Uncertainty, risk aversion, and the game theoretic foundations of the safeminimum standard: a reassessment

Contrary to a widely-held perception, game theory can provide a consistent and rigorous economic justification for the safe minimum standard (SMS) con straint on economic development. S.V. Ciriacy-Wantrup (1968) based the SMS on the idea that risk-aversion is an important public policy motive, and Ri chard Bishop (1978) tried to theoretically justify this idea 20 years ago b y applying the minimax decision rule to an insurance (loss avoidance) game- theoretic model. More recently Richard Ready and Bishop (1991) distinguishe d two different games against nature and determined that the minimax rule i mplied opposite choices (for preservation, for development) in the models a nd, therefore, game theory could not provide a consistent rationale for the SMS. Ready and Bishop's two games can be viewed as subgames of a more comp rehensive dynamic game of society against nature. The minimax decision rule yields contrary results because the two subgames embody different kinds of uncertainty. Further, the minimax rule both ignores the social cost of wro ng choices and violates Milnor's bonus invariance axiom for game-theoretic decision rules (Milnor, J., 1964). A minimax-regret decision rule is prefer red because it emphasizes risk-aversion while explicitly incorporating the opportunity cost of making a 'wrong' choice between preservation and develo pment. The rule gives rise to a consistent choice of preservation over both the insurance and lottery games and transfers the burden of argument from preservationists to developers. On the other hand, the SMS constraint on de velopment is contingent on the size of development benefits foregone and th us is not absolute and binding. (C) 1999 Elsevier Science B.V. All rights r eserved.