Παρασκευή, 6 Φεβρουαρίου 2015

Risk-sharing, hubris, and a possible Grexit from the Eurozone

The new Greek Finance Minister Mr. Varoufakis, a reputable game theorist with deep knowledge of the Eurozone crisis, has been recently touring European capitals to drum up support for his plan to handle the Greek debt crisis. His strategy is to take advantage of the anti-austerity mandate of the newly elected government in Greece to force creditors to renegotiate the entire framework of the bailout agreement between Greece and its creditors. That is why he refused to enter the 5th and final review of the bailout program by the troika, thus rejecting the last 7.2 billion Euros due to Greece if the review is successfully concluded. He does not want to make a move within the current framework. He wants to change the framework itself. He wants to force a paradigm change.

Will he succeed? He has certainly forced the issue of austerity on the European agenda. Several sympathetic articles have been written in international newspapers by reputable analysts, who have pointed out the failure of the current bailout program. Austerity, at least, becomes widely debatable. Mr. Varoufakis is likely to get a few concessions from creditors when the question of debt relief is decided. But the Eurozone is not an academic seminar, in which Habermasian “ideal speech” conditions prevail. The terms of debt relief for Greece will be decided, ultimately, by politics. Power is what matters, and power is with creditors, not Greece. The fundamentals of the bailout program are unlikely to change. Meanwhile, the program expires on 28/2/2015 and if Greece is not in it, its banks will be hugely exposed and the country will run out of cash.

Varoufakis has long been arguing, quite rightly, that the debt crisis that has gripped the European south is a crisis of the entire Eurozone, not merely a crisis generated entirely within the countries directly affected. The Eurozone is a flawed structure. There is a common currency but no fiscal union and certainly no political union. The pillars sustaining the edifice are ill-designed. However, this is not the diagnosis of the most powerful member of the Eurozone, Germany. The German Finance Minister said as much recently (5/2/2015): the causes of the Greek crisis are to be found within Greece, not elsewhere. This is partly true. The other part, however, not mentioned, is that a monetary union of countries so widely different in productivity, competitiveness and institutions is bound to be shaky. In a monetary union, trade surpluses in a rich country are closely linked with trade deficits in a less competitive economy. A currency union that is unsupported by common fiscal and political institutions creates collective action problems and an unequal sharing of risks (as rightly pointed out by the Bank of England governor M. Carney). The result is economic misery, the rise of political extremism and instability.

Is Mr. Varoufakis’ plan for handling the Greek debt crisis sound? On purely economic grounds, it is. So say some of the most reputable economists, such as the Nobel laureate P. Krugman and astute analysts such as Martin Wolf of the Financial Times. Greek debt is simply unsustainable. No country, especially Greece with its several institutional flaws, can pay back a debt as high as 175% of its GDP. Growth is needed, but the bailout austerity program has delivered misery so far – 26% unemployment (50% youth unemployment), contraction of the economy by 25%, decrease of Greek spending power by 40%, a near-collapse of pension funds, lots of new taxes, and so on. Rightly, several economists draw the analogy between the depression in the USA in the 1930s and the current Greek situation. Another analogy is between austerity-stricken, extremism-riven Greece and the poverty-stricken Weimar Republic in Germany, in the interwar years that led to Nazis’ rise. Anyone who knows life in Greece today knows that there is a lot of suffering, massive hopelessness and rising political extremism.

However, the main assumption northern Eurozone members make is that Greek debt is sustainable. Varoufakis, quite rightly, has been arguing for the opposite. His idea of swapping Greek debt with new bonds linked to growth is sensible and has been tried in other heavily indebted countries in the past. Importantly, it is a way of sharing risk in the Eurozone. What is disappointing in the creditors’ (especially German) attitude is their aversion to share risk with the indebted south, especially Greece. This is, ultimately, a political question, which is swept under the carpet, or, at least, couched in technocratic language. The real source of the problem is that the euro is not supported by a political community that is willing to share risks.

Germany hides itself behind formalities such as “keep your commitments and stick to the agreements Greek governments have signed”. While this is important, it is also important to acknowledge that the current austerity program does not work. Political leaders should have the courage and the vision to revise plans, to adapt to realities as they unfold. Yes, Greek governments have been incompetent, protective of special interests and the oligarchs, while tax evasion and corruption are chronic problems. That is hardly new and unexpected for anyone knowing Greek politics. But austerity in itself is a huge problem too. The problem is that northern Eurozone members do not trust Greece that it will deliver on reform needed to stimulate growth. They have good reasons for this. Greek governments have been dragging their feet on structural reform, which, at the very best, only reluctantly accepted (and not always enacted). Thus, even if creditors were prepared to offer a substantially better financial deal to Greece, they are, partly at least, prevented from doing so by their lack of trust in Greek governments.

Notice the looming impasse: several key Eurozone players want Greece to keep its commitments and stick to a bailout program whose harsh terms and conditions have generated widespread suffering for Greeks. Being a group of sovereign countries rather than a single country, Eurozone faces a collective action problem: they are unwilling to share risks and are prepared to settle to the lowest common denominator (“agreements should be kept”), rather than face reality and revise agreements. To do the latter would be politically risky, since it may open Pandora’s box - certain countries (like Portugal) have already incurred great costs by sticking to the bailout program, others (like Cyprus) may ask for a more relaxed treatment like Greece’s, while others (like Spain and France) fear that their populist opposition parties may benefit if rules are relaxed. In short, once the agreed rules begin to relax, there is a fear that this may be a self-feeding process, at the expense of fiscal discipline. Given the suspicion in which the profligate south is held by the fiscally virtuous north, sticking to the rules appears to be the optimal strategy for the powerful members of the Eurozone. Adhering to what has been agreed maintains peace, albeit a very costly and precarious peace. Thus, it is not surprising that “sticking to the agreements” (i.e. to the harsh bailout program) seems to be the equilibrium point for a pool of countries, keen to protect their national interests and wanting, at the same time, to preserve their pool. Bureaucratic inertia has incentives to prevail.

On the other hand, the Greek government wants its bailout terms to relax but is unable to convince Germany and its allies that Greece is a trustworthy partner who will deliver on reform. How could Mr. Schäuble have faith in the Tsipras government when his party has been against every reform of the economy and the state in the last six years? How could Mrs. Merkel trust a Greek coalition government that consists of a populist left party (Syriza) wanting to enlarge the role of the state in the economy and a populist far-right party (Independent Greeks) that has been describing Mrs. Merkel as a Nazi, is deeply nationalistic and intensely xenophobic? In short, the current (and the previous) Greek government cannot deliver what Germany and its allies need most: credibility and determination to carry through structural reforms.

How will the Greek crisis unfold? It appears that Germany will intransigently insist on Greece sticking to the bailout program and the harsh financial conditions it imposes. The Greek government was recently elected with the mandate to renegotiate the entire framework of the bailout program. The two parties cannot agree, or, as Mr. Schäuble recently said (5/2/2015), they “have agreed to disagree”.

The future of Greece depends on its baking system. When the 28/2/2015 deadline comes, and if Greece is not in the agreed bailout program, ECB will need to decide on whether it should allow Greek banks to draw funds from Emergence Liquidity Funding (this was the dilemma they put to the Cyprus government in April 2013, forcing it to accept a bail in). If ECB switches off the liquidity tap, there will be death by financial asphyxiation and an almost certain Grexit. My sense is that Tsipras will not back off, for if he does, he knows he will incur the fate of his predecessor – sticking with austerity will cost him dearly. Besides, he may hope that by putting up a fight, he may ultimately force creditors to change their view, since a Grexit will be potentially disastrous for the Eurozone (a view, however, not shared by Germany who thinks the contagion effect is minimal – they could not be more wrong, by the way, but this is another matter). Unless there is compromise (which for the time being I see as difficult to be achieved), a likely scenario is for Tsipras to put whatever deal he cuts with the creditors to a referendum or call fresh elections. That will complicate things enormously, especially since, most likely, there will be a bank run and the banking system will collapse. That will be another route to a Grexit.

Of course other scenaria are possible, such a national union government in Greece. I do not see this very likely, although I hope I am wrong. Of course, Europe is a continent that thrives on compromise, and a deal of some sort may be eventually reached. Moreover, Chancellor’s Merkel innate conservatism may prevail, thus making concessions to Greece in order to preserve the integrity of the Eurozone. However, if my analysis is right, the above scenaria are less likely. Creditors, most probably, will hold their position. If Tsipras holds his, a Grexit is a very probable outcome. If Tsipras compromises, he will incur significant political costs at home. The Eurozone crisis may soon reach its climax.

Those who view historical actors as rational players may think that a solution will be eventually found. I hope they are right. No one can live a civilized life without believing in the power of reason. But I take a more pessimistic view of human affairs, one that has been taught by the likes of Thucydides, Sophocles, Shakespeare and Machiavelli. Major problems tend to be solved by major crises. Kings, presidents and ministers are often plagued by strategic myopia, excessive preoccupation with self-interest, and the arrogance that comes with being powerful enough to define reality. Tragedy is caused not by a failure of rationality but by hubris. We will soon see whether reason or hubris prevails. We will soon find out whether Sophocles was right in being skeptical about leaders’ ability to make wise decisions. Life teaches us wisdom, he notes, albeit after the fact.

Can our political leaders be pro-actively wise? Can Greece stop its slide into misery and instability? Can the dissolution of the Eurozone be averted? If there are any statesmen in Europe, now is their finest hour.

2 σχόλια:

Μανώλης Γκερεδάκης είπε...

Dear Hari,

I am afraid that I cannot disagree with your analysis at all. The two sides (Greece and its creditors, I wouldn’t call them “partners”) have taken hardline stances, which make the negotiation outcome unpredictable, to say the least. As Krugman says today in his NYT article “This isn’t diplomacy as usual; this is a game of chicken, of two trucks loaded with dynamite barreling toward each other on a narrow mountain road, with neither willing to turn aside.”

Most people think that Germany and the rest of the Eurozone countries have nothing to lose, if Greece exits the Eurozone. Only Greece will lose a lot (it’s certainly true that the Greek economy will collapse). Yet, they are wrong. A “Grexit” will not only signal to investor and market communities that the Eurozone project is reversible (if a country cannot grow within the Eurozone, it may choose to leave) – causing immense pressure on Southern European bonds (esp. Italy) -, but, most importantly, will signal that, for the Eurozone project to succeed, at critical moments, Europe has to accept a democratic deficit. The voice of the people just makes little difference in the decision making process of the elite Eurogroup. It is striking that German politicians are persistently refusing to “read” the outcome of Greek elections. What does it mean? Apparently, Schauble only “reads” it as the willingness to not stick to “commitments”, and hence, demonstrating disrespect to European solidarity… With this kind of framing strategy, hope for a political solution vanishes. I am afraid that only Merkel’s innate conservatism, as you say, might bring this crisis to a halt… not her leadership.


Ανώνυμος είπε...

Χάρη, ευχαριστούμε πολύ για την ανάλυση! Σε παρακαλώ θερμά, αν είναι δυνατό, ένα σχόλιο για το κατά πόσο θεωρείς εφικτό το antifragility του Taleb.