Monday, 9 February 2015

Can Greece escape the ultimatum game? (And no, Draghi's not trying to help them do it)

At the start of a crucial week for Syriza's effort to negotiate a revision to the disastrous current arrangements between Greece and the Troika, I thought it would be helpful to try to describe the bargaining situation in a systematic way using game theory a very simple diagram (yes, it is game theory, but it's very straightforward).  Here it is:

The European Commission (EC) needs to decide whether or not they will propose a compromise or insist on the Troika's current terms.  Greece then needs to accept or reject the offer.  The rectangles at the far right show possible outcomes--if Greece rejects whatever the EC proposes, it leaves the Euro (Grexit).  Let's make some assumptions about how the parties rate the outcomes: Greece prefers a compromise to the Troika's terms, and both to Grexit.  The EC prefers the Troika's terms to compromise, and both to Grexit.

If this is an accurate depiction of the situation, the EC gets what it wants--it can face the Greece with the choice between taking the Troika's terms and Grexit, and Greece will choose the Troika.  It's an "ultimatum game;" Greece has to take whatever the EC offers, because otherwise it's faced with the catastrophe of Grexit.

So how can the Greek government change the game?

  1. Announce that it prefers Grexit to Troika terms. Then (bottom right in the diagram) Greece would be expected to choose reject, giving the Grexit outcome. Since the EC prefers compromise to Grexit, it would offer a compromise. So why doesn't Greece just do this?  
    • To announce this might set off an even worse banking panic than Greece is currently experiencing.
    • It only works if the EC reliably prefers compromise to Grexit.
    • It might not be believed
  2. Disable its capacity to accept Troika terms, or at least create uncertainty about whether it would be able to accept Troika terms (meaning that Troika intransigence would lead to Grexit)
    • This is one way to interpret Tsipras' "defiant" speech yesterday, in which he promised very publicly and very vigorously that Greece will not accept a continuation of the present Troika. (Political scientists just love talking about how "domestic audience costs" -- the costs of going back on a promise to a domestic constituency -- allow politicians to make threats on the international stage that would otherwise not be credible. Compare this discussion by Jacques Sapir.)
    • Again, this only works if the EC fears Grexit; Varoufakis is trying to make sure that they do
  3. Convince the EC leaders that compromise should be be preferred to Troika terms. So far this doesn't seem to be going very well.
  4. Find a way to create another possible outcome, with no compromise but also no Grexit
    • It's sometimes suggested that because Greece is presently running an obscenely large primary surplus (i.e., it's budget is heavily in the black before debt repayment is taken into account), it could just stop repayments, and abandon new borrowing.  However, since the Greek government can't print Euros, the sustainability of this path would depend on the cooperation of the ECB to keep the prospect of bank panics at bay.
So this week's negotiations will turn on whether the Greek government has managed credibly to cut off the possibility of accepting the Troika's terms and how much the rest of the Eurozone fears Grexit.  

PS: Was the ECB trying to help Greece by refusing to accept its bonds as collateral?

Last week, the ECB stopped accepting Greek government bonds as collateral for ECB loans. The immediate and obvious interpretation of this decision was that it continued the pattern (long version) of using the withholding of ECB emergency lending as a form of policy leverage. Paul Krugman pleaded unconvincingly that Draghi was too subtle for such a brutal display of strength, arguing that really this measure was meant to wake up Germany--a position the Greek government had little choice but to echo.  

One version of the claim that the ECB was not trying to intimidate Greece into accepting the Troika terms, proposed by Frances Coppola, rests on the idea was that weakening Greece strengthened its bargaining hand in a strategic context (as under 2, above).  But the argument doesn't work: A bargaining analysis offers no support for the idea that the ECB was trying to help Greece.  The ECB decision did nothing to make accepting the Troika conditions more difficult, or make Grexit relatively more attractive. Indeed, given that the ECB explicitly mentioned that it was the prospect of a failure in negotiations with the Troika over continued support for Greece that prompted the decision, it raised the benefits to Greece of a successful agreement. Moreover, to the extent that the decision signalled the likely attitude of the ECB toward supporting Greek banks in the absence of a successful agreement, it worked against option 4, as well. So to the extent that the ECB decision did reflect a bargaining logic (other things may have been at stake), it would make sense only as an effort to coerce Greece, not to help it.