What Does the Prisoner’s Dilemma Have to Do with Public Pension Funds?
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.
Systemic Risks Require Informed Action
Public pension funds are uniquely positioned to break out of this cycle. Unlike short-term investors, these funds are investing for decades, not quarters. That perspective gives them both the incentive and the responsibility to address systemic risks that threaten the long-term health of the market and the retirement security of millions of workers.
Systemic risks like climate disruption, widening inequality, and political instability can’t be diversified away. They affect the entire system. If the economy falters because of the unchecked impact of climate change, even the best-managed portfolios will feel the shock.
That’s why pension funds that voice conviction through engagement coalitions, proxy voting, and policy advocacy help change the equilibrium. They demonstrate that cooperation is strategic, influencing corporate behavior, demanding transparent risk reporting, and pushing asset managers to align with climate transition plans and governance standards that benefit all investors.
Escaping the Dilemma
Breaking out of the Prisoner’s Dilemma requires trust, transparency, and alignment. In the context of public pension funds, that means:
Information sharing: Understanding and disclosing climate-related financial risks helps all investors to make more informed decisions.
Engagement with Shared Conviction: Intentional voting and robust dialogue increase the pressure on corporations to change course.
Policy support: Encouraging consistent governance and fiduciary guidance helps level the playing field so no single fund feels penalized for doing the right thing.
When pension funds pursue shared goals, they shift the game from short-term competition to long-term stability. It’s the difference between two prisoners turning on each other and both losing, and two trustees recognizing that they’re better off cooperating to safeguard the entire system.
The health of the market depends on the collective behavior of its largest investors. It’s ethics and economics.
And public pension funds have the scale, influence, and mission-oriented mandate to help move the system toward cooperation and long-term resilience, turning the logic of the Prisoner’s Dilemma on its head and proving that shared responsibility are the most rational choice.
At Climate Finance Action, we catalyze the courage of trustees, unions, and pension fund stakeholders to collaborate, understand, and mitigate systemic risks and advocate for investment practices that benefit people and the planet. Because when it comes to safeguarding the future, cooperation is the best way forward.
