negotiating bilateral treaties must have started with them, and there was clearly no point in going and knocking on other doors, as long as these two bilateral schemes were not nailed down and secured.

Without entering into highly speculative details, one thing is sure and certain: this particular step in the Perfect Plan simply didn’t work. Neither France nor Germany expressed any will to play one-on-one with the British government. Instead, they quickly secured beachheads in that sort of international political void being created by Britain pulling out of the EU, and worked towards brutally pushing the Britons against the wall. As a result, today, we have that strange architecture expressed in the ‘Future relationship…’ policy paper, where Britain enters an agreement with the whole of EU, without being a member of the EU anymore.

In theoretical terms, this political episode demonstrates an important trait in games: they are made of successive moves. When you play chess, or any other game with sequenced moves, you have that little voice in your head saying: ‘This is just a game. In real life, no sensible person would wait until their opponent makes a move’. Weelll, yes and no. It is true that in real life we play few games with gentleman’s rules in place. Most real games involve a fair dose of sucker punches, coming from the least expected directions. Still, there is that thing: even if you firmly intend to be the meanest dog in the pack, you need to adapt accordingly, and in order to adapt, you need to observe other players and figure them out. You just need to leave them that little window in time, during which you will be watching them and learning from their actions. This is why in theoretical games we frequently assume sequential moves. It has nothing to do with being fair and honest; it is much more about having to learn by observation.

This is what comes to mind when somebody studies the Brexit policy finally adopted by the government of Her Majesty. ‘Couldn’t they have predicted that…[put whatever between those parentheses]?’. No, they couldn’t. When you want to know the move of another player, you have to make your move in order to force them to make theirs. Once you have made that move, it can be too late to back off. This is probably the biggest difference between mainstream economics and the theory of games. The former assumes the existence of equilibriums, which we can sort of come close to, and adjust, in a series of essentially reversible actions. The theory of games assumes, on the other hand, that most of our actions bring irreversible consequences, as what we do makes other people do things.

After that short distractive excursion into Brexit, I come back to my scientific development on the market of energy. The political distraction allowed me to define something important in any kind of game: a single move. In those three games, which I imagine being played in parallel in the market of energy – the min[PESU(t) – PEBU(t)] game, the max{U = f[PESU(t) – PEBU(t)]} game, and the conservation of status quo – a single move can be defined as what people usually do when dealing with a supplier of energy. My intuition wanders around what I do, actually, and what I do is signing, every two years, a contract with my supplier for another fixed term of two years. Batter that than nothing. I assume that one move, in my energy games, consists in negotiating and signing a fixed-term, two-year contract.

As I define one move in this manner, I intuitively feel like including quantities in the formal expression of those games. Thus, I transform the min[PESU(t) – PEBU(t)] game into min{QSU(t)* [PESU(t) – PEBU(t)]}, and the max{U = f[PESU(t) – PEBU(t)]} into max{U = f[QSU(t)*PESU(t) – PEBU(t)]}. I just remind you that QSU(t) is the typical consumption of energy per one small user, like one household. An explanation seems due. Why have I made that match between ‘one move <=> one 2-year contract’ and the inclusion of quantity consumed into my equations? A contract for 2 years is a mutual promise of supplying-consuming a certain amount of energy.

That QSU(t) can be provisionally identified with the average, individual consumption of energy on one year. Hence, and individual move – contract for two years – amounts to committing to [PESU(t+1)*QSU(t+1)]+[PESU(t+2)*QSU(t+2)]. Such a formal expression allows further rewriting of my two games, namely I have:

Game A: min{QSU(t+1)*[PESU(t+1) – PEBU(t+1)] + QSU(t+2)*[PESU(t+2) – PEBU(t+2)]}

Game B: max{U = f{QSU(t+1)*[PESU(t+1) – PEBU(t+1)] + QSU(t+2)*[PESU(t+2) – PEBU(t+2)] }

With this formulation, my two games are very nearly identical. They both contain an identical aggregate, calculated between the ‘{ }’ parentheses. As I put it a few paragraphs ago, I want to explore my model through the testing of a hypothetical equilibrium point between those two games. This, in turn, amounts to searching a function, which, for a given range of Q and P, can yield a maximal utility out of {QSU(t+1)*[PESU(t+1) – PEBU(t+1)] + QSU(t+2)*[PESU(t+2) – PEBU(t+2)] }, and, in the same time, has at least one intersection point with a function that minimizes the same aggregate.

As I think about it, I need to include transaction costs in the model. I mean, moves in those games consist in signing contracts. A contract implies uncertainty, probability of opportunistic behaviour, and commitment of assets to a specific purpose. In other words, it implies transaction costs, as in: Williamson 1973[1]. I need to wrap my mind around it.

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund  (and you can access the French version as well). You can also get a free e-copy of my book ‘Capitalism and Political Power’ You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

[1] Williamson, O. E. (1973). Markets and hierarchies: some elementary considerations. The American economic review, 63(2), 316-325.

Support this blog