Prospect Theory and Foreign Policy Analysis in the Asia Pacific

Rational Leaders and Risky Behavior

Kai He, Huiyun Feng

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781135131197
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: International Relations
• Index: Politics & International Relations

Why does North Korea behave erratically in pursuing its nuclear weapons program? Why did the United States prefer bilateral alliances to multilateral ones in Asia after World War II? Why did China become "nice"—no more military coercion—in dealing with the pro-independence Taiwan President Chen Shuibian after 2000? Why did China compromise in the negotiation of the Chunxiao gas exploration in 2008 while Japan became provocative later in the Sino-Japanese disputes in the East China Sea? North Korea's nuclear behavior, U.S. alliance strategy, China's Taiwan policy, and Sino-Japanese territorial disputes are all important examples of seemingly irrational foreign policy decisions that have determined regional stability and Asian security.

By examining major events in Asian security, this book investigates why and how leaders make risky and seemingly irrational decisions in international politics. The authors take the innovative step of integrating the neoclassical realist framework in political science and prospect theory in psychology. Their analysis suggests that political leaders are more likely to take risky actions when their vital interests and political legitimacy are seriously threatened. For each case, the authors first discuss the weaknesses of some of the prevailing arguments, mainly from rationalist and constructivist theorizing, and then offer an alternative explanation based on their political legitimacy-prospect theory model.

This pioneering book tests and expands prospect theory to the study of Asian security and challenges traditional, expected-utility-based, rationalist theories of foreign policy behavior.

1 Prospect Theory, Neoclassical Realism, and Foreign Policy Puzzles in Asian Security

Introduction

This book employs prospect theory within the framework of neoclassical realism to explain risk-taking behavior in the Asian security domain. Prospect theory is a behavioral theory of decision making under different conditions of risk. Neoclassical realism is a realist model in the study of foreign policy. The integration of prospect theory and neoclassical realism not only extends the application of prospect theory to international relations and area studies, but also broadens the theoretical domain of realism beyond traditional rational choice approaches. In sum, therefore, this book explores the possibility of employing prospect theory and neoclassical realism in the study of Asian security issues in international relations.

This introductory chapter contains discussions of three sets of general questions. First, why should we employ prospect theory in the study of foreign policy in general and Asian security in particular? We suggest a neoclassical realist view that risk-taking behavior is inevitable in world politics, due to its roots in the anarchic nature of the international system that intensifies the degree of uncertainty in international relations (see Lobell, Ripsman, and Taliaferro 2009). We contend that prospect theory can shed some light on explaining states’ risk-taking behavior, for which is insufficiently accounted by mainstream international relations theories. As one of the most dynamic and uncertain regions in the world, Asia’s security and foreign policy decisions provide a natural experimental field for the theoretical specification and empirical testing of prospect theory.

Second, why are we integrating prospect theory and neoclassical realism as the general theoretical framework of this book? We suggest that although prospect theory provides a psychological tool for neoclassical realism to specify the domestic transmission belt for the systemic effects on state behavior, neoclassical realism supplies an international relations context that is necessary in order for prospect theory to identify a reference point when explaining and predicting foreign policy decisions. The integration of prospect theory and neoclassical realism helps explain risk-taking behavior in world politics, which is sometimes seen as “irrational behavior” by mainstream international relations scholars. We introduce a “political legitimacy-prospect model” to explain some rationalist puzzles in the study of Asian foreign policy, especially in the security arena. The status quo of political leaders’ political legitimacy serves as both the reference point for prospect theory and the transmission belt for neoclassical realism. We suggest that political leaders are more likely to make risky decisions when they face a deficit of political legitimacy, i.e., they are seriously challenged domestically or/and internationally, and they are framed in a domain of losses.

Third, what are the major empirical rationalist puzzles that we address in subsequent chapters and what are our major findings? Employing the political legitimacy-prospect model, we examine four important rationalist puzzles in the study of Asian security. They are U.S. bilateralism-based, alliance behavior in Asia in contrast to its NATO experience in Europe in the Cold War era, North Korea’s erratic nuclear policies after the Cold War, China’s surprisingly soft policy toward Taiwan’s pro-independence leader Chen Shui-bian in the early twenty-first century, and China’s unexpected compromise in dealing with Japan and Japan’s unnecessary provocation during the East China Sea disputes in the early twenty-first century. We conclude that variations in risky behavior are driven by both the systemic uncertainties of anarchy and individual leaders’ prospects in the decision-making process within the domain of action. Therefore, more academic attention is merited to explore risky behavior in the study of Asian security.

Anarchy, Risk-Taking Behavior, and Prospect Theory

Anarchy, the lack of overarching authority in the world, is one of the most prominent features of international politics. All mainstream international relations theories in different degrees take anarchy as the key presumption for their theories although constructivists question the origin of anarchy in a sociological sense.¹ Anarchy is a constant attribute in world politics, but its impact on state behavior is channeled by the uncertainty variable that is embedded in anarchy. Because of uncertainty in the international system, states do not know what others will want (intentions) and will do (behaviors) in the future. The fears of states associated with anarchy and uncertainty dictates states’ behavior in the system (Lebow 2008; Tang 2008).² Because uncertainty is a variable and not a constant, its impact on state behavior varies and depends on the extent of uncertainty. For example, the United States and Canada are neighbors, just as China and India are. However, because of geopolitical, historical, and cultural reasons, the uncertainty between the United States and Canada regarding the possibility of military conflicts between the two nations is much lower than between China and India. Therefore, state behavior under anarchy is also shaped by the level of uncertainty to a certain extent in different situations.

Under a relatively low level of uncertainty, states are more likely to behave rationally, i.e., by making decisions based on a sophisticated calculation of costs, benefits, and their probabilities regarding a certain policy. As subjective expected utility theorists suggest, states make decisions based on “the choice they believe maximizes expected utility” (Bueno de Mesquita and Lalman 1992, 36).³ Although expected-utility theorists face the unsolved problem of lacking a theory of preferences, i.e., specifying and measuring the expected utility for individual states, relatively low uncertainty provides a conducive environment for political leaders to make decisions based on their beliefs about the maximization of utility. It is not to say that political leaders’ decisions under low uncertainty are free of risk. Any decision under conditions of uncertainty faces some risk. However, the risk (probability of losses as an outcome) associated with a decision under a low level of uncertainty is much lower than a decision under a high level of uncertainty.

Under a relatively high level of uncertainty, state leaders encounter more challenges when making decisions. Besides time constraints and the urgency of events, state leaders face more temptations from risk-taking choices. As Rose McDermott (1998, 3) points out, “risk is inherent in any situation where there is uncertainty, and even more so when the stakes are high or the prize is big.” The payoff for each choice is the probability times its utilities, and the normal, rational choice is the one with the highest product (payoff). Contrary to expected utility theory, however, prospect theory predicts that under certain conditions the decision maker will choose the option with the highest utilities without regard for the level of probability associated with each option. For example, in casinos, we see some “crazy” gamblers who use their fortunes to bid for the big prize. However, the probability for them to win the prize is relatively slim. It means that these gamblers choose the option with the highest utilities, but associated with a relatively low winning probability. Their behavior is certainly risk-taking or risk-acceptant in nature. On the one hand, risk-taking behavior by definition means making a decision with a higher, but less probable, payoff than a lower, but more probable, option. On the other hand, the high level of uncertainty about the probabilities of success or failure provides a greater incentive for leaders to bid on their chances for higher utilities, although they know that a higher risk-taking decision may also lead to disaster in the event of failed execution.

Political leaders do not always choose high risk-taking decisions under high uncertainty. A high level of uncertainty with high stress and incomplete information, however, sometimes erodes the setting for policy makers to make decisions rationally, i.e., by maximizing the expected utilities of decisions, as expected utility theorists suggest. Therefore, states’ policy choices may fall outside this optimal rationality model and enter the domain of bounded rationality because of cognitive biases concerning risk propensities associated with decisions.⁴ Prospect theory as a prominent behavioral theory within the paradigm of bounded rationality becomes an alternative model to examine what expected utility theorists would normally label irrational behavior.

Prospect theory was introduced by Daniel Kahneman and Amos Tversky (1979) through laboratory experiments. They found that how people interpret their situation for making choices, as either in a domain of gains or losses, influences how they behave in terms of their risk orientation. Taking a risky decision refers to the probability of likely losses rather than likely gains associated with a decision; the higher the probability of losses, the riskier the decision. Prospect theory argues that people tend to evaluate choices with respect to a reference point. People choose risk-averse behavior in a domain of gains but risk-acceptant behavior in a domain of losses. If people are in an advantageous situation (a domain of gains), they are more likely to behave cautiously (risk-aversely) in order to protect their gains and avoid losses. However, when people are in a disadvantageous situation (a domain of losses), they are more likely to choose risky behavior that may either reverse or worsen their losses. They accept the risk of further losses in order to reverse them, even though in the extreme case the probability of such losses may be greater than the probability of gains (McDermott 2004, 294). In other words, they choose irrationally by going “against the odds” of expected utility calculations, as in the case of the debt-ridden lottery player in the domain of losses whose odds (probability) of winning the lottery (achieving gains) are much worse than losing the purchase price (incurring losses) of the lottery ticket.⁵

There are two reasons for applying prospect theory to political science in general and international relations in particular. First, prospect theory can provide an alternative account of political decisions taken under risk and complement the intellectual deficiency of a rational choice approach in the study of politics. Derived from the subjective expected utility paradigm, rational choice approaches have been influential in the study of politics and international relations for a long time. Rational choice theorists dismiss the findings of cognitive and social psychology that people sometimes fail to make utility-maximizing, rational decisions. Moreover, rational choice approaches often make an “as if” assumption about people’s optimal rationality to account for policy makers’ decisions and a state’s policy choices.⁶ However, contrary to what rational choice theorists assume, numerous empirical anomalies in both everyday life and high politics indicate that people do not always behave “as if” they are rational.⁷

Challenging the “as if” assumption of rational choice approaches, prospect theory provides a systematic way to explain and predict decisions under conditions of risk without prior knowledge about individual preferences. Through examining the different situations (domains of action) in which people make decisions, prospect theory explains and predicts risk propensities as well as preferences and choices. Although prospect theory was based initially on classroom experiments, its findings have been tested and confirmed by many scholars in the field of economics, business, management, finance, and political science. In the study of foreign policy, recent scholarship on prospect theory is also promising (e.g., Farnham 1995; Taliaferro 2004a; Mercer 2005; Chan 2007). This book continues the intellectual effort of prospect theorists in the study of foreign policy, but we treat prospect theory and rational choice approaches as complementary rather than competitive. We do not argue that prospect theory necessarily has a superior position compared to rational choice approaches. Instead, we suggest that prospect theory provides an alternative perspective for us to explain states’ foreign policy decisions, which are complex and multifaceted in nature.

Second, international politics and foreign policy decision making normally take place under conditions of relatively high uncertainty and complexity, thereby also involving high levels of risk in the form of probable losses. The high level of uncertainty and risk sometimes influences and even distorts policy makers’ preferences. In other words, the utilities of policy makers may no longer be static as the expected utility theorists assume. Because the assumption of the static type of subjective utility has been an unsolved problem for rational choice approaches, the dynamic feature of utility under a high level of uncertainty and risk poses even more challenges to rational choice approaches. Therefore, risk-taking behavior is normally treated as irrational and as a deviant case by rational choice theory.

For example, why do great powers frequently initiate and persist in risky diplomatic and military interventions in the periphery despite mounting economic, political, and military costs? After criticizing two rational choice explanations, domestic politics and offensive realism, Taliaferro (2004b) introduces a prospect-theory-based, balance of risk argument. He suggests that policy makers of great powers are more likely to choose risky diplomatic and political intervention strategies when they are faced with perceived losses—in terms of relative power and status, i.e., when they are framed in a domain of losses. In other words, the real reason for great powers to intervene in the periphery is not to gain more power and prestige as rational choice approaches suggest, but to avoid and recoup perceived losses. Although it is still difficult to argue that all great power interventions in history fit Taliaferro’s story, the prospect-theory-based balance of risk argument sheds some additional light on our understanding of the risk-taking behavior of great powers.

Similarly, this book applies prospect theory to the study of several Asian security issues. As one of the most dynamic regions in the world, Asia harbors many diplomatic and military hot spots. China’s rise and its relations with Taiwan may drag the United States into military conflicts. North Korea’s nuclear program threatens regional peace and stability and has been a major headache for major powers in the world for more than two decades. A bilateralism-based, U.S. alliance strategy in Asia was a cornerstone of regional security after World War II. But why did the United States choose bilateral alliances instead of the multilateral alliances it made with NATO in Europe? Whether the United States changes its alliance strategy in the future will directly influence regional security in Asia. Finally, China-Japan territorial disputes in the East China Sea are flash points for military conflict between these two giants in the Asia-Pacific. How to explain and predict states’ foreign policy decisions, especially risk-taking behavior, in these hot spots is a significant task for scholars of Asian security.

Although mainstream international relations theorists provide some insights into these issues, rational choice approaches sometimes encounter inevitable shortcomings. Because of their assumptions of optimal rationality and a fixed utility function, risk-taking behavior sometimes is excluded from the theoretical perimeter of mainstream international relations theory. Prospect theory offers a new psychological perspective on these Asian security issues. The analyses of Asian security issues in our book demonstrate that prospect theory can play at least a complementary role in broadening and deepening our understanding of states’ risk-taking behavior in the Asia-Pacific region.

One common criticism of psychological theories in general in international relations targets the applicability of individual-level theory to state-level behavior (Verba 1961; Levy 1997). Prospect theory is a behavioral decision-making theory with individuals rather than states as units of analysis in Kahneman and Tversky’s experiments. However, as Taliaferro (2004a, 231) points out, “the growing experimental literature on escalating commitment and investment behavior shows that prospect theory provides a descriptive model for organizational and group decision making.” In his study of interventions in the peripheries by great powers, Taliaferro also applies prospect theory to aggregated, state-level behavior. Here we also apply prospect theory to state-level behavior while acknowledging a debatable aggregation problem in using prospect theory in international relations. We assume that states are the unit of analysis just as utility-based, rationalist theory does in international relations. However, we avoid the “as if” assumption by analyzing individual leaders’ statements and speeches and governmental documents to assess the perceptions and the preferences associated with decisions by states. In other words, we treat political leaders or decision makers as the agent that represents the interests of states in the international system.

One major problem for political scientists in applying prospect theory to real-life, political events is how to set the reference point that defines the domains of gains and losses in case studies. Because there is no theory of framing or setting the reference point, international relations scholars have introduced different techniques pragmatically to set a reference point for determining an actor’s domain of gains or losses.⁸ As Mercer (2005, 4) suggests, there are five major prevailing methods to determine an actor’s domain: “status quo as reference point, aspiration as reference point, heuristics, analogies, and emotion.” In our research, we choose the status quo as the reference point for determining domains of action for unitary actors (states) in the international system. How to determine the status quo situation for states in the international system is beyond the theoretical scope of prospect theory. As an experiment-based theory of decision under risk, prospect theory cannot directly apply to international politics without an international relations theory to help prospect theory identify what the status quo is as the reference point in the framework.

The Political Legitimacy-Prospect Model and Neoclassical Realism

In this book, therefore, we integrate prospect theory with neoclassical realism—one of the prominent realist frameworks in the study of foreign policy—and introduce a political legitimacy-prospect model to explain political leaders’ risk-taking behavior. On the one hand, neoclassical realism provides insights on defining the reference point of prospect theory, i.e., assessing the status quo situation of states in the international system. On the other hand, prospect theory offers a unique, psychology-based, causal mechanism for neoclassical realist explanations to employ in analyzing high risk-taking—the so-called irrational behavior of states in international politics.

Neoclassical realism is not a single theory, but a research program or framework, which stems from the realist tradition and focuses on foreign policy studies. Neocl...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Dedication
• Contents
• List of Figures and Tables
• Series Foreword
• Acknowledgments
• 1. Prospect Theory, Neoclassical Realism, and Foreign Policy Puzzles in Asian Security
• 2. “Why Is There No NATO in Asia” Revisited: U.S. Alliance Strategy under Risk
• 3. North Korea Goes Nuclear: Rational Decisions and Risky Behavior
• 4. China’s Policy toward Taiwan under Risk: Between Military Coercion and Political Pressure
• 5. China-Japan Territorial Disputes in the East China Sea: Risky Behavior during Power Transition
• 6. Rational Leaders and Risky Decisions: Risk-Taking Behavior in World Politics
• Notes
• Bibliography
• Index