Prof. Robert Aumann is sitting in his office at the Center for the Study of Rationality on the Givat Ram campus of the Hebrew University of Jerusalem. Every floor of the building is adorned with large posters featuring Aumann's photograph. The text on the posters reveals the reason for the hoopla: Aumann, co-winner of the 2005 Nobel Prize in economics, has just celebrated his 80th birthday.

Five years ago he shared the Nobel with American economist Thomas Schelling, for using game-theory analysis "to explain economic conflicts such as price wars and trade wars, as well as why some communities are more successful than others in managing common-pool resources," and to clarify "the raison d'etre of many institutions, ranging from merchant guilds and organized crime to wage negotiations and international trade agreements," according to the Nobel academy.

Today, in his small, modest and messy room, there is no trace of excitement. His desk is covered with piles of documents. On one wall is a board on which dozens of mathematical formulas have been written with markers. On the opposite wall is Aumann's main source of pride: the "family tree" of 14 Ph.D.-holders whom he supervised directly, as well as all 100 of the doctorate-holders - "the grandchildren and great-grandchildren" - his students have trained.

Prof. Aumann, are you in fact a rationalist?

"Rationality is behavior that advances your goals. Maybe it is a bit egoistic and maybe it isn't. The shahids [martyrs in the name of Islam], or - not to suggest that they are in any way comparable - Maj. Roi Klein, of blessed memory, who threw himself onto a grenade to prevent harm to his soldiers, sacrificed their lives, but they are rational. Everyone has a goal and he wants to advance it. A goal is a goal; you can't categorize it as rational or not. Rationality relates to the question of whether the action you are taking advances the goal or not - that is, whether you are using your head in order to advance your goal."

In the interest of advancing my goal I could lie to you, threaten you or trick you. Is that still rational?

"Rationality is not morality. It is not something nice. It is like intelligence, which isn't especially beautiful. It might be a gift from God, a gift from genes or from the environment or perhaps a gift from yourself, but it is not something especially worthy of praise. The question is what you do with it. You can do ugly things in the interest of achieving the goals. This is something I call 'perpendicular to morality': It is not moral and it is not immoral."

And do you feel you always act out of rationality? Are you always rational with your children and your wife?

"I don't act out of rationality. The fact that it is your field of research doesn't mean you yourself are rational. For example, I don't always like to learn new things. I hate technology. I go crazy when they change the computer program and make improvements, because I have to invest in learning the new program. I can waste a lot of time on things the new program could have solved. I am shortsighted in this respect. Instead of investing half an hour or an hour in learning, I say: 'To hell with it, I'll do it with the old program.' This isn't smart or rational. Rationality and game theory aren't relevant to everything.

"I don't 'calculate' what I do with my wife, my children and my grandchildren. That I do out of love. There is a lovely verse we say twice a day: 'And thou shalt love the Lord thy God with all thy heart, with all thy soul and with all thy might.' About this verse, from the Va'ethanan portion of Deuteronomy [3-7], Rashi says that it is necessary to serve the Holy One, blessed be He out of love and not out of fear. If you serve out of fear and that's rational and that annoys you - you will leave him. If it is out of love, you will not leave him. The love for my children and my wife and my relatives and Talia my secretary isn't in order to get a reward. And it isn't out of fear."

The next crisis

Prof. Aumann's rationalist approach has led him to a sharp and clear view of the government-sponsored economic rescue plans implemented in the American and European banking systems during the past two years, for auto manufacturers in the United States, and in the current attempts in the eurozone to rescue Greece. His position is unambiguous: States must not rescue banks, auto-makers or Greece. The reason: By rescuing organizations that have failed, we are only inviting the next crisis.

"The rescue plans are causing inflation because they entail printing money, and in that way they are causing the next crisis. Additionally, there could be a domino effect - if one organization rescues another, in the end, the rescuer will also need to be rescued. This causes a moral hazard. These are undesirable incentives that will accelerate the arrival of the next crisis and in the end it will cheapen the currency."

I accept that rationale, but if you don't rescue the banking system, and it collapses, the public of depositors will be badly hurt. So how does one balance the rationale and the practice?

"I don't accept the claim that the banking system would collapse. This is something people say, but it isn't correct."

So what should governments do when they see that the banking system is falling apart? Sit and do nothing?

"I didn't say it isn't necessary to intervene. There are other things that can be done: It's possible to reduce certain taxes; it's possible to build infrastructure; it's possible to encourage the economy in various ways. But if you have assembled a rescue plan, it means in effect that [institutions] can act in an irresponsible way and nothing bad will happen to them. Banks go bankrupt all the time. In the United States there are lots of banks that go bankrupt, and there is deposit insurance that covers up to a certain sum. [But] the governments have rescued the banks, not the savers. They have rescued the auto companies."

Let's take your rational approach to another area. Look at what has happened to Israel in the wake of the Turkish flotilla affair. The state had a goal to which it stuck: to stop the ships from reaching Gaza. The goal was achieved but at a high price, including a significant worsening of Israel's international relations and condemnation from all sides. Is that rational?

"In game theory, there is the paradox of the extortionist. Someone offers Reuven and Shimon NIS 1,000 together, if they can manage to agree on the question of how to split the money between them. Reuven says to Shimon: 'Great, let's split it half and half.' Shimon says: 'No. I am not leaving here with less than NIS 900. You will get 100. Take it or leave it.' Reuven says to him: 'Be rational. What is the difference between us? Why should you get more?' Shimon says: 'Rational or not, do what you want. Either I leave here with 900 or with nothing. You decide.'

"Reuven thinks and says: 'Okay, NIS 100 is money nevertheless. What am I going to do with this irrational mule? I myself am rational and I will take the 100. I need to advance my goal of getting as much money as possible, and my choice is between zero and 100. One hundred is still something.'

"What is the paradox? That the irrational person gets more than the rational person. Each needs to decide whether he wants to insist on what he is asking for, or is prepared to compromise. In order to persuade Shimon not to give in, Reuven first has to convince himself. Without willingness to concede, he will not succeed in persuading [anyone else].

"Twenty years ago, a brigadier general came here, maybe a major general, who didn't identify himself. He wanted to talk to me about the negotiations with Syria. He said to me: 'You know, Prof. Aumann, the Syrians will not give up a single centimeter of land and the reason is that the land is holy for them. Therefore, they will not concede.' Then I told him about the extortionist. I said to him: 'The Syrians have succeeded in convincing you because first they convinced themselves.'

'Nothing sacred'

"What is our problem? That nothing is holy. We don't manage to convince ourselves that anything is sacred. Not Jerusalem, not the right of return, not even Tel Aviv. We will be prepared to negotiate, and in the end even to give up Tel Aviv. We are rational as can be, and that's our problem. You can say of me that I am a crazy religious nut who talks about holiness, but I am not talking about faith and the Holy One, blessed be He.

"In the end we will sanctify life abroad, and maybe they will be prepared to give us that. There isn't anything that we can convince the other side is sacred to us, that we're willing to 'be killed for it, rather than transgress.' If there were something like that, then we wouldn't be in the situation we are in today.

"That is what I have to say about the flotilla. We give in all the time. What led to the flotilla? The expulsion from Gush Katif [the Jewish settlement bloc in the Gaza Strip]. This led to the Second Lebanon War, to three years of bombardment of the south and to Operation Cast Lead - and that led to the flotilla."

So in your view, should the government not have considered any possibility other than stopping the flotilla?

"The decision makers have to relate to additional considerations, but they aren't considering this in the right way. I think it is wrong to prevent those ships from entering Gaza. If you have given Gaza to the Arabs, then why impose a blockade on it? But if we do decide to stop the flotilla, we have to tell the Turks we are cutting off relations with them, that we are recalling our ambassador from Ankara and prohibiting Israeli citizens from visiting Turkey. This isn't a declaration of war, but it is the taking of harsh steps. And there won't be any committee of investigation... and if you send another ship we will not come with paint in our rifles, but rather with 1,000 men and real bullets in the rifles. That's the way we will get respect.

"When did we get a lot of respect? When we bombed the reactor in Iraq, in Operation Entebbe, in the Six-Day War. Gestures don't bring respect, but rather scorn, not just here but everywhere in the world because that's human nature. Anyone who remembers the expulsion from Gush Katif relates to it with a shrug: 'You expelled your own people.' We didn't get points because of the expulsion."

In your way of thinking, is there no room for gestures or a middle ground?

"I am not saying the whole land is ours and that it is impossible to partition it. It is possible somehow to share. But to say that we have no right, that we are the problem? The whole business, after all, didn't start in 1967. In 1948, Kfar Darom [in the Gush Katif bloc] was already in our hands. Why did they have to expel the people?

"If we don't understand that we have a right here and we keep apologizing for the occupation all the time, we will not survive here. If I don't convince myself of the justice of my path, that I deserve and I have a place, I will end up without anything. You can't isolate the incident: The flotilla was caused by the expulsion from Gush Katif and by post-Zionism. If we don't know what we are doing here, let's leave.

"This is game theory: You need a goal and if you are prepared to pay the price, you will not need to pay [in the end]. If you are ready for war, you will not need to fight. If you cry 'peace, peace,' you will end up fighting. What was the greatest failure of World War II? They wanted to wage a war in which they didn't want to kill and didn't want to get killed. In a war people kill and get killed and you have to be prepared for that."

Are the so-called proximity talks with Palestinian President Mahmoud Abbas doomed to failure?

"The talks can help if two rational bodies participate in them, not when one is an extortionist. The proximity talks aren't being conducted with the right side. It is necessary to talk with Hamas. Why are they conducting talks with someone who has no power? What is that worth? Abu Mazen is prepared to conduct proximity talks, and therefore we are talking only with him? I am not in favor of proximity talks in general, but if you're having them already, then they should be with someone who has something to say."

In Livni's place

Do your colleagues at the Center for the Study of Rationality think the way you do? Ostensibly, if you are presenting a rational outlook here, then your colleagues should hold the same views.

"Some of my colleagues think the way I do and some don't. People aren't prepared to accept these conclusions because of their political leanings."

And don't you draw your conclusions from your political leanings?

"I at least draw my conclusions from the profession. They don't do that."

Israel used quite a lot of force in Operation Cast Lead and paid a high price, so much so that former foreign minister Tzipi Livni is liable to be arrested if she enters Britain. There is a price to your uncompromising approach.

"I think in her place I would go to Britain and ask to be put in jail. Admittedly, it's easy for me to say so."

What's rational about that?

"It will look like we are willing to fight not only with bullets but also in the courts for our most elementary right."

You said that at home you aren't necessarily rational. I assume that if your son didn't want to clean up his room, you didn't take such a tough line, but rather found more pragmatic methods. Why is it that the state is forbidden to be pragmatic and has to stick to a rational line that is costing us a high price?

"My son isn't going to shoot me if I tell him to tidy his room. It is possible to be pragmatic, but what we are doing is the opposite of pragmatic. After all, it isn't working. People think concessions bring peace closer, but they just bring war. Let us learn from this!

"I want peace, but that's not how you get peace. Do you know who the world champions were when it came to peace? The Romans. I don't like the Romans especially. They burned down the Temple, and in Judaism, they are the embodiment of evil. But they knew how to make peace, and for that they deserve credit. They achieved peace by saying, 'If you want peace, prepare for war.'"

"What brings war is that you signal weakness and concessions and ultimately you aren't ready to leave Tel Aviv, and in the end there will be war and in much worse circumstances. We were guilty in Operation Cast Lead because we showed signs of weakness. We should have reacted at the first mortar shell.

"Prof. Sergiu Hart [of the Hebrew University], a student of mine and one of the greatest economists in the world, suggested setting up an immediate automatic system that wouldn't even be operated by humans. When a shell is fired into Israel, within half an hour a shell would be fired back at the place from which it came. You tell the people there they have half an hour to leave. We sat quietly for two years and didn't do anything. We gave them to understand we would sit quietly for another two years. If gestures could bring peace, I would understand the left. Let's try something else. We've been fighting like this for 90 years now."

Let's get back to economics. You believe executives shouldn't be compensated with options, but only by means of shares so they will be a partner to the risk and the risk of change in the shares' value. Are you opposed to placing other restrictions on executive pay?

"Swinishness doesn't bother me. What I need is for things to be good for me, but if someone else has 1,000 times more [money or other things], good for him. I don't need more material things. That is socialism's big mistake. I heard the governor of the Bank of Israel, Stanley Fischer, at a luncheon at the university for recipients of honorary doctorates, and he said one of Israel's aims is to overcome the social gaps. I think every person should have a good life, but if someone has 1,000 times more of something than another person, what do I care? The utility decreases. Someone who has half a million dollars a year - how much better can it be for him?"

And what about the discoveries of natural gas offshore? Do you have no problem with the idea that the profits will go into a limited number of pockets?

"The argument against giving the franchise for the natural gas to a single company or person is correct. If that were the best way to deal with this asset, then I wouldn't care if Yitzhak Tshuva were the owner of it. [But] what can he do with $100 billion? I know what the state can do with it. I think this has to be corrected.

"However, I also understand the developers' argument that agreements were made. I haven't studied this thoroughly. I can't go into everything. Every day someone gets in touch with me about an injustice somewhere. What do they want from me? I did get a Nobel Prize, but I can't lend my name to everything."

Executive pay is closely connected to the low level of competition in some major sectors of the economy. Do you think symmetry should be created between the consumers' degree of freedom in a certain sector and the degree of freedom in determining executive pay in that sector?

"The market needs to be freed up. The country is small, but it is big enough for the markets to be much freer than they are. One of the questions I was asked after I was awarded the Nobel Prize was why the Israeli economy is a wreck. I said: 'I don't understand much about economics, but my economist friends say the Israeli economy isn't a wreck, but rather is doing very well.' That was close to Netanyahu's resignation as finance minister. When I said I didn't understand much about economics everyone burst out laughing, but the bitter truth is that I don't. I understand economic theory. What I am saying about executive pay is correct when you're talking about a free market.

"I have a suspicion that the Antitrust Law helps to create monopolies more than it helps to prevent them ... There is market failure because the market is not free, and what's needed is to pay a lot more attention making it free.

"It's possible to do this in a number of ways. It's possible to give the Antitrust Law teeth and to enforce it, and it's possible to become part of the world, which will be an open market for investments, and for us to be part of the global market. Limiting executive pay will lead to other distortions because they will play tricks in all kinds of other ways. Pay has to be structured correctly. The most important thing is free competition. In the end, all incentives have to lead to free competition, and not to a free market.

"What does a free market mean? That you can do whatever you want except kill. And that is not right. This is because in order to achieve the good of every individual - of the collective, of all the citizens - it's necessary not only for the individual to be able to do what he wants within accepted limitations, with transparency and honesty. It is also necessary that there be competition."

Rashbam on competition

At this point, Aumann goes over to the bookcase in his office and takes out a volume of the Talmud, Tractate Bava Batra, and reads a commentary of the Rashbam (Rabbi Shmuel ben Meir, the grandson of Maimonides ) on prices and competition.

"The Rashbam lived in the 12th century, and he said there is no need to supervise prices, but only measures and weights. Why? Because there will always be someone who will come along and offer a lower price, and therefore there is no need for price controls. Weights and measures [however] need to be supervised. The meaning of this is that regulation has to enforce honesty, fairness and transparency, but not prices."

But isn't this true only in a situation in which there are enough competitors in a competitive industry?

"Definitely. This is on condition that there are several producers and the consumer has an alternative. This is lacking in Israel and it could be that is our mistake. The Rashbam understood this before everyone else, including economist Adam Smith. One of the problems in Israel is that everyone knows everyone else and everyone was together in the army, and this leads to 'unfree' competition. Nowadays fewer people are serving in the army, so maybe this will correct itself. One of the problems with regulation is that its aim is to help the inspectors and not those it is supposed to protect. The relationship between the regulator and the companies under supervision is too friendly. Therefore regulation has to be minimized."

But isn't regulation there to deal with the problem of centralization and low competition?

"I am a theoretician, and I mingle with economists, and it really seems there is too much centralization. More important than centralization, there is too much cartelization. It seems to me we aren't up to the criteria of the United States. There too, not everything is kosher. The government of the United States sued Microsoft on the grounds that it violated antitrust laws, and then it cancelled the suit - and that is a scandal. They flex muscles and that isn't right. It is necessary to aspire to competition, to prohibit cartels - and that doesn't happen here. Among the banks in the United States, you see more variance and differences. Here all of them take the same fees and that isn't right. That's exactly what the Rashbam said - and it isn't being done."