Video: Let’s Talk About the Prisoner’s Dilemma...
Video Transcript:
If you’ve ever played a game where everyone loses because no one was willing to take the first risk, you already understand the Prisoner’s Dilemma. It’s one of the simplest and most powerful concepts in economics and game theory. And it offers a surprisingly relevant lesson for how public pension funds approach systemic risks like the climate crisis.
The Classic Prisoner’s Dilemma
The Prisoner’s Dilemma describes a situation where two people or institutions must make decisions that affect both of them, but without knowing what the other will do.
Here’s the classic version: two suspects are arrested and questioned separately. Each has two choices: stay silent or confess.
If both stay silent, they each get a light sentence.
If one confesses while the other stays silent, the confessor goes free and the other gets a heavy sentence.
If both confess, they both get a medium sentence.
The rational choice, according to pure self-interest, is to confess because no one wants to risk being the only one who stays silent. But if both confess, they end up worse off than if they had cooperated.
That’s the dilemma: individual incentives lead to a worse collective outcome.
The same logic plays out every day in financial systems. Each investor, company, or fund acts in its own best interest, but when everyone does that without informed coordination, the system itself becomes more fragile.
Take climate change, for example. Each company might reason that it’s cheaper in the short term to continue high-emission operations or delay transition planning. And each pension fund might think that engaging one-on-one won’t make much difference, or that selling off risky holdings could reduce short-term returns. But collectively, this short-term thinking intensifies the risks that threaten everyone’s portfolios.
The Prisoner’s Dilemma teaches that individual rationality can create collective irrationality. When everyone looks out only for themselves, the group ends up worse off, and systemic risks, like climate change or market instability, go unchecked.
