Economics - General

Backing down on Greece’s debt is the safest, most rational option

John Quiggin160 Comments

I wrote this for The Guardian and Crooked Timber in response to the Greek referendum result.

Lots of people have raised the suggestion of applying game theory to the the Greek debt crisis. I haven’t attempted this, reflecting my general scepticism about game theory in the absence of a well-defined strategy space. But now the Greek government and public have made, what is, in effect, a final move. In view of the No vote, Syriza can’t accept a deal that doesn’t include an explicit debt write-off or one that obviously crosses its stated red lines. Within those parameters, its clearly eager for a face-saving compromise.

For the other side (effectively the Troika and the German government), since Syriza’s move has already been made, the problem has now been reduced to one of decision under uncertainty, which is something I am comfortable with. More precisely, it’s a choice between a “safe” option, with an outcome that is fairly predictable, and a “risky” option where the outcome is uncertain.

The safe option for the European insitutions is to cave in, write off lots of debt and lose a lot of face. (Added in response to comments: the loss of face will particularly affect the elites in peripheral countries that accepted austerity, and will mean a further shift away from austerity in general. But the effect of a non-disastrous Greek repudation would be far greater).

The risky option is to foreclose, and force Greece out of the eurozone, and leading to a repudiation of debt. The possible outcomes involve several interdependent sources of uncertainty
* Whether the Greek economy does so badly that the Greek public regrets their choice and throws the government out at the next opportunity
* Whether exit from the eurozone is followed by exit from the EU
* Whether the process generates a broader financial crisis

From the European viewpoint, all of these outcomes except one would clearly be worse than an immediate backdown. If Greece leaves the euro and recovers, the whole austerity project will be shown up as the failure it is. If Greece leaves the EU (and especially if the UK also does) the European project is done for. And, while the institutions seem to have convinced themselves there won’t be a financial crisis, their past track record gives little ground for confidence.

So, the only case that could conceivably counted as a win is the one when the Greek economy fails, but Greece stays in the EU and there is no immediate financial crisis. I’d argue that, even here, the damage to confidence in the euro and to the European project would be greater than the costs of a backdown. If that’s right, then the “sure thing” principle applies to this decision. Backing down is the best option with probability 1.

Even if least-bad case is regarded as slightly better than a backdown, any reasonable calculation of expected payoffs for the institutions concerned would indicate that backing down is the rational choice. That doesn’t mean that such a choice will be made. People aren’t generally rational after all. Moreover, individual rationality may not be the same as institutional rationality. Quite possibly, failure will be seen as career-ending for key individuals, notably Lagarde, Merkel and perhaps Juncker. So, they may prefer institutional disaster to personal failure.

From the viewpoint of Australia and the world at large, there’s no doubt about the outcome we should prefer. European austerity has been a complete failure and raises the threat of a new global financial crisis. The sooner this delusion is abandoned, the sooner it will be possible to address the real source of the problem: the unsound and unsustainable growth of the financial sector.

160 thoughts on “Backing down on Greece’s debt is the safest, most rational option”

  2. @Megan

    … and probably the neo-Nazi Golden Dawn (although they are ostensibly anti-EU??) …

    All the reports I have seen represent Golden Dawn as anti-EU. Do you have any information that casts doubt on this?

  6. In his first interview since resigning as Greek finance minister, Yanis Varoufakis took aim at Greece’s creditors, revealed the extent of the country’s preparations to leave the euro and warned of the rise of the far right. Late Night Live reports.

    “‘In the coup d’état the choice of weapon used in order to bring down democracy then was the tanks. Well, this time it was the banks. The banks were used by foreign powers to take over the government. The difference is that this time they’re taking over all public property.’”

    http://www.abc.net.au/radionational/programs/latenightlive/greek-bailout-deal-a-new-versailles-treaty-yanis-varoufakis/6616532

  7. Ikonoclast :
    I wonder how spending cuts and tax rises will help a nation in a deep economic depression, and help restore demand and economic activity?

    I don’t think it’s supposed to. Look at what the demands are: hand over more public property to the banks at every step. Regardless of whatever morsels of debt relief are offered and all the other variables, the one thing that’s not open for negotiation appears to be privatisation. Well, privatisation and impoverishment. The *two* things…

  8. Varoufakis also did an interview with ‘New Statesman’:

    HL: What are you referring to?

    YV: The complete lack of any democratic scruples, on behalf of the supposed defenders of Europe’s democracy. The quite clear understanding on the other side that we are on the same page analytically – of course it will never come out at present. [And yet] To have very powerful figures look at you in the eye and say “You’re right in what you’re saying, but we’re going to crunch you anyway.”

    HL: You’ve said creditors objected to you because “I try and talk economics in the Eurogroup, which nobody does.” What happened when you did?

    YV: It’s not that it didn’t go down well – it’s that there was point blank refusal to engage in economic arguments. Point blank. … You put forward an argument that you’ve really worked on – to make sure it’s logically coherent – and you’re just faced with blank stares. It is as if you haven’t spoken. What you say is independent of what they say. You might as well have sung the Swedish national anthem – you’d have got the same reply. And that’s startling, for somebody who’s used to academic debate. … The other side always engages. Well there was no engagement at all. It was not even annoyance, it was as if one had not spoken.
    …
    The negotiations took ages, because the other side was refusing to negotiate. They insisted on a “comprehensive agreement”, which meant they wanted to talk about everything. My interpretation is that when you want to talk about everything, you don’t want to talk about anything. But we went along with that.

    And look there were absolutely no positions put forward on anything by them. So they would… let me give you an example. They would say we need all your data on the fiscal path on which Greek finds itself, we need all the data on state-owned enterprises. So we spent a lot of time trying to provide them with all the data and answering questionnaires and having countless meetings providing the data.
    …
    Because time is of the essence, and because during negotiations the central bank was squeezing liquidity [on Greek banks] in order pressurise us, in order to succumb, my constant proposal to the Troika was very simple: let us agree on three or four important reforms that we agree upon, like the tax system, like VAT, and let’s implement them immediately. And you relax the restrictions on liqiuidity from the ECB. You want a comprehensive agreement – let’s carry on negotiating – and in the meantime let us introduce these reforms in parliament by agreement between us and you.

    And they said “No, no, no, this has to be a comprehensive review. Nothing will be implemented if you dare introduce any legislation. It will be considered unilateral action inimical to the process of reaching an agreement.” And then of course a few months later they would leak to the media that we had not reformed the country and that we were wasting time! And so… [chuckles] we were set up, in a sense, in an important sense.

    So by the time the liquidity almost ran out completely, and we were in default, or quasi-default, to the IMF, they introduced their proposals, which were absolutely impossible… totally non-viable and toxic. So they delayed and then came up with the kind of proposal you present to another side when you don’t want an agreement.

    He also describes his plan to issue IOUs etc… but Tsipras wanted to go along with the Troika.

  9. Greece needs immediate help, in whatever form and through whatever institutional mechanisms to deal with the refugees from Syria and elsewhere. It is extremely difficult for a small country like Greece to cope with the numbers of refugees even under normal conditions. It is a catastrophy now. For example, friends from Greece report beaches where paying tourists like to go are now populated by refugees because they have nowhere else to go. (Such uncovered ‘refugee camps’ are not naturally available in Finland or on the North Sea or the Baltic Sea).

    Greece needs immediate help to pay for imported medicine.

    Capital outflow from Greece shortly before the referendum is estimated to be about Euro 1billion. There is an estimated immediate cash (‘liquidity’) gap of about Euro1.2 billion in the banking system. Who left the door wide open?

    Professor Quiggin organised fund raising campaigns when major natural disaster occurred in Australia and he put money in it.

    What is Yanis Varoufakis doing?

    And what is Yanis Varoufakis saying on the involvement of non-EUROzone banks in the development of the Greek dilemma? Come on Yanis, show your strength of conviction by sending a bill to Goldman-Sachs and co instead of stirring emotions with words that mean nothing.

    Does anybody know for sure whether military equipment is explicitly excluded from the set of assets to be pledged for the loan? If these ‘assets’ are not excluded then there is an idea on how to save the national assets which really count for people on the ground while returning assets bought by previous governments to the suppliers or third parties for cash. Varoufakis was economic adviser to the Papandreo government from 2004 to 2006.

    (I read up on the Treaty of Versailles and found reparation payments demanded and partially paid consisted of gold marks and goods.)

    July is a big holiday month for tourists as is August. The tourist numbers aren’t in yet. Last year there was a record number of tourists (23 million) and some Greek people interpreted this as people from other European countries trying to support Greek people economically. People can’t eat ideologies.

  10. @Megan

    Y.V.’s comments are very revealing. I see no reason to doubt him. His description of the way the Greek government was ignored and obstructed is consistent with what I have read in many other contemporary and historical sources. This is the consistent way the powerful “negotiate” with the weak. What the weak say or hope or need means nothing. They get destroyed regardless. The destruction seems to have gone far into the willful and gratuitous zone. There can be no long term profit in this for the EU economy as a whole. Clearly the financial elite is willing to destroy the real economy for money. The funny thing is, all that money will be useless once the real economy collapses. There will be nothing real to buy.

    These are the final stages of the class war of late stage capitalism. This much is very clear.

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