Prospect Theory 1

NAVALPOSTGRADUATE

SCHOOLMONTEREY, CALIFORNIA

Prospect Theory: An Alternative to Rational Theories of Deterrence

SO3882- Deterrence, Coercion, and Crisis ManagementProfessor Leo Blanken

28 August 2009

byMAJ Ian S. Davis

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Prospect Theory: An Alternative to Rational Theories of Deterrence

The nature of the international political system, and the interaction of the states within

that system, is best described as anarchic. Derived from Webster’s definition of anarchy, an

anarchic system is absent of government and wrought with lawless confusion and disorder.(The

New International Webster's Concise Dictionary of the English Language1997) Since one state

does not have absolute power over all of the other states in the international system, states must

maintain a balance of power to maintain equilibrium in the system. The equilibrium of the

system is affected by the decisions and subsequent actions of the states. Every action of a state

has costs, benefits, and associated implications that affect balance in the international system. In

an attempt to understand and explain the international political system, political scientists,

economists, sociologists, and psychologists study the states’ decisional processes identify the

manner that states resolve conflict. Theories of rational choice form the foundation of

international deterrence theory, but do not account for human factors in decision making and

expected outcome. The cognitive approach to deterrence known as prospect theory is an

alternative model of decision making that considers additional variables and is better suited to

international politics than traditional rationalist theories.

The starting point of understanding current deterrence theory is to explore how states

interact with each other in an anarchic system. In Theory of International Politics,Waltz {{73

Waltz,Kenneth Neal 1979/a;}} finds that states in anarchy must rely on the means they can

generate and the arrangements they make for themselves. This self-help system reinforces that

states, for their own benefit and the greater good of the system, should act for the sake of the

system and not for their own advantage. Operating within the structure of the system, the states

interact with each other to establish order, norms, and balance-of-power. A basic assumption of

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rationalist balance-of-power theory is that states are unitary, rational actors who, at a minimum,

seek their own preservation, and at a maximum, drive for universal domination. The theory

makes assumptions about the interests and motives of the state to rationalize the expected cost

versus benefit outcome, rather than exploring the internal variables that explain how the state

arrived at its decision. Based on the unitary, rational actor assumption, the competitive system is

regulated by the “rationality” of unitary states who seek to maximize expected outcomes in the

international political system without regard to internal motivating factors. Based on the

expected outcome of conflict, states may still decide to go to war.

War is a costly endeavor. The cost of war is not simply financial loss, but includes the

loss of the sons and daughters of the state. Furthermore, the outcome of war could determine the

existence of the state itself. With so much at stake, a central puzzle is the reason that leaders go

to war instead of negotiating a peaceful settlement. In Rationalist Explanations of War, {{72

Fearon,James D. 1995/a;}} addressed rationalist explanations for war that are based on theory

and empirically plausible. He posed that the rationalist arguments do not address the puzzle that

since war is costly to both sides, rational states should seek to find a negotiated settlements as

opposed to going to war. Fearon defined costs as ex ante (prewar) and ex post (postwar)

efficiency. As long as both sides suffer some costs from waging war, then war is always

inefficient ex post. As opposed to going to war, both sides are better off to resolve the conflict

without suffering the costs, or by paying lower costs. The rationalist establishment of the ex ante

bargaining range is based on the ex post inefficiency. Once this range is established, rational

states may determine the expected utility of war is greater than the expected utility of peace

based on the level of risk. Fearon determined that two explanations may explain why rationally

led states may seem to act irrationally: the combination of private information and incentives to

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misrepresent resolve and capability, and the inability to uphold a deal. Fearon’s model relied on

the assumption of states being unitary, rational actors and did not explore internal causative

factors that drove unitary states to arrive at their decisions.

The framing and weighting ex post outcomes presents an alternative to the rationalist

theory of deterrence: prospect theory. In Prospect Theory: An Analysis of Decision Under Risk,

Khaneman and Tversky(1979) critiqued rationalist expected utility theory and developed an

alternative model for decision making under risk. The alternative theory assigned value to gains

and losses rather than to the final assets of the bargaining process. The principle distinction

between prospect theory and conventional rationalist theory is the asymmetrical relationship

between gain and loss. Since more variables are incorporated in the model, prospect theory

provides a better approach to interstate competition and deterrence than conventional rational

theories. The key metrics of the variables used in prospect theory are the state’s assessment of

the status quo, competitor’s decisional frames, and the credibility of threats. (Berejikian, 2002)

Berejikian (2002) indicates that the state’s status quo, or strategic condition, plays a

central role in explaining deterrence behavior. Depending on how the state feels about its current

status in the international community, the state may desire to maintain or improve its position. In

contrast to conventional rational deterrence theories, prospect theory predicts that although a

gamble of expected value may have an expected value of further gain and also some probability

of loss, the state will opt for the certainty of the status quo. Alternatively, prospect theory

predicts that a state will gamble further loss if it has some probability of maintaining, or

returning to, its position of strategic condition. Thus, preservation of the status quo outweighs

the risk of attempting to improve one’s position in prospect theory.

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In the case of mutual deterrence, the most important variable is each state’s level of

satisfaction with its strategic status. If both states are satisfied with its position, then neither side

is compelled to compete for an advantage. Unilateral deterrence, where one state is satisfied and

the other is not, presents a different dynamic. The stronger state is satisfied with the status quo

and the weaker one is not. Although the weaker state may achieve minimum gains by defecting

from cooperation, it stands to lose more that it would gain. Because the weaker state has more to

lose by defecting, it is more apt to maintain the status quo. Where prospect theory diverges from

contemporary rationalism is in the situation where the weaker state may act in a manner regarded

as irrational to return to an acceptable strategic condition. The reasons for this will be discussed

later. The greater desire a state has to return to the status quo, the less effective threats are in

deterring aggression. Extended deterrence presents unique dynamics relating to the status quo.

Introducing a third party into deterrence can possibly alter the target state’s perception of the

status quo and provide a successful create deterrence by shaping the target’s anticipated ex post

efficiency. Additionally, prospect theory suggests that providing the target with inducements

may help to shape the perception of the status quo to avoid defection.(Berejikian, 2002)

Contrary to rational deterrence theory, Berejikian (2002) suggests that prospect theory

suggests non-rational choices are both stable and predictable. When compared to conventional

theories that evaluate outcomes on gain versus loss, prospect theory evaluates both gain and loss.

These multi-dimensional outcomes provide the basis for decisional framing that are not predicted

in rational choice. Another deviation from the rational model is that the decisional determinant

in prospect theory is not the expected outcome, but how the choice is perceived relative to the

status quo. Based on their satisfaction of the status quo and the placement in their decisional

frames, states become risk acceptant, risk adverse, or loss averse.

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In the prospect theory model of decision making, the value function for losses is steeper

than gains, indicating that losses hurt more than gains feel good. Jervis (2004, p. 165) adds that

“losses inflict psychological harm to a greater degree than gains gratify, which means that people

are more willing to run risks to avoid or recoup losses than to make gains.” Berejikian (2002)

claims that since the state’s assessment of the strategic status is the key to deterrence behavior,

changes provide a guide to the content of the decisional frame. Prospect theory predicts that

when two states are in the gains frame, a stable deterrent relationship exists. Using the

conventional model, if a state expects the gains of defection from cooperation to outweigh the

costs of cooperation, it will attempt to change the status quo. Since the state in the gains frame is

risk adverse under prospect theory, deterrence threats are more likely to succeed. If neither state

is satisfied with its strategic status, then both states are in the loss frame and are predicted to

defect from cooperation, which can lead to war.

In unilateral deterrence, prospect theory differs from rational theories the weaker state

has more options for gains. Since the weaker state is in the gains frame, it is risk adverse and

will continue to operate under the unacceptable status quo due to its risk avoidance. When the

stronger state is in the loss frame, it is risk acceptant and more likely to defect to return to the

status quo. The theory adds that retaliation is a risk-acceptant, non-maximizing choice motivated

by a loss frame. Extended deterrence provides a shift in the status quo from the perspective of

the target. The introduction of a third party may open the target’s perception of the status quo

from the loss to the gain frame through not only military, but economic aid. (Berejikian, 2002)

A critical piece in any deterrent threat strategy is that the threat must be credible to be

effective. Nalebluff (as stated in Berejikan, 2002) demonstrated that the central component of

threat credibility lies in the proper manipulation of the rival’s perceptions about the state’s

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hidden cost of actions through the judicous use of threats and agression (p. 167). The lower the

hidden costs, the more likely the state is to follow through on its threats because the ex post cost

is low. This increases the state’s actual strength in bargaining. Through this strength, the state

can make deterrent threats that are credible because it has the ability to follow through on those

threats. In prospect theory, the credibility of the threats is essential for shaping the framing and

perception of the targeted state. That being said, if an opponent is in the loss frame, even a

highly credible deterrent threat is unlikely to be effective. Credibility not only plays a major

factor in mutual and unilateral deterrence, it is crucial in extended deterrence. Third-party

extended deterrence is difficult because crediblity is the centerpiece of the policy. If the targeted

state does not believe the state that promised extended aid has the resolve to come to the aid of

the third state, then deterrent threats will be not be perceived as credible. Without credibility,

deterrence is has no substance. (Berejikian, 2002)

In conclusion, prospect theory provides a better approach to interstate competition and

deterrence than conventional rational theories. The theory looks inside “billiard ball” (Fearon,

1995) and examines the values of the unitary rational actor, the state’s assessment of the status

quo, decisional frames, and credibility of threats to provide an analytical framework for decision

making that incorporates more variables than the traditional rationalist theories. While the

unitary rational actor assumption serves as the basis for most deterrence models, prospect theory

provides a wider range of possible outcomes by incorporating more factors of the human

decision making process.

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References

Berejikian, J. D. (2002). Model Building with Prospect Theory: A Cognitive Approach to International Relations. Political Psychology, 23(4), 759-786. Retrieved August 4, 2009 from http://www.jstor.org/stable/3792366

Fearon, J. D. (1995). Rationalist Explanations for War. International Organization, 49(3), 379-414. Retrieved August 4, 2009 from http://www.jstor.org/stable/2706903

Jervis, R. (2004). The Implications of Prospect Theory for Human Nature and Values. Political Psychology, 25(2), 163-176. Retrieved August 4, 2009 from http://www.jstor.org/stable/3792560

Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-291. Retrieved August 4, 2009 from http://www.jstor.org/stable/1914185

The New International Webster's Concise Dictionary of the English Language(1997). In Landau S. I. (Ed.), (2002 International Encyclopedic ed.). United States of America: Trident Press International.

Waltz, K. N. (1979). Theory of international politics (1st ed.). New York: McGraw-Hill.

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