Negotiating strategies and political constraints regarding Greece
I am going to leave my market-based analysis and enter the murky waters of the political economy. I don’t like the uncertainty of the political economy, given how it is based on the quixotic and unpredictable actions of individuals. But the political economy is important in crisis situations and one cannot analyze an outcome properly without taking the politics into consideration. I was a diplomat at one point in time and hope that experience will aid me here. I have been good at understanding some of the political constraints in Europe so far and intend to discuss them here.
At the outset, let me say that the framework I am using to analyze this is one I have used in the past. It’s a framing of negotiations as one of mutually acceptable outcomes and fallback positions known as best alternatives to a negotiated agreement or BATNA, something I picked up in business school. Basically, there are three main variables here: each party’s set of interests and constituents, the relative importance of those interests and constituents and the BATNAs. In negotiation, each party has a “reservation point” beyond which they will refuse to negotiate and will simply walk away and accept their BATNA. Thus, the art of negotiating is finding an agreement which meets both parties’ thresholds on the main points of interest.
Now, in many negotiations, though the BATNA is not as good as a mutually acceptable agreement, it is an acceptable outcome. But in the Greek situation, the alternatives for the Troika and the Greek government are very poor indeed. And this ensures that both parties will be willing to negotiate no matter what the starting position of the other side may be. Both the Greek government and the Troika interests know this and have made extreme statements, suggesting there is a red line that will blow up agreement. I believe this is just posturing because it is each party’s best interest to make a stark statement, knowing that negotiations are inevitable and unavoidable. This is not a reflection on what can actually be achieved in a negotiated agreement.
From the Troika’s perspective, there are three constituents, each of which also has constituents. We have the periphery, the core and the IMF, with diverging interests. This alone means that the Troika’s position will be malleable. But my understanding is that unanimity is a stumbling block that means Finland or Germany can have a blocking view. In Germany, for example, even if Angela Merkel is amenable to a debt writedown, her own faction constituents may not be. And the German public may not be. The same is true in each of the 19 eurozone capitals. So I believe this limits the Troika’s ability to negotiate a debt writedown at this point in time. But the 3/60 Maastricht hurdle is malleable as we have seen before. How malleable remains to be seen.
From Greece’s perspective, the new government has run as an anti-austerity party with a mandate to end austerity as a means of restoring growth. The biggest constraint here is that it has pledged to not leave the euro under any circumstances because Greek citizens still want the euro and because leaving the euro would be a logistical and economic minefield. This limits their negotiating room to demanding an end to austerity or defaulting unilaterally as a BATNA.
Other factors to consider in terms of the BATNAs are that Greece has a primary surplus, meaning they are not that far away from being able to run their government without needing external financing. That is critical to making a default threat real. On the flip side, Greek banks are still very dependent on emergency liquidity from the ECB and that means a cutoff of the Greek banks is a potent counter threat as it would mean a collapse of the Greek banking system, making Grexit a real politically viable possibility.
Herein lies the only area for agreement then:
- No debt writedown: only maturity extensions and interest rate reduction. From the Troika perspective, a principal reduction looks to be a non-starter. Finland has said so, and the Germans have said so. They do appreciate that the vast majority of Greek debt is in public hands, meaning that contagion from a writedown may be limited. But I don’t think the ruling coalition in Germany could get approval on this in parliament or in opinion polls.
- Back-loaded austerity: although stimulus is the opposite of austerity, Syriza could still get some stimulus in the short-term if they commit to reforms and a plan that has the deficit and debt numbers moving toward the Maastricht criteria over time.
Then there are the best alternatives to a negotiated agreement. There are really only two left.
Scenario #1: Default
I still believe this is an option that has a high likelihood of occurring. It is the main reason the Greek yield curve is inverted with 3-year debt more expensive than 10-year debt. Greece now has a primary surplus, which means that it doesn’t necessarily need fresh funding to maintain itself. It could simply default and meet non-interest obligations indefinitely until the existing debt obligations get restructured. This was always going to be the trump card for Greece. Greece is relatively unique and I think the contagion from this scenario would be manageable. So even here, we wouldn’t necessarily see Armageddon. The questions is whether the ECB then pulls the Greek banks’ ELA as a negotiating tactic. If they did, then Grexit would become a viable option.
Scenario #2: Greece exits the eurozone
The problem for Greece is that at the prevailing currency level, the country’s productivity levels are too low. In a currency union with Germany, the only route to success is a combination of transfer payments and internal devaluation i.e. wage and price suppression. When Germany re-unified, the eastern states in Germany were able to get there over a 20-year period because of a net migration to the west and huge transfer payments through the German solidarity tax. Even then, the unemployment rate in the east has been crushingly high for most of that period. Germany has been in a soft depression. But the labor migration opportunities within Germany are greater than they are within the EU because of language and culture and the fiscal transfers are not going to occur. An internal devaluation tactic across the eurozone is impossible from a social and political perspective. So we could be looking at a eurozone exit then.
The euro is slipping now to $1.12, and that should aid Europe to the degree it wants trade with countries outside of the eurozone. But if the Greek crisis grows in magnitude, then a Greek exit from the euro becomes a viable talking point, which makes a Portuguese, Spanish and Italian exit a viable talking point. That’s a situation that is disastrous for the euro then. Without the southern bloc, the euro would rise significantly in value. Think of what happened with the Swiss franc when it gave up its 1.20 Swiss/euro floor. Germany would lapse back into its soft depression again and France would be forced to think about exiting the euro as well.
Let me repeat the conclusion from December here. I think the Germans know they have benefitted greatly from a weak euro. And so it behooves them to maintain the euro intact, even if it means giving ground in negotiations with Greece. Right now, Greek markets are in a panic. This could even threaten the Greek recovery. The danger is that the Germans come to believe Greece can be isolated without spillover into the rest of the periphery. This could tempt them to play chicken with Greece. And the potential for a eurozone-wide crisis and market meltdown increases as a result.