The saga in Greece is like a psychology experiment, a cross between a “Prisoner’s dilemma” and “Nash equilibrium”. (Psychological gamesmanship exists across all types of financial negotiations with participants balancing stability, compromise, and moral hazard/future problems that might arise as a result of current decisions.)
Greece’s debt burden in excess of 175% of its GDP is untenable and in excess of what it can repay. Greece’s creditors, on the other hand, want to be repaid. All parties will act in their own interests. However, there are secondary considerations. Decisions made now will have ramifications for other countries in similar situations watching on the sidelines.
Greece’s total GDP of about $250B represents only about 1.5% of the total EU GDP. The European Union creditors could forgive a portion of this debt (given the relatively small size) without too much repercussion.
However, Greece is not alone in carrying large debt loads. Italy, Portugal, Spain, and France all face similar burdens (see here). If Greece’s politicians secure debt forgiveness, citizens and politicians in those other countries should demand similar treatment and rebel against their debt burdens. However, those countries are much larger, making debt forgiveness untenable (especially for multiple countries/debtors).
Further, creditors have pause about forgiving debt for fear that doing so encourages irresponsible behavior. Spending money that one does not have feels good. If debts are forgiven, what will prevent such irresponsible spending from being repeated?
There has been a rise of extremist parties (both far-left and far-right, often anti-Euro) across the EU. If Greece’s far-left Syriza party can secure debt forgiveness, this could serve as encouragement and validation of similar parties. Such parties are already gaining traction. The most recent example is the gains made by far-left party Podemos in Spain’s regional elections on May 24. France’s “Popular Front” and Italy’s “Five Star” movements have also gained traction to the point of becoming legitimate political voices.
If Greece cannot get satisfactory resolution from creditors, it may elect to leave the Euro zone. It has been widely debated how that would play out for all parties. For Greece, it could prove catastrophic, or it could possibly provide relief (as Greece would eliminate its debt by defaulting) and the potential for Greece to then rebound. If Greece successfully left the Euro, other extremist parties could look to follow suit. That could be catastrophic for the Euro zone. With such an overhang, creditor countries should be willing to compromise and provide debt relief to keep Greece stable. But too much debt relief could prove problematic if other countries demand similar treatment. This is the convoluted Catch-22 that makes the situation much like a game theory psychology experiment.
The conventional thinking is that Greece will ultimately yield to creditor countries’ demands and that there will be little compromise. I see no reason to expect a different outcome. The rise of “fringe” political parties merits attention and makes it tough having confidence around predictions.
Sources: Wikipedia “Prisoner’s Dilemma“; Wikipedia “Nash Equilibrium”; The World Bank “European Union Data”; Statista “National Debt in EU countries in relation to GDP”; The New York Times “Spain’s Local Election Results Reshape Political Landscape”; Euronews “Le Pen’s Front National hopes to top local elections in France”; Stratfor “Fringe Parties Strengthen in Germany and Italy”