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Cost of collision is too high for both parties
By Dimitris Kontogiannis
As Greek elections get
closer, the game of chicken between the country and its creditors is
bound to intensify. However, this does not mean that a mutually
acceptable solution cannot be found after the elections by having both
sides renegotiate some terms of the bailout agreement despite all the
current signaling to the contrary from the EU and the IMF. After all,
the MoU (Memorandum of Understanding) itself allows for amending or
supplementing the conditions from time to time.
Game theory was developed in previous decades to study strategic
decision-making by using mathematical models. The study of complex
negotiations between intelligent rational parties with different
preferences leading to various outcomes was at the center of interest
when John Nash, a bright economist, came up with a solution in a game
called Nash Equilibrium.
In a game with two players, Nash Equilibrium implies, each player makes
the best decision he/she can by taking into account the other player’s
decision, but it does not mean the best payoff for all the players.
Back to the present, many economists and commentators think the
situation between Greece and its trading partners, mostly Germany, can
be described by the so-called game of chicken.
In its typical form, two cars head for a single-lane bridge or at each
other from opposite directions. If neither driver backs off, they crash
into each other. They both understand the cost of a crash will be too
high and each rationally assumes the other will give in.
It is obvious that the worst thing that can happen is for both drivers
to collide. The best thing that can happen is for one side not to yield
and let the other side become the chicken by conceding. Being chicken is
the second-worst outcome, but much better than dying. Still, a
cooperative outcome in the game of chicken can be reached when both
sides back off, no one is hurt and no one can call the other a chicken.
Incalculable cost
Undoubtedly, the direct costs of a collision between Greece and the core
of the eurozone appear bigger for the former. The direct exposure of
eurozone countries and the ECB to Greece is estimated around 290-300
billion euros according to two different studies by Barclays and Nomura.
Assuming a 70 percent haircut, the total cost is around 200-210 billion
euros, which is big but manageable if one takes into account that the
economy of the eurozone is around 9.5 trillion euros. Still, some
countries like Spain and Italy with exposure of 37 billion and 55
billion euros respectively may find it more difficult to absorb.
However, it is extremely difficult to estimate the indirect cost of a
Greek exit from contagion -- this may be quite high if financial markets
lose confidence in the eurozone. Moreover, it is reasonable to assume
that markets will view a Greek exit as the beginning of of the
eurozone’s unraveling. This could change if Germany and other core
countries are ready to guarantee the safety of bank deposits and the
repayment of debts of other euro-periphery countries, and the ECB is
prepared to engage in large-scale interventions in the bond and currency
markets. We are not sure whether some of these moves will be approved
by Germany’s constitutional court, while others will definitely be in
breach of existing EU treaties, further complicating matters.
As far as Greece is concerned, there is no doubt that the economic cost
of a euro exit would be catastrophic and have negative geopolitical
consequences. Inside the country, the need for law and order, and the
descent into economic misery would strengthen the two opposite extremes
of the political spectrum at the expense of mainstream parties.
A rational game
So, no rational Greek government would chose to quit the euro
unilaterally, especially if one considers the 80 percent approval rating
for the single currency. Since it cannot be legally expelled, Greece
can only be forced by, let’s say, having the ECB cut off support to the
Greek banking system, but this would not look good.
From the point of view of any new Greek government, the preferred
strategy would be to negotiate changes in some terms of the bailout
agreement by presenting a reasonable plan to put public finances in
order and turn around the economy while pledging to stick to structural
reforms.
It is hard to imagine how the other eurozone countries will say no to
such a plan when the direct costs of a Greek exit are high and the
indirect costs are difficult to estimate. Moral hazard may be an
argument against accepting such a Greek plan but one should remember
that decision-making at the eurozone level, which assigned too much
weight to moral hazard, has not produced good results.
If it is indeed a game of chicken between Greece and the core of the
eurozone, it is in the best interest of all sides it leads to a
cooperative outcome where a collision is avoided. Especially when the
possible miss of budget deficit target and the slower pace of reforms
call for renegotiation of the MoU regardless of political intentions. |
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