Greek Power (Not a Post About Fraternities)

I don't know much about international macroeconomics, to put it mildly, but I know a little about game theory. So I've been puzzled by the way the Greek government just let the Germans roll over them in the euro crisis. Not exactly Spartan, except in the life they were signing up for.

The story in brief: Greece, having run up big budget deficits and lied about it, needs to get money from the rest of Europe (which basically means Germany) to avoid defaulting on its debt.  Germany has said OK, on the condition that that Greece make savage budget cuts, which have tipped Greece into a real live depression. The questions are (1) how much to ease up on Spartan austerity, and (2) whether Germany should be asked to do anything  that might ameliorate the situation (such as following a more expansionary fiscal policy itself, or even allowing a little more inflation in Europe). Germany's answers appear to be (1) not at all, and (2) no.

The conventional interpretation is that it's a simple application of the cynic's golden rule: he who has the gold makes the  rules. Germany has the money, Greece needs the money, end of story.

But does Germany really have all the power here? One way to evaluate the balance of power is to look at how well Greece does with and without Germany's cooperation, and compare that to how well Germany does with and without Greece's cooperation.

Skipping over details, here's the choice. Alternative A: Germany bails out Greece, in return for savage austerity (think Great Depression). Alternative B: Greece defaults and, presumably leaves the euro. Greece then has a very hard time borrowing money to pay its bills, and Greeks are furious when they see that their savings are worth a lot less in drachmas than in euros. Let's assume that Alternative B is perceived  by the Greeks as somewhat worse than Alternative A.

But consider how it looks from Germany's perspective. Alternative A: Germany goes on pouring (some) money down a (small) rathole. Alternative B: German banks take a (smallish) hit on loans to Greece. Greece leaves the euro. Speculation, in both senses, arises over whether Spain and Italy will be next. Since those two countries together are bigger than Germany, and more than ten times as big as Greece, bailing them out starts to look problematic. There's a good chance of panic about lending to countries on the European "periphery," which leads to those countries' having to pay much higher interest rates, which increases budget deficits, leading to more defaults, which end up breaking up the euro altogether, with unknown consequences for the whole idea of European unity.

Looked at this way, it seems clear that Alternative B is a lot worse for Germany than Alternative A. This means that Greece has some bargaining power if it threatens to default. Default would be bad for Greece (let's assume), but also bad for Germany. There's a strong resemblance to a game of Chicken, with each side trying to bluff the other: Greece trying to convince everyone that default is an option, Germany trying to convince everyone that it's not.

Recent elections in Greece, where the two main parties were thrashed, of course strengthen Greece's bargaining power. As in any game of Chicken, it is helpful, though risky, to be able to tie one's own hands. If you're driving toward a head-on collision with some who has disconnected his steering, you will (probably) swerve before you crash. In this case Greece's negotiators get more leverage from being able to say, "I see your point of view, but my people will never go for that."

A few final words about Germany's tendency to moralize about how Greece screwed up and should pay the price. After World War One, the Allies imposed harsh reparations on Germany in the Treaty of Versailles. These are generally considered to have led to economic depression in Germany and thence to the rise of Hitler. So at the end of World War Two, the Allies decided not to repeat their mistake, and the U.S. established the Marshall Plan instead, even though Germany's responsibility for the devastation of Europe was if anything greater than in the previous war. It's ironic that it is Germany that seems most willing to engage in finger-pointing, and least willing to learn the lessons of Versailles.