3 Things Settlers of Catan Teaches Us About Economics
He who can, does; he who cannot, teaches.
~George Bernard Shaw
Name as many billionaires as you can. Now some millionaires. Who are the richest people you know personally?
Aside from being rich, what do they all have in common? Very few of them are economists.
Most of the world’s billionaires are businessmen or inventors—they’re people with big ideas. Many studied engineering in university, and many more don’t even have degrees.
What about the millionaires? I bet you named famous performers (athletes, actors), local entrepreneurs, or people with “boring but safe” jobs like lawyers, doctors, or architects—people with professional degrees.
How many economists did you name? Not many.
You’d think knowing how the economy works would be a big advantage—it’s not. The proof’s in the pudding: most economists work for the government. Many are cubical-dwelling corporate drones. A lucky few teach. Why? Because they can’t do.
Listening to economists is a sure-fire way to ruin your restaurant, bankrupt your business, and implode your investment portfolio. Why? Economics is abstract while reality is complicated, thus what works in theory rarely works in practice.
The best way to learn economics is to start a business and read books that will give you the intellectual tools to figure things out for yourself—books on history, statistics, and psychology.
Or, you could play Settlers of Catan.
No, I’m not being facetious: you’ll learn more about economics playing Catan than you would in a university economics class. Don’t believe me? Here three of Catan’s greatest economic lessons:
1. Killing Homo Economicus & the Myth of the ‘Rational Consumer’
It’s getting late. You’ve been playing Settlers of Catan for hours. And Joe is pissing you off.
He keeps moving the “knight” piece onto your tiles and stealing your resource cards. Not only that, but he’s been turning everyone else against you with his snide remarks.
Suddenly Joe presents you with a proposition: “trade me some clay and I’ll give you wheat”. It’s a good deal: you need clay just as much as Joe needs wheat, and trading will get both of you one step closer to winning the game. Trading with Joe is the rational decision—it makes economic sense.
What do you do?
If you’re anything like me, you’ll tell Joe to take a hike: there’s no way you’re trading with a lowlife like him. You’d rather lose the game than trade with your nemesis!
Your response may not be all that rational, but it’s real. People aren’t computers that constantly weigh their options rationally, and then make the most reasonable choice based on the available evidence.
People are animals. We’re emotional. We have instincts—or more accurately, we have decision-making heuristics (mental shortcuts) that are hardwired into our brain’s architecture. Basically, people aren’t rational.
This is the first, and most important economic lesson from Settlers of Catan, and its implications are far-reaching.
Behavioral Economics & the Anchoring and Adjustment Heuristic
Classical economic theory is based on the assumption that people behave rationally: we are rational consumers who weigh the relative utility of products before buying them. For example, economists assume that when presented with two different, but identical, items, people will invariably buy the cheaper one. Although this makes perfect sense in an abstract, theoretical sense, reality is messy.
People make irrational decisions all the time. In fact, behavioral psychologists like Daniel Kahneman (who won the Nobel Prize in economics for establishing “behavioral economics” as a field of study) thinks irrationality is the norm in the marketplace.
For example, Kahneman has shown that people are willing to pay more for a product if they are psychologically primed with completely unrelated high numbers than with low numbers (that is, if they were shown a sheet of paper with either high or low numbers on it a few minutes prior). This is because of something called the anchoring and adjustment heuristic, which is how the human brain interprets numbers.
Essentially, the brain will anchor to the last number with which it was primed, and then adjust down or up from that to arrive at a price. Say you ask ten people to estimate a price for a product—one that is fairly valued at $500. If they are primed with the number 1,000, their guesses will likely average around $550. However, if you primed a different group of people with the number 10, their guesses will likely average around $450.
There’s nothing rational about that, is there?
Behavioral psychologists have discovered many other heuristics that have big economic consequences, but the fact that even one exists is enough to undermine the foundation of classical economics. People just aren’t that rational.
Complexity & Emergent Properties
Economists often retort that that while individuals are irrational, the law of averages smooths this out in the population as a whole. Unfortunately, the relatively new interdisciplinary field of emergent properties and complex systems puts the kaibosh on this.
Simply put: groups follow different rules than individuals, these rules often differ according to the size of said group, and these rules could not be predicted given the individual characteristics. Given this, there is no reason to expect that purely rational consumers would make rational choices in the aggregate—never mind irrational consumers.
Groups have to be investigated on their own terms.
And of course, there is a large body of empirical evidence that shows aggregating people doesn’t magically make them rational—groups are just irrational in different ways.
For example, in his book The Hour Between Dog and Wolf, John Coates explains how stock markets vacillate between periods of irrational exuberance and panic across all time-horizons, be it minute-by-minute, hour-by-hour, or year-by-year. Emotions like hope and fear govern the market, not rational expectations.
Economic theory is based on the presumption that people are rational. This is a lie. There is no homo economicus—no rational consumer. There are just homo sapiens, and they’re irrational.
If you’ve played Settlers of Catan then you already know this, and you’re miles ahead of everyone currently enrolled in Economics 101.
2. In Praise of Monopolies
There are only five resources in Catan: timber, clay, wheat, ore, and sheep. In order to win, you will eventually need all of them. Sometimes you get lucky and can produce them for yourself, but usually you need to trade. This is where the game gets frustrating, yet interesting.
Generally speaking people are willing to trade resources on a 1:1 ratio because this is considered fair (the resources are generated roughly equally).
But once in a while chance causes one resource to be particularly scarce, and when this happens people are willing to “pay” more for it.
For example, if I am the only person in the game who has ore, and Joe needs ore, Joe will need to pony up a sweet deal to get it, otherwise he’s out of luck. The same thing happens in the real world: water can be worth even more than gasoline under the right conditions.
The bottom line: scarcity raises prices.
This may sound bad, but it really depends on your perspective. In our Catan example Joe is disadvantaged by the relative lack of ore, but I profit handsomely. Scarcity is good if you control the scarce resource.
This brings us to monopolies: the only thing better than having access to a valuable scarce resource is being the only person with access to said resource. Why?
Because if you are the only one with access to a resource, you don’t need to worry about a competitor undercutting your prices. Monopolies inflate prices. Monopolies inflate profits. You want a monopoly—both in Catan and in real life.
National vs Corporate Monopolies
But what about all that stuff you learned in school about monopolies being bad for consumers? I agree: it would be absurd to allow a single individual or company to generate all of America’s electricity—prices would be artificially high, and both the people and the nation would suffer.
But that’s not what we’re talking about.
Private monopolies in the domestic sphere are bad, but national monopolies are good. That is, if your nation has a monopoly in something, the nation as a whole can reap inflated profits on the international markets—even if 100 different domestic companies produce the good.
Imagine for a second if all the world’s oil was located in one nation—that nation would be richer than Croesus. How about if that same nation also had a monopoly in aircraft manufacturing: if another country wanted airplanes, they had to buy from the first nation. Even better, yes?
This example is somewhat analogous to America’s own economic history. Oil became extremely important when the Industrial Revolution began in the early 19th century—oil lamps kept the lights on and oil greased the machines. Oil was indispensable.
And where did oil come from? Whales. Big, blubbery whales.
This was a problem. Whales lived in distant seas, were fairly hard to find, and there weren’t all that many of them—not when you consider how rapidly industry was expanding.
America, along with Great Britain, led the world in whaling, and reaped huge profits selling the relatively scarce resource to European factories.
But the real money was made after Edwin Drake drilled the first successful petroleum oil well in 1859, located in Titusville, Pennsylvania—13 years after the world hit “peak whale oil”.
Fortunes were made in oil. Rockefeller became a household name. The nineteenth century witnessed America’s rise as a world power. And this was not just because oil was valuable, it’s because America was the only nation which produced oil in significant quantities. We had a monopoly.
Of course European powers were quick to develop their own reserves, and conquer oil-rich territories, but there’s no denying that oil was important to America’s economic development.
Likewise, America reaped huge profits from aircraft manufacturing in the post-war period—if countries like Japan, Brazil, or the Philippines wanted aircraf, they bought American. The same was true of automobiles, and later computers.
Since then we’ve allowed our companies to offshore production abroad, thereby eroding our national monopoly in technologically sophisticated manufactured goods—we sacrificed long-term profits for short-term gain.
If you wouldn’t voluntarily surrender your ore monopoly in Settlers of Catan, it makes no sense to support the offshoring of monopolist industries in real life—and yet that’s exactly what the “free trade brigade” recommends.
3. Robust Autarky & Optionality
I played a game of Catan with by buddy “Joe” last week.
Joe is a very smart guy: he studied economics at a great university, and will soon have a law degree from another honored institution.
Furthermore, Joe has a job lined up—he’ll soon be practicing in a prestigious-but-boring field like international trade law. The guy knows his stuff. He’s a hot-shot.
Also, Joe sucks at Catan.
I pounded him into the dirt. It wasn’t even close (sorry Joe, but it’s true). Why?
Joe tried to apply his theoretical knowledge of economics into the game. He thaought if he maximized his comparative advantage in clay production he’d be better off than if he produced everything himself less-efficiently. After all, it was to everyone’s advantage to trade with him, and he (and everyone else) could produce more stuff this way.
To that end, Joe placed both his starting settlements on high-yield clay-producing vertices (he made lots of clay but nothing else). This made sense, in theory.
The problem is that efficiency doesn’t matter. Leverage matters. Joe lost because he had no leverage.
My settlements weren’t as good as Joe’s, but what they lacked in production capacity they made up in variety: I had access to all five resources. I was robust. I had autarky (economic self-sufficiency). This meant that I didn’t need to trade with Joe, but he needed to trade with me. Joe was fragile.
This asymmetry between Joe and I gave me something called optionality: I had the option of trading with Joe, but I didn’t have to. As it turns out, I did trade with Joe—but only when he offered me extra resources to “sweeten the deal”. He didn’t have a choice. My self-sufficiency ensured I had leverage over him.
This self-sufficiency also gave me optionality when other resources became temporarily scarce: I could benefit by “selling” any resource when “prices” were high, but Joe could only do so for clay. I had more options.
This is why experienced stock traders always keep cash on hand: cash doesn’t provide yield like a bond or stock, but it does provide options—you can buy anything with cash, which is handy when stock prices plummet in a fire-sale.
When stocks crash, cash is king. Or more technically, cash is optionality.
Money is Power: Economics is Politics
Joe may have lost, but he made a good point: it makes sense to trade stuff you’re relatively good at making for stuff you’re relatively bad at making, since doing so will ensure there is more stuff to go around. Everyone would be richer if they listened to Joe.
And it’s not just Joe who thinks so. This idea is the animating force behind David Ricardo’s theory of comparative advantage—the intellectual scaffolding upon which global free trade is built.
But there’s one big problem with Joe’s theory: competition.
Joe’s right: trading with him will benefit us both. Trading is an economically rational choice.
However, if Joe is close to surpassing my score, it doesn’t benefit me to trade with him (provided that doing so will hurt him more than it hurts me). After all, I want to maintain my lead, and Joe is my competition. It is politically rational to screw Joe over.
Political, not economic, logic usually governs international trade relations. Why? Money is power. Economics is politics. Let’s look at a historical example.
The following passage comes from my article on Great Britain’s economic decline, which was caused by the asymmetrical adoption of free trade (Britain traded freely, its partners did not). Read it, then we’ll talk about the consequences:
Mercantilism was gospel in Britain until the middle of the 19th century, when things began to change. In the 1840s Parliament consumed itself debating the merits of a radical new ideology: international free trade. Politicians speculated and deliberated, insults were exchanged, but ultimately free trade became Britain’s credo—after all, it looked good on paper. The tariff wall that had protected British industry since the Middle Ages was quickly dismantled from highs of over 50 percent in the 1820s, to just 5 percent decades later. For a time, Britain managed to convince its less-industrial European neighbors to play along, and reaped the benefits accordingly.
But the Germans, French, and Italians were not blind. They watched mass-produced British goods flood their markets, saw their economies slow. In fact, Europe’s lowest average economic and industrial growth of the century (1.7 percent and 1.8 percent respectively) coincided with the free trade experiment. Something had to be done. Between the 1870s and 1890s the Europeans again imposed mercantilist measures. It worked: between 1891 and 1911 GNP growth in continental Europe averaged 2.6 percent, while industrial output grew at 3.8 percent—over twice as fast as during the liberal era.
But Britain held fast. It doubled down on free trade, keeping its markets open and its tariffs low. As a result, Britain’s manufacturing supremacy eroded as their factories were forced to compete against a coalition of European companies and governments. Asymmetrical competition caused exports to fall, and imports to rise: a trade deficit was born. Between 1873 and 1883, the value of British exports fell by 6 percent. This led to a full-blown “made in Germany” crisis—Britain even found itself importing steel from Spain for the first time since the Middle Ages, when Spanish swords were all the rage.
In the late Victorian Period, Britain’s economy stagnated: growth was 55 percent slower than it was just decades earlier. This was caused by a weak manufacturing sector, crippled by competition with foreign government-backed rivals. Between 1870 and 1913 British manufacturing grew by only 2.1 percent on average, whereas German manufacturing grew by 4.7 percent on average. Adding to this problem was the fact that British investors chased higher returns abroad, rather than reinvesting their profits in Britain. Consider this: in 1815, the British invested only £10 million abroad, but by 1825 this had increased to £100 million, and by 1870 over £700 million left the country. By 1914, fully 35 percent of British wealth was held abroad. Northern Britain became a rust belt, and cities like Glasgow and Manchester became the “Detroits” of their age.
As interesting as it is that Britain’s economy declined relative to Europe’s after it adopted free trade (while Europe remained protectionist), the more important point is the difference in outlook. Britain, like Joe, saw things in economic terms: if we all trade together, we will all get rich. Conversely, Europe’s leaders saw things in terms of politics: trade with Britain killed their domestic industry and made them dependent upon British imports.
Import dependency is a major problem because it deprives you of leverage.
Remember how Joe was forced to trade with me (because he only produced clay), whereas I didn’t need to trade with him? If Europe lacked independent industry, it lacked leverage. They knew it, and that’s why they protected it. And of course, the data shows that it made them richer in the long run.
Britain failed to understand this lesson, and ended up sacrificing their economic, and political, might on the altar of free trade. America is currently making the same mistake.
Addressing The Ludic Fallacy
This article was strange, I’ll admit—but I hope you enjoyed it. And more importantly, I hope I’ve challenged your assumptions. Economics isn’t as cut-and-dried as most people think. Even its most basic assumptions are contentious, and often demonstrably incorrect.
I think we’re on the verge of reexamining much of what we know—and just in time. Economists have ruined America’s economy with their “knowledge”.
Finally, for those of you who think this article is subject to the ludic fallacy (conflating a game or model for reality), I’ll point out that none of my conclusions are derived from playing Settlers of Catan, nor any other game. The game was just a scaffold on which to hang my disparate ideas.