Greece is play­ing to lose

Financial Mirror (Cyprus) - - FRONT PAGE -

The fu­ture of Europe now de­pends on some­thing ap­par­ently im­pos­si­ble: Greece and Ger­many must strike a deal. What makes such a deal seem im­pos­si­ble is not the prin­ci­pled op­po­si­tion of the two gov­ern­ments – Greece has de­manded a debt re­duc­tion, while Ger­many has in­sisted that not a euro of debt can be writ­ten off – but some­thing more fun­da­men­tal: while Greece is ob­vi­ously the weaker party in this con­flict, it has far more at stake.

Game the­ory sug­gests that some of the most un­pre­dictable con­flicts are be­tween a weak, but determined, com­bat­ant and a strong op­po­nent with much less com­mit­ment. In th­ese sce­nar­ios, the most sta­ble out­come tends to be a draw in which both sides are partly sat­is­fied.

In the Greek-Ger­man con­fronta­tion, it is easy, at least in the­ory, to de­sign such a pos­i­tive-sum game. All we must do is ig­nore po­lit­i­cal rhetoric and fo­cus on the eco­nomic out­comes that the pro­tag­o­nists re­ally want.

Ger­many is determined to re­sist any debt write-offs. For Ger­man vot­ers, this ob­jec­tive mat­ters much more than the de­tails of Greek struc­tural re­forms. Greece, for its part, is determined to gain re­lief from the puni­tive and coun­ter­pro­duc­tive aus­ter­ity im­posed on it, at Ger­many’s in­sis­tence, by the “troika” (Euro­pean Com­mis­sion, ECB, IMF). For Greek vot­ers, this ob­jec­tive mat­ters much more than de­tailed cal­cu­la­tions about the net present value of na­tional debt in 30 years.

A deal should be eas­ily ne­go­tiable if both sides con­cen­trate on their top pri­or­i­ties, while com­pro­mis­ing on their sec­ondary aims. Un­for­tu­nately, hu­man fal­li­bil­ity seems to be work­ing against such a ra­tio­nal so­lu­tion.

Ya­nis Varo­ufakis, Greece’s new fi­nance min­is­ter, is a pro­fes­sor of math­e­mat­i­cal eco­nomics who spe­cialises in game the­ory. But his ne­go­ti­at­ing tech­nique – un­pre­dictable os­cil­la­tions be­tween ag­gres­sive­ness and weak­ness – is the op­po­site of what game the­ory would dic­tate. Varo­ufakis’s idea of strat­egy is to hold a gun to his own head, then de­mand a ran­som for not pulling the trig­ger.

Ger­man and Euro­pean Union pol­i­cy­mak­ers are call­ing his bluff. As a re­sult, the two sides have be­come stuck in a pas­siveag­gres­sive stand­off that has made se­ri­ous ne­go­ti­a­tion im­pos­si­ble.

There was noth­ing in­evitable about this out­come. Just last month, ECB Pres­i­dent Mario Draghi pro­vided a text­book ex­am­ple of how th­ese ne­go­ti­a­tions could, and should, have pro­gressed, when he out­ma­neu­vered Ger­man op­po­si­tion to the mon­e­tary stim­u­lus that Europe clearly needed.

Draghi spent months be­fore the ECB’s Jan­uary 22 an­nounce­ment that it would launch quan­ti­ta­tive eas­ing (QE) in in­tense public de­bate with the Ger­mans over which point of prin­ci­ple they chose as a “red line” – the point be­yond which no deal would be pos­si­ble. Ger­many’s red line was debt mu­tu­al­i­sa­tion: there must be no shar­ing of losses if any eu­ro­zone coun­try should de­fault.

Draghi let Ger­many win on this is­sue, which he viewed as eco­nom­i­cally ir­rel­e­vant. But, cru­cially, he was care­ful not to back down un­til the last pos­si­ble mo­ment. By fo­cus­ing the QE de­bate on risk-shar­ing, Draghi man­aged to dis­tract Ger­many from an in­fin­itely more im­por­tant is­sue: the enor­mous size of the QE pro­gramme, which com­pletely de­fied the Ger­man taboo against mon­e­tary fi­nanc­ing of gov­ern­ment debts. By con­ced­ing at the right time on an is­sue of no im­por­tance, Draghi achieved an enor­mous break­through that re­ally mat­tered to the ECB.

Had Varo­ufakis adopted an equiv­a­lent strat­egy for Greece, he would have stuck doggedly to his de­mand for debt can­cel­la­tion un­til the last mo­ment, then backed down on this “prin­ci­ple” in ex­change for ma­jor con­ces­sions on aus­ter­ity and struc­tural re­forms. Or he could have adopted a less ag­gres­sive strat­egy: con­cede from the start the Ger­man prin­ci­ple that debts are sacro­sanct and then show that aus­ter­ity could be eased with­out any re­duc­tion in the face value of Greek debt. In­stead of con­sis­tently pur­su­ing ei­ther strat­egy, Varo­ufakis veered be­tween de­fi­ance and con­cil­i­a­tion, los­ing cred­i­bil­ity both ways.

Greece started the ne­go­ti­a­tion by in­sist­ing on debt re­duc­tion as its red line. But, in­stead of stick­ing to this po­si­tion and turn­ing a de­bate over debt for­give­ness into a Draghi-style di­ver­sion­ary tac­tic, Greece aban­doned this de­mand within days. Then came the point­less provo­ca­tion of re­fus­ing talks with the troika, de­spite the fact that the three in­sti­tu­tions are all much more sym­pa­thetic to Greek de­mands than the Ger­man gov­ern­ment.

Fi­nally, Varo­ufakis re­jected any ex­ten­sion of the troika pro­gramme. This cre­ated an un­nec­es­sary new dead­line of Fe­bru­ary 28 for the with­drawal of ECB fund­ing and con­se­quent col­lapse of the Greek bank­ing sys­tem.

Greece’s ide­al­is­tic new lead­ers seem to be­lieve that they can over­power bu­reau­cratic op­po­si­tion with­out the usual com­pro­mises and ob­fus­ca­tions, sim­ply by bran­dish­ing their demo­cratic man­date. But the pri­macy of bu­reau­cracy over democ­racy is a core prin­ci­ple that EU in­sti­tu­tions will never com­pro­mise.

The up­shot is that Greece is back where it started in the poker con­test with Ger­many and Europe. The new gov­ern­ment has shown its best cards too early and has no cred­i­bil­ity left if it wants to try bluff­ing.

So what will hap­pen next? The most likely out­come is that Syriza will soon ad­mit de­feat, like ev­ery other eu­ro­zone gov­ern­ment sup­pos­edly elected on a re­form man­date, and revert to a troika-style pro­gramme, sweet­ened only by drop­ping the name “troika.” An­other pos­si­bil­ity, while Greek banks are still open for busi­ness, might be for the gov­ern­ment to uni­lat­er­ally im­ple­ment some of its rad­i­cal plans on wages and public spend­ing, de­fy­ing protests from Brussels, Frank­furt, and Ber­lin.

If Greece tries such uni­lat­eral de­fi­ance, the ECB will al­most cer­tainly vote to stop its emer­gency fund­ing to the Greek bank­ing sys­tem af­ter the troika pro­gramme ex­pires on Fe­bru­ary 28. As this self-in­flicted dead­line ap­proaches, the Greek gov­ern­ment will prob­a­bly back down, just as Ire­land and Cyprus ca­pit­u­lated when faced with sim­i­lar threats.

Such last-minute ca­pit­u­la­tion could mean res­ig­na­tion for the new Greek gov­ern­ment and its re­place­ment by EUap­proved tech­nocrats, as in the con­sti­tu­tional putsch against Italy’s Sil­vio Ber­lus­coni in 2012. In a less ex­treme sce­nario, Varo­ufakis might be re­placed as fi­nance min­is­ter, while the rest of the gov­ern­ment sur­vives. The only other pos­si­bil­ity, if and when Greek banks start col­laps­ing, would be an exit from the euro.

What­ever form the sur­ren­der takes, Greece will not be the only loser. Pro­po­nents of democ­racy and eco­nomic ex­pan­sion have missed their best chance to out­ma­neu­ver Ger­many and end the self-de­struc­tive aus­ter­ity that Ger­many has im­posed on Europe.

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