Greek debt crisis: game on—do Greece's demands make sense?

The new government in Athens has some moral force on its side. But so far, its tactics look more like a chaotic stream of threats than game theory

February 13, 2015
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This article is taken from the new issue of Prospect Magazine, out Thursday 19th February. Subscribe here

Two planks of Varoufakis's position are well-founded—in arguing that Greece cannot pay its debts as they stand, and in challenging the rigid interpretation of austerity that Germany has prescribed for the eurozone. One is clever, in proposing a restructuring of the debt. One is right but the new government is unlikely to deliver it—proposals for 10 reforms including taxing the shipping families and others of the wealthy elite that have avoided such impositions throughout modern Greece's history. One is plain wrong—reversing many of the reforms that the previous government had so painfully made.

His tactics, too, may prove counterproductive, for all the excited tribute paid to his academic background as a game theorist; he appears to have shifted demands repeatedly even in the first few weeks in power, and presented them with immense aggression even to those most disposed to agree.

Overall, his proposals do still mount an important challenge to the narrow and damaging doctrine which Angela Merkel, Germany's Chancellor, has imposed on the eurozone. But for all their radical sounding nature, his challenge to Germany is not matched by one to Greece itself—to embark on a transformation that would actually make it a modern European country.

What has he proposed? Greece at the moment has €317bn of debt, equivalent to 175 per cent of GDP; almost two thirds of that total is composed of loans from the European Central Bank and the eurozone. Details of demands are not all public; the protagonists are keeping them close to their chests. But the first blunt demand of the new Greek government was for at least some debt to be written off. This won short shrift from Berlin; Germany, invoking its history, has chosen to take it as an article of faith that the face value of debt must be repaid, at some point; if you have borrowed money, you must pay it back.

Greece then shifted to a proposal to change the terms of some of the debt. Under these plans, there would be both a short term solution, enabling Greece to pay interest to the International Monetary Fund; and after September, a new four-year deal. It wants its debts owed to the eurozone to be converted to bonds where the interest rate would be linked to the growth rate of Greece's nominal GDP (before accounting for inflation). Its debts to the European Central Bank would be converted to what Varoufakis calls "perpetual bonds"—meaning that Greece would, in essence, pay only the interest on this portion.

In return, Tsipras and Varoufakis have proposed a package of 10 reforms. This would include running a perpetual surplus on the government budget, calculated before interest payments, although at between 1 and 1.5 per cent, not the 3 per cent to which it is now committed under its bailout deal with the "troika," the ECB, IMF and European Commission. It made some noises, too, about pursuing shipping families for tax; they have been subject only to a (low) rate of tax on the tonnage shipped.

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Meanwhile, it would also reverse many reforms of the previous government; it has pledged to rehire 20,000 public sector workers, end a hated property tax and restore public sector pensions to pre-crisis levels.It would halt the privatisation programme imposed by the troika.

The strongest part of this pitch is Greece's demand to change the terms of its debt burden, which it clearly cannot pay down at its current level. Most of this debt represents the bailout that was summoned up in order to prevent those who had extended loans to the Greek government and Greek banks suffering a cascade of bad loans. The terms of the bailout were that the government had to slash public spending; the result has been that Greek GDP has fallen by a quarter since the crisis, but this understates the impact on ordinary people. The programme imposed by the troika has also led to youth unemployment of about 50 per cent and widespread poverty which almost any democracy would find intolerable; the election of Syriza is no surprise.

The bailout plan has demanded, in essence, that Greek citizens have to suffer these huge cuts to generate a budget surplus big enough to pay back the loans on rescuing these lenders; this is manifestly unfair. There are two retorts to the apparent moral argument that Germany is making for Greece to be forced to pay the whole of the face value of the debt. The first is that those who lent Greek banks and the government money surely should share some of the moral responsibility; they had, after all, more than a little evidence about the risk of the loans. The second, as Germany has been reminded pointedly by many commentators in the past month, is that it benefited in the 20th century from other countries' willingness to forgive its debts.

Greece's alternative proposals for the treatment of its debt are potentially face-saving for Germany, in that in the most literal terms they do not write down the face value of the debt, although they are effectively similar. If debt reduction can be managed in some form, it could help the eurozone as well as Greece, although many governments—not just in Spain—have a fear of boosting the cause of anti-austerity radicals (it's well worth reading David McKittrick's account in the new issue of Prospect of how Sinn Féin and Gerry Adams are riding the anti-austerity wave).

There has, rightly, though, been a lot of criticism of Varoufakis's notions. Some argue that by linking interest rates to growth, he has tried to ensure that Greece would be paying very little interest for some time; others, that it gives Greece little incentive to make the reforms to maximise growth (or at least to display figures which show high growth, and Greece's national statistics are all too malleable, as recent history has shown). Nor is the ECB likely to be keen on "perpetual bonds"; it would perhaps find it easier to contemplate a long extension of their term that was still short of infinity.

Varoufakis has also pursued these arguments in a manner which may prove needlessly provocative, and appears to have drawn little from game theory, even if he has done wonders for the social profile of his academic tribe. He has been confrontational with the troika, even though he has more potential supporters there than in the German government. And he used a visit to London, outside the eurozone, to announce his "menu." The scattered threats by the new government that turning to Russia or China is its Plan B if their demands are not met hardly improve the mood of talks.

The rest of his plan is less solid. The claim to be able to run a budget surplus of 1.5 per cent in 2015 might sound reasonable, given that Greece said that in 2013 it ran a surplus of 0.8 per cent (before interest). But Varoufakis himself wrote a blog in April last year saying that the claims to be in surplus, even though passed by Eurostat, the statistics arm of the European Commission, were "a statistical mirage." Greece has form in that department; its own crisis began in February 2010 when an incoming government revealed that the 2009 figures had been heavily distorted—as had those supporting its entry into the euro. And the IMF has now said Greece is not on course to hit the 1.5 per cent in 2015, whatever it says.

It is a matter of arithmetic more than ideology that Greece will struggle to run a surplus with the spending increases it may put through, and a discinclination to make deep reform that is the equal of its predecessors'. It is not a modern economy judged by European standards; it has a huge public sector, a wealthy shipping sector allowed to stand outside normal taxes and responsibilities; a public and commercial life riddled with cronyism and corruption; hosts of small family businesses, and too little other commercial activity. Many of the reforms the last government so painfully forced through were worth keeping, and will have to be made some day.

The new government shot out of the starting blocks fast, and startled the eurozone with a scheme of demands that no one saw coming. It has some moral force on its side. But so far, its tactics look more like a chaotic stream of threats than game theory, with a real risk of an explosive end to talks and of an exit from the currency. Even if Greece wins concessions but fails to make changes at home, that would only postpone the problem, and not even for long.