Casinos as Institutions

In the previous post I gave a very simple–not to say uncontroversial or entirely accurate–definition of an institution: an actor who codifies constraints upon his/her/its own behavior. This post provides two related examples of what I mean, taken from games.

One clear example of an actor placing explicit and clear constraints upon himself is the dealer at a blackjack table. While the rules can vary, the basic version is that the dealer has two cards, one of which is face down. Of the many potential variations, one simple example to consider is whether or not the dealer hits on 17. According to Wikipedia, a dealer who hits on 17 decreases the house edge by about 0.2 percent. Over the long run this is not a trivial sum when you consider the average revenue of a casino. Thus, it is more common for the dealer to stand when his cards total 17.

Either way, though, the dealer’s rules are literally written on the table. His behavior is codified there for all players to see. This can influence there calculus not only of whether to enter the game, but of what decisions to make once they are playing; a dealer who stands on 17 encourages players to make riskier bets when their own total is less than 17. It is this marginal increase in risk that leads to the casino’s higher profit under the stand-on-17 rule. The key thing to notice here is that the institutions restraints on its own behavior affect the behavior of other players.

Don’t these self imposed rules make it easier to cheat? Of course they do. Even when cheating is difficult (some casinos use as many as eight decks of cards to discourage counting), there will be some people who are smart enough, bold enough, and greedy enough to try it. And none of that is to criticize them–I’m not even entirely comfortable calling it cheating, but even so it is entirely rational.

This is where the second element of institutions, at least political ones, comes into play. Once they have imposed constraints on themselves they become predictable. In order to keep from getting screwed by people who find loopholes in the rules, casinos need some way to make cheating less likely. Enforcement often takes the form of brawny guys with brass knuckles. More generally, our government and others around the world maintain police and militaries to impose constraints on domestic and international actors who might try to take advantage of their predictability.

To simplify the casino example and connect it to government, let us consider a very basic and common game: Matching Pennies. Readers not familiar with game theory can find a treatment of it in Osborne (2004: 19-20, 111-112, 136-137) or at Wikipedia, where it is described as the two-strategy equivalent of Rock, Paper, Scissors. There are two players, which we will call Government and Citizen, two actions (heads or tails), and four possible outcomes. If they show the same side of their coins, the government takes the citizen’s penny. If they show different sides of their coins, the citizen takes the government’s penny. These outcomes are shown in the following table:

The Matching Pennies Game

Predictability in this game means losing. Whichever player I am, if I know what you are going to do I get to choose the action that will give me the highest payoff. However, the game is typically played simultaneously. When it is played this way there is no best pure strategy in which you always do one thing or the other. As Osborne will tell you, the best thing to do is just flip your coin and let it land randomly on heads or tails. If both players do this and the coins are fair (50/50 odds of heads/tails), over the long run both will break even.

But say you have two types of governments: autocrats and populists. Autocrats really like the strong personality of Abraham Lincoln, so they always show the head of their coin. Populists feel more strongly about the e pluribus unum message on the tail side of the coin, and always show it. Either one is predictable, and a citizen or foreign government playing against the government can choose the outcome because the government is predictable. This is what I meant by an institution codifying its own behavior.

Say the government is an autocratic institution that always shows heads. How will it be able to continue pursuing its favored course of action and keep from losing its penny in every iteration of the game? It could change the rules, start randomizing its actions, or maybe just poke the other player in the eye. Empirically, we observe all of these outcomes in different scenarios. This extends the argument of the previous post in two ways:

  1. A political institution is an actor who codifies constraints on their own actions in a way that reveals their preferences AND
  2. contrains the other players’ actions in such a way as to lead to the institution’s preferred set of outcomes.

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