The euro crisis has become a game of chicken

Published in Business Spectator (Melbourne), 29 January 2015

Much has been written about the results of the Greek elections and most of it is even true. Yes, the real loser of the Greek vote was not ousted prime minister Antonis Samaras but German Chancellor Angela Merkel. Yes, Merkel’s crisis management of the past five years has reached a dead end after the election of Alexis Tsipras’ radical anti-austerity government. And it is also correct to note that the success of the Syriza party will encourage similar political groups in other countries, most notably Spain’s Podemos.

But beyond such truisms, the most important question of what the Greek election result will mean for the euro crisis has not been answered satisfactorily. There is no easy answer to this question, only a range of different scenarios. As of today, it is hard, if not impossible, to put probabilities to them.

That is because we are dealing with a classic game-theoretic problem also known as the game of chicken. The two players are new Greek Prime Minister Alexis Tsipras and German Chancellor Angela Merkel.

If you are not familiar with the game of chicken, you have neither watched Rebel Without a Cause nor studied economics. You should quickly do either to prepare yourself for what will happen next in Athens. To save you some time, here is a brief synopsis.

In the game of chicken, the two players are facing off in a sort of duel. They stand to gain most if the other side blinks before them; they both face disastrous consequences if neither side blinks; and they could reach a half-way satisfactory result if both parties blink simultaneously (while suffering some reputational loss).

In the new standoff between Tsipras and Merkel, we can see precisely such a constellation.

The positions of the two players are clear. Merkel may well be aware that her previous euro policies have not produced the desired results. However, she also knows that things could still get a lot worse for her. If she gives in to Tsipras’ demand of ending austerity (while Greece continues to receive European aid), Merkel’s position in Europe would be severely weakened. If she also gives in to Tsipras’ call for debt relief, it would hit Merkel’s budget since some of Germany’s guarantees would be activated.

On the other hand, if Merkel does not change her position and Tsipras does not change his either, then the two politicians’ confrontation could well end in disaster. Greece could become insolvent within weeks. This would not only cause a default on Greece’s debt which might cost Germany up to €65 billion in one go. It could also have flow-on effects across the eurozone and beyond, which might trigger the next global financial crisis.

There is only one scenario that Merkel could easily live with: If Tsipras just forgot about his election promises and continued his predecessor’s commitment to the “help in exchange for reform” mantra.

For the new Greek Prime Minister, the options are a mirror image of those facing Merkel. Tsipras’ goldilocks scenario is the one in which Merkel blinks first. Afraid of taking a massive hit to her budget, she might give in to Tsipras’ demands and let him get away with some limited debt relief and an end to austerity, so he might hope.

Conversely, should Tsipras give in to Merkel’s demands and continue his predecessor’s austerity policies, his reputation would lie in tatters. Greece would then continue its long and painful march back to normality but Tsipras would never ever get re-elected.

And of course Tsipras knows that the worst thing that could happen is that he remains just as stubborn as Merkel, in which case Greece collapses and Germany takes a massive hit to its budget.

In a way, this is the classic game of chicken constellation. However, the problem is much more complex than in textbook scenarios since all sides are dealing with various unknowns. The payoffs for each scenario are hard to determine in advance. Say a complete economic meltdown occurred in Greece, it is possible that the repercussions across Europe may be contained by the European Central Bank and the European Stability Mechanism. But then again, they may not.

The other problem in this game is that the two players do not know each other. Merkel and Tsipras have not met yet. They might therefore struggle to assess each other’s actions and wonder how rational the actions of the other might be. Then again, Tsipras might even seek to exploit this to his advantage. By trying to present himself as a reckless ideologue who does not care about wrecking his or any other country in the pursuit of his policies, he could attempt to fool Merkel into giving in first.

Sounds mad? Well, that is exactly the name by which this strategy has become known in game theory. It was none other than US President Richard Nixon who used this ‘Madman Theory’ in order to stop his foreign-policy enemies from provoking America. Of course, Nixon was not all too successful with this approach (and being mad is probably among the nicer things one might think of Nixon today). Nevertheless, Tsipras might give it another go and see how far he gets with Merkel.

Tsipras ought to be careful though. Merkel, being a physical chemist with a PhD in quantum chemistry, is known for her systematic and strategic approach to conflicts. Her strategies, of course, do not always work. Otherwise the eurozone would not be such a disaster area today. But she has an uncanny ability to observe, analyse and kill her political opponents as many of her own fellow party members can attest to. All her old rivals are gone while Merkel has consolidated her power.

There is one major difference between the game of chicken and the conflict between Merkel and Tsipras, however. In a game of chicken, the players make their decisions and then they will find out more or less immediately whether they are dead or alive. Not so in this political game. It is conceivable, if not likely, that we are not going to see a quick game but one that will be dragged out over many weeks and months.

In playing this game, both Merkel and Tsipras will try to find a solution which lets them appear to be winners to their respective audiences. For example, this could be a form of debt relief which gives Tsipras some fiscal room for manoeuvre while not causing any immediate write-offs for Greece’s creditors. Interest rates and maturities on Greek bonds could be massaged a bit more in order to camouflage the damage to German taxpayers, this might still allow Tsipras to claim victory and fulfil some of his spending promises.

It would be an outcome in which both players blinked and yet both would maintain that the other one did so first.

However, in all honesty, this game would no longer be called chicken but politics.

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