Wednesday, 8 June 2016
Sisyphus,Tantalus and a prisoner's dilemma
Should Greece leave the Euro? That was the title of the Oxford debate at the Prague Summit in which I had the pleasure of participating yesterday.
But this is the wrong question. Unless there is a considerable shift in Eurozone politics, Greece WILL leave the Euro - eventually. The question is when, and how.
To see this, we need to look at the motivations of all the players involved in the negotiations. The Greek negotiations resemble a "prisoner's dilemma", in which the best outcome for everyone is achieved through collaboration but the participants don't trust each other enough to collaborate. Games are fundamentally psychological, and their outcome is often determined by unspoken or even unconscious drivers. In this case, despite the collaborative rhetoric of the Memorandum of Understanding, distrust and self-interest are the real drivers of the negotiations. In such a situation, true collaboration is impossible and the eventual outcome must be negative for all players.
So, let's look at each player in turn.
Firstly, Greece. Greece's attempt to play the cliff edge game ("go on then, push me") backfired badly last year when the European Council called its bluff. The essence of the cliff edge game is that the player at the edge of the cliff must be prepared to be pushed over the edge, because otherwise the psychological barrier for the other players ("if you push them over you are a murderer") is not credible. But when the European Council threatened to push Greece over the edge ("agree to our terms or leave the Euro"), Greece backed off. In a long and intensely painful night of negotiations, its prime minister, Alexis Tsipras, effectively accepted the European Council's terms.
Since then, Greece has agreed to everything the Eurozone institutions have thrown at it. Everything, however unreasonable. Having failed at the cliff edge game, Greece is now trying to collaborate, apparently in the hope that this will eventually lead to the prized debt relief, along with easing of monetary conditions and the return of investment. It is quite a gamble, but since it has rejected leaving the Euro, Greece has no alternative. This is a very weak negotiating position.
Secondly, the European creditors, led by Germany. Despite its name, the Eurogroup essentially represents the European creditors, since its members are the finance ministers of Eurozone member states.
The creditors want their money back. All of it. Their sole objective in this game is to achieve full repayment. They have no interest in restoring Greece's economy except in so far as it would enable them to extract more of their money. And since the failure of the cliff edge game, psychologically they have the upper hand. They know Greece will not take the risk of being pushed out of the Euro, and so they can make whatever demands they wish in the certain knowledge that Greece will comply. Unless some Exocet hits the negotiations, they can't lose.
But of course there is the European Commission (EC). Isn't that interested in an outcome that benefits everyone, including Greece?
Not really. The EC is interested in furthering the goal of EU integration. Since a state leaving the Euro would be (at least) a step backwards, and there is a not insignificant risk that other states might follow, furthering EU integration means doing whatever it takes to keep Greece in the Euro. If keeping creditors happy is the only way of keeping Greece in the Euro, then the EC will side with the creditors. Of course, since blatantly siding with creditors makes it look biased, which is a bad political message for a supposedly neutral institution, it may attempt to push the creditors towards a gentler approach. But if the creditors resist it will give in, thus making itself look weak.
So the EC also has a very weak negotiating position. In fact the weakness of the EC is telling. One of the fundamental problems with the Euro is the weakness of its institutions relative to the governments of nation states.
Hang on though - what about the ECB? Surely that is a powerful Eurozone institution?
No. The ECB is by far the weakest of the major central banks. Despite its supposed independence and protection from political influence, it is in reality fenced in by treaties and subject to both political and legal challenge. It has been forced into a political role that it should not have. In this game, the ECB is trying (and mostly failing) to stay out of the limelight and preserve the appearance of political neutrality. And beneath this, its primary objective is to keep the Euro together. Since Greece leaving the Euro carries unquantifiable risks to financial stability and the integrity of the Eurozone, the ECB does not wish this to happen. Therefore its natural bias is towards the creditors. It will do whatever it takes to force Greece to comply with creditor demands.
It should be apparent by now that the Eurozone dimension of this game has reached an unhealthy equilibrium. Greece has been cast in the role of Sisyphus, forever pushing a rock up the hill of "structural reforms" only to see it roll back again as it fails to meet fiscal targets or creditors impose more demands. Or perhaps in the role of Tantalus, forever reaching for the water of debt relief only for it to be drawn out of its reach. These perpetual-motion myths are descriptive of the psychological traps created by more powerful players to perpetuate the game.
This is not simply a problem for Greece: any debtor country is potentially in the same situation. Such toxic game-playing does not bode well for the long-term future of the Eurozone. Sisyphus and Tantalus were punished in perpetuity for offending the gods. But the Eurozone is a human construction: the political pressures created by such a power imbalance between debtors and creditors will eventually tear it apart. If the Euro is to survive in the longer term, this imbalance must be corrected.
The Eurozone desperately needs to strengthen its institutions relative to nation states, develop procedures for managing sovereign insolvency, and impose loss sharing on official as well as private sector creditors. But since these reforms would not serve the interests of creditor countries, it seems unlikely that they will ever happen. Eventually, therefore, the Euro is likely to fail.
Of course, there is one more player in this toxic game. To its credit, the IMF has been trying to force a resolution. Everyone knows that Greece's debt is unsustainable, but it suits the European players to pretend that if Greece does enough "reforms", it can be made sustainable. It is this pretence that locks Greece into its Sisyphean role, and keeps debt relief tantalisingly out of reach. But it is a bluff, and the IMF has called it.
However, the IMF itself is a creditor - an expensive one. And like the rest of the creditors it wants its money back. Unsurprisingly, therefore, the IMF's demand that other creditors accept losses while it accepted none did not go down too well. The European creditors dismissed the IMF's assessment that the demands placed on Greece were impossible, and its forecast that eventually Greece would default, They pointed out that the IMF's record of accuracy in forecasting is dismal, and repeated their assertion that Greek debt could be made sustainable through structural reforms. And to stick the knife in further, they offered to refinance IMF loans to Greece at lower interest rates than those charged by the IMF. Ouch.
The truth is that there is no genuinely independent arbiter in this negotiation, and there is a massive institutional bias in favour of creditors. True, the latest Memorandum of Understanding (MoU) includes some sensible reforms: but the overriding aim throughout is to construct the sustained 3.5% primary surplus that would be necessary to make Greece's debt sustainable without debt relief. The MoU imposes a fiscal tightening of 3% of GDP on an economy that has already contracted by 27% and is now back in recession. To counter the IMF's argument that 3.5% was neither desirable nor sustainable, the MoU provides for an additional contingent tightening of 2% through unspecified spending cuts and tax increases should Greece fail to meet its primary surplus target. Claims that Greece has "done" its internal devaluation are clearly wrong. Greek prices and incomes have a lot further to fall.
While this remains a wholly intra-Eurozone matter, with the IMF involved only because the creditors don't trust the EC to promote their interests (and itself significantly weakened by partisan interests), there can be no collaborative resolution to the game. But the longer it continues, the worse the eventual outcome will be, not only for Greece but for the other players too. A disorderly breakup of the Euro, possibly involving not only Greece but other countries too, would be terrible for everyone. But unless there is a major shift in the political stance, that is what will eventually happen.
European creditors have no incentive to offer debt relief unless they are faced with the credible threat of losing much more of their money. And they are hardly going to allow Greek default on official sector debts while remaining within the Euro. So as long as there is no prospect of Greece leaving the Euro, there will be no debt relief. Therefore, as Sisyphus and Tantalus cannot exist forever in our human world, eventually Greece WILL default and leave the Euro, whether it wishes to or not.
The Eurogroup statement on Greece, annotated
The Greek bailout: repeating the mistakes of the past - Forbes
The Great EU-IMF Standoff - Forbes