Greece's game theorist leaders overplayed their hand

The January election of Greece’s Syriza party on an anti-austerity platform brought with it high hopes among voters that the country would finally be able to get out from under the European yoke, rebuild its economy and agree to a sustainable debt package under prime minister Alexis Tsipras and finance minister Yanis Varoufakis.

Varoufakis, a former academic with a background in Game Theory, became something of a rock star as he took the battle to Greece’s creditors. Observers of an early meeting believed he almost got into a fight with Dutch finance minister, and EU Group president, Jeroen Djsselbleom, although Varoufakis denied it.

It didn’t do anything to hurt his image as a tough negotiator at home, but his confrontational style upset creditors and raised questions about whether Varoufakis was running some sort of game theory-based strategic battle.

Tony Aspromourgos, professor of economics at University of Sydney, where Varoufakis spent some of his early career teaching, explained game theory and its application to the Greek crisis in January as:

A method of research in the social sciences is first and foremost about the logic of strategic interaction between players. The situation that is being played out now, between Greece (as well as others of the “south”) and the political establishment in Europe, is without doubt a strategic situation. It is a game of high-stakes policy poker with the players on both sides, perhaps engaged in an element of bluff.

Varoufakis denied he was taking such an approach to negotiations. But, as Mike Bird pointed out in February the now vanquished finance minister’s own book summarises how to handle “the incredible threat.”

It’s an analogy Varoufakis used to describe the Greek threat in 2011:

When this false promise was shattered by the reality of a deepening Greek recession (and an impressive contagion spree across the European continent), the same falsity metamorphosised into an incredible threat: Greece would be allowed to hang if it did not do as it was told. No fifth instalment of the bailout money and no new funding for 2012 and beyond.

The problem with incredible threats, just like false promises, is that it is as if they have never been issued. And what makes a threat credible? The simple answer is: a discernible reason of why the threat’s issuer will, if some pre-specified condition is not met, be worse off ex post if she does not carry out the issued threat.

Think about that in the context of Varoufakis repeated claims that the euro will collapse if Greece exits. Greece believed threats to force it out of the euro were not credible because as they saw it, there was no way the EU or Germany would “ex post” (after the fact) believe they would be better off if they followed through.

Varoufakis’ playbook was straight out of his “incredible threat” premise. Both he and the government believed and approached negotiations from that standpoint.

They all believed – including new finance minister Tsakalotus (who has been integral to negotiations) – and acted as though the EU, or particularly Germany, believed it would be worse off if Greece left the Euro.

This is where the strategy has been clear, and also why it has unravelled. They completely misread the situation.

The Greeks are now discovering that perhaps Germany and the EU were indeed making a credible threat the whole time. Varoufakis said on his blog overnight that Grexit was always part of Germany’s plan and that “five months of intense negotiations between Greece and the Eurogroup never had a chance of success”.

“Condemned to lead to impasse, their purpose was to pave the ground for what [German finance minister] Dr [Wolfgang] Schäuble had decided was ‘optimal’ well before our government was even elected: That Greece should be eased out of the Eurozone in order to discipline member-states resisting his very specific plan for re-structuring the Eurozone,” Varoufakis says.

He adds that he says this because Schäuble told him.

That’s where the game theorists of Greece have overplayed their hand.

It is not as though Schäuble has been passive in his approach to Greece.

He, and his Dutch colleague, have been the main protagonists during discussions since Syriza was elected. In May Schäuble said Greece may need a parallel currency. Yet Tsipras threw caution to the wind by calling the referendum, perhaps, as Ambrose Evans-Pritchard wrote last week in the hope of talking up the “No”, but getting a “Yes” vote to austerity so he could go back to the table.

Just this weekend a German plan surfaced which put a Grexit on the table and reports over the weekend also suggest Schäuble has wanted Greece out of the euro since 2011.

How could Greek negotiators have missed the signals they would have received in the negotiations and other meetings? Painting Schäuble as an arch villain is the most obvious explanation. It plays well internationally and with the Greek electorate. But it is too simplistic an answer because, leaving aside the obvious need for a debt restructure, the Greek side can not deny some culpability for the allowing the situation to spiral out of control.

Already it appears to be laying the foundation for what could turn out to be long-term antipathy between Greece and other European nations, especially Germany. It’s a common theme I’ve noticed when talking to Greek Australians at the moment. They are annoyed at what they see as the ill-treatment of the Greek people.

This kind of sentiment is fractious for European harmony. Indeed when 1953’s debt relief for Germany became a popular meme, endorsed by people like Thomas Piketty, as a reason why Germany is doing the wrong thing in 2015, it’s clear antipathy is growing.

People not schooled in the history of international debt relief might wonder why such an apparently different approach is being taken toward Greece now.

The problem is that amid all the game theory, acrimony between leaders, talk of bailouts, failed talks and Grexit, it’s the Greek people who must endure capital controls, a shuttered banking system on the brink of collapse (if not already over the cliff) and an economy falling deeper into the mire each day.

No one is blameless. Over the years since the first Greek bailout the list of villains has grown, on both sides.

But a different approach from the Greek negotiators: less combative, less certain this was an “incredible threat”, might have had a deal on the table. It would have given Germany less solid ground for insisting that the consequences now need to be Greece’s exit from the euro.

It’s not over yet, and the complete collapse of resistance from the Greek PM gives his country its best chance of a deal if it wants one. But, it has also strengthened Schäuble’s hand.

So we wait. The Greek people wait and wonder why they’re being treated so harshly.

The answer isn’t pretty. Because the people Greece voted for six months ago to fix things got it horribly, foolishly wrong.

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