Lee Crawfurd emails me about events in Sudan. North and South Sudan have agreed to a price at which the North will supply oil to the South. On his blog, Roving Bandit, Lee writes:

So – whilst this seems like a good deal for North Sudan in the short run and a good deal for South Sudan in the long run, my main concern is the hold-up problem. What is stopping North Sudan ripping up the agreement in 3 years, demanding a higher cut, and just confiscating oil (again).

In his email he adds:

As it turns out, the South’s strategy is to resume piping oil through the North, but also to simultaneously build a pipeline through Kenya, giving them an extra option.

The fact that the North can hold up later makes it less likely that the North and South will invest and trade in their relationship now. This makes both the North and South worse off. For this difficulty to be resolved, the North has to be able to commit not to exploit the South in the future. But the Kenyan pipeline gives them this commitment power to some extent: If the North threatens to raise prices, the South can go the Kenya route. This means the North will not raise prices in the future and that is good for trade and the welfare of both parties. Paraphrasing the wrods of the great philosopher Sting, “If Someone Does Not Trust You, Set Them Free“.

One issue is that the South may overinvest in the pipeline to get more bargaining power. That could lead to inefficiency as the North then has bad incentives.

Another classic Williamsonian solution is to use hostages to support exchange. I don’t know enough about North and South Sudan to know what they might transfer that is of little value to the recipient and high value to the donor. This sort of solution has been attempted recently in the US in the debt reduction negotiations. Automatic cuts in defense (bad for Republicans) and entitlement expenditures (bad for Democrats) go into force in January if Republicans and Democrats do not agree in debt negotiations. This has not worked so far. First, this is because there are crazy types who are willing to send the country over the “fiscal cliff”. Second, this is because there is no commitment and the automatic cuts can be delayed by Congress and so they are not real hostages.

My memory is terrible but I vaguely recall papers relating to investment in changing outside options in hold up models. These would be the most relevant to the Sudan scenario.