Greece’s Game of Chicken

“We are going directly to hell.”
That was the trajectory newly elected Prime Minister Alexis Tsipras predicted for Greece in 2012 if it were to continue under austerity measures imposed by the eurozone. Tsipras’ leftist Syriza party launched itself into power during last month’s parliamentary elections on a promise to “end the vicious cycle of austerity” that the nation has endured since international creditors saved it from bankruptcy in 2010. The European Troika—the European Commission, European Central Bank, and International Monetary Fund—demanded in 2010 that Greece increase taxes and cut budgets to demonstrate fiscal discipline to its international lenders.
Instead of reenergizing the Greek economy, these policies have cast it into a downward spiral. Real GDP in the country has dropped over 20 percent since 2009. Unemployment rates in 2014 reached 25 percent, with over half the youth in the labor force out of a job. And even for the employed, real wages were the lowest they have been since 2001. Tax revenues have dropped accordingly as wages have fallen and as unemployment has increased. This has resulted in a drop in social spending, and government pensioners, among others, have been left out in the cold.
Syriza has promised to increase social spending to bolster living standards and stimulate the economy. Tsipras and Finance Minister Yanis Varoufakis submitted a plan to the European Union to soften the requirements of 2010’s €240 billion ($270 billion) bailout package. Under their proposal, Greece would pay back 70 percent of the money agreed upon during the financial crisis but would seek to renegotiate the terms of the remaining 30 percent, ideally having some of the debt forgiven. Other EU member states have displayed willingness to make some compromises, such as extending deadlines on certain principle repayments, but are largely resistant to the Syriza deal. European Commission President Jean-Claude Juncker has warned that Greece should not expect the eurozone to accept its proposed terms.
Yet without sufficient wiggle room on the terms of the bailout, Greece may default on its debt and abandon the euro, potentially causing another continent-wide financial meltdown that would strike Greek creditors hard. In an interview with the HPR, Professor Matthias Matthijs of Johns Hopkins University described the current state of affairs as “a game of chicken” to see whether Greece or Europe caves first. To avoid mutual downfall, the two sides will likely be forced to seek a series of compromises which will leave neither happy but both appeased.
An Empty Threat
As Greece struggles to meet its financial obligations, many have predicted that it will be forced to flee the eurozone. Perhaps the most prominent individual to take such a stance is Alan Greenspan, former chairman of the U.S. Federal Reserve, who argues that Greece’s exit would benefit all parties involved. Never, however, has Syriza hinted at such a “Grexit.” The Greek people are evidently of a similar opinion, with a recent poll indicating that as many as 70 percent hope to keep the euro as their official currency. This sentiment seems wise, as Greece’s departure could trigger crises both within the Mediterranean state and across the Union—crises that neither party will allow to happen.
If Greece were to issue a new currency, the International Monetary Fund predicts that it would immediately devaluate to less than half the value of the current euro. Subsequent price inflation would leave the country’s struggling workforce with even less purchasing power than they had previously. In addition, Greek firms with foreign debts booked in euros would have to default and file for bankruptcy. The IMF estimates that this could cause GDP to fall by over 10 percent in the first year. There is a chance the Greek economy would be able to bounce back slightly in the long run, as a devalued currency would give them a favorable balance of trade. Even so, a “Grexit” would constitute political suicide for Syriza in the short run, given Greeks’ overwhelming desire to stay in the currency bloc.
Some observers have suggested that Greece could mitigate the costs of exiting the eurozone by finding alternative creditors, such as the United States, Russia, or China. In an interview with the HPR, however, Paolo Mauro, a senior fellow at the Peterson Institute for International Economics, said, “It is completely impossible. The U.S. would essentially be financing Europe, and the same goes for China, so in terms of geopolitics it’s just not possible.” He said Russia could be a potential lender if it were not “experiencing a crisis of its own.”
From the rest of the eurozone’s perspective as well, a potential au revoir from Greece presents bleak prospects. The European Central Bank would be left holding billions of euros in Greek debt. The currency would probably face rapid short-term devaluation, and see an exodus of foreign capital. Even within the bloc, investors would likely grow wary of other struggling European economies. Depositors would pull their money from banks in places like Spain, Portugal, Ireland, and Italy, which were also hit hard by the continent’s financial crisis. Foreign banks would be hesitant to extend loans to companies in these countries, and foreign firms would be reluctant to trade with them.
More broadly, companies across Europe could expect to see interest rates climb, increasing the cost of borrowing money. This could, in a worst-case scenario, lead to a further breakup of the union, with the aforementioned nations being forced out. Yet even if affairs don’t reach such a state, the IMF predicts a close to 2 percent drop in eurozone real GDP within the first year. This means that the best-case scenario would be that “Grexit” puts Europe on the brink of another recession.
Neither Greece, nor the Troika, nor EU member states want the economic consequences of a Greek departure from the eurozone. A “Grexit” would be “the most expensive solution for both Greece and the euro area,” said European Stability Mechanism managing director Klaus Regling. Therefore, although neither side of the negotiations on debt restructuring seems eager to budge—Greece still wants its proposed terms and the eurozone still wants to resist them—both parties will likely be pushed toward compromise by the threat of another financial catastrophe.
The New Deal

The current terms of the bailout package, aimed at stabilizing Greece’s finances, are antithetical with Tsipras’ leftist political philosophy. They have involved lowering minimum wages, cutting pensions, laying off civil servants, and privatizing many industries. Stringent budget surplus requirements have greatly constricted social spending. Having ridden a wave of support largely from the country’s struggling middle and working classes, the party must find a way to appease these interest groups in the short run in order to retain support. Achieving increased budget flexibility, however, will be impossible if Greece cannot reach a new deal with its fiscally strict financers.
The first step for Syriza will be instilling confidence in the rest of the currency bloc about its commitment to leading a responsible government. Tsipras has already made strides on this front by fighting government excess: he announced a plan earlier this month to sell half of all state limousines and a private jet. Officials in Berlin also mentioned minimizing corruption and improving tax collection as keys to earning German backing. The latter issue is especially pressing. Lost revenue from cigarette and fuel smuggling costs the state an estimated €1.5 billion each year. Before last month’s elections, many Greeks stopped paying taxes in anticipation of cuts to be implemented by the incoming left-wing coalition. Government revenue fell by about a fifth in January as a result, and a former finance minister anticipates the country’s budget to be derailed by March. The Greek government, therefore, will have to tidy up internal operations if it hopes to gain its creditors’ trust.
Shifting focus to the actual terms of the deal, the area in which the eurozone is most prepared to capitulate is that of budget surpluses. Under the current bailout package, Greece is to maintain a primary budget surplus equal to 3 percent of GDP this year and 4.5 percent in 2016. This requirement puts strain on the state’s ability to dole out money on social spending and other programs, and the country has struggled to meet the target in the past, even with austerity measures in place. Tsipras is willing to set a primary budget surplus target but wants it lowered to about 1.5 percent. Whether or not the Troika allows the number to drop so much, reducing the budget surplus requirement is the most likely substantial compromise to come out of the negotiations.
Greece’s debt burden could also be lessened by replacing IMF loans with ones from the European Stability Mechanism. IMF loans mature quickly and have high interest rates, making their cost in terms of net present value relatively high. Loans from the latter agency, essentially Europe’s bailout fund, are longer-term and offer lower interest surcharges. Thus, they are easier to pay off. If the Troika could convince the eurozone to transfer Greek debt held by the IMF to the European Stability Mechanism, it would give Syriza more flexibility in its budget, reduce uncertainty in the Greek economy, and attract previously loath foreign investors. Furthermore, these results would be achieved without eurozone countries having to offer any debt forgiveness, a prospect that major policymakers have been unwilling to entertain. Such a move would hardly be a novel strategy: similar steps were taken in Portugal and Ireland in 2014.
Some experts have presented an alternative strategy of indexing debt repayments against Greek growth. This would, in theory, allow Euro area lenders to share the risk of the Greek economy. If GDP were growing quickly, interest rates on debt repayments would hike, and if growth were slow, they would drop. There are two problems with this method. Firstly, it is difficult to envision skeptical eurozone lenders being eager to buy into the risk of a Greek economy that has, to put things lightly, struggled in recent years. Furthermore, Greece is already paying very low interest on its publicly held debt. Therefore, linking debt repayment to growth rates would only increase the chances of higher interest rates if the economy does rebound, which could partially stifle future growth.
Unfortunately, these strategic considerations will not matter if all sides do not come to the negotiating table willing to make significant compromises. “I don’t think [Syriza] will back down,” warned Matthijs, “These are radicals. They have been elected for a specific purpose.” Yet if a deal is to be reached, Greece will have to accept that debt relief and some other proposed terms are not likely options. The Euro, for its part, will have to acknowledge that if it does not offer Syriza significant flexibility on its repayments, the continent could be thrust toward another economic crisis.
If the current bailout package—set to expire this month—is extended into the summer as expected, there will be plenty of time to weigh the pros and cons of each proposal. With Greek commitment to maintain fiscal and governmental responsibility and European willingness to offer the Mediterranean nation more generous terms, the country could begin to gradually emerge from enduring economic nightmare.
In any case, one thing is certain: Finance Minister Yanis Yaroufakis was correct when he wrote in the New York Times that there was no time left for games.
Image Credits: Flickr/Day Donaldson; Wikimedia Commons/Robert Crc