PARIS: To understand the impact of a potential Greek exit from the eurozone, imagine an operating theater inside a betting shop. As surgeons prepare to amputate a gangrened foot to prevent infection spreading to healthier parts of the body, gamblers on the sidelines lay bets on which limb will be next for the chop.
Talk of a possible Greek exit has already sapped investors’ confidence in the 17-nation single currency area and contributed to higher borrowing costs for Spain and Italy. It is making a planned return to market funding next year harder for Ireland and Portugal, which are implementing tough bailout programs.
Some European politicians and central bankers clearly see jettisoning a delinquent member as a salutory lesson to others not to abuse club privileges. Like the English in Voltaire’s philosophical novel Candide, they believe “it’s a good thing to execute an admiral from time to time, to encourage the others.”
Other policymakers and market participants fear that pushing Greece toward the exit would start a chain reaction, materializing huge costs for investors and taxpayers and perhaps triggering a breakup of the euro.
German Chancellor Angela Merkel, Europe’s most powerful political leader, has appeared to be on both sides of the argument at different times.
She said last November that ensuring the stability of the euro was a bigger priority than guaranteeing Greece’s continued membership. But she has also said a Greek exit would cause a disastrous “domino effect,” scaring investors away from Europe.
The election last month of a Greek government committed to sticking to an adjustment program agreed with the eurozone and the International Monetary Fund in exchange for some 240 billion euros ($290 billion) in loans has brought only a temporary respite.
Greece has slid further off course from its fiscal and economic reform targets; the man in charge of privatizing state enterprises resigned last week in despair at delays; and the European Central Bank stopped accepting Athens’ bonds as collateral for lending to Greek banks.
Pundits are now vying to forecast which country may have an interest in leaving first – EU paymaster Germany or Greece, creditors states or debtors.
U.S. economist Nouriel Roubini, a regular doomsayer on Europe, has suggested that Finland, a triple-A rated fiscally prudent northern state, might be first out the door due to anxiety about ever growing liabilities for eurozone weaklings.
“If Greece moves closer to exit and Italy and Spain end up on the verge of losing market access and requiring even more risky financial support from the eurozone core, Finland may decide that the additional credit risk is not worth the benefit,” Roubini wrote on his EconoMonitor website.
Regardless of their accuracy, such prophecies highlight how European governments and lawmakers are coming to see membership of the euro area as a zero-sum game, in which each state feels like a victim of its partners’ actions and decisions.
Foreign exchange strategists at Bank of America Merrill Lynch enlisted game theory to analyze which eurozone country might see an economic interest in jumping ship.
Put simply, game theory states that players may not trust each other enough to cooperate or may see greater gains for themselves in non-cooperation, even though the outcome would be better for all players if they did cooperate.
Hence, while Germany and Greece would both stand to gain if Greece carried out its austerity program and Germany accepted common eurozone bonds, neither is likely to choose that course because each would be better off without making a sacrifice.
Applying the same techniques to the economics of a voluntary exit from the euro, strategists David Woo and Athanasios Vamvakidis concluded that Italy and Ireland both had a greater interest in leaving than Greece.
By contrast, Germany had the lowest incentive of any country to leave, despite its economic power and strong fiscal position, because it would suffer lower growth, possibly higher borrowing costs and a negative balance sheet effect, they said.
Italy had a relatively high chance of achieving an orderly exit and could make significant gains in competitiveness and growth with a weaker currency, they argued.
Former Italian Prime Minister Silvio Berlusconi, who is pondering a political comeback in a general election next year, has said that leaving the euro would be “no blasphemy.”
European monetary union was officially declared to be irrevocable and irreversible. The Maastricht Treaty provides no exit clause once countries join the euro, although the 2009 Lisbon Treaty did for the first time make it legally possible for a country to leave the European Union.
An EU official involved in crisis management, speaking on condition of anonymity due to the sensitivity of the issue, said it would be fatal for confidence if the euro area came to look “like a hotel lobby with a revolving door.”
Yet some outside experts say the absence of an exit clause is one of the design flaws of the euro that should be fixed now.
U.S. Federal Reserve policymaker James Bullard said this month the possibility of an exit from Economic and Monetary Union was one of the principal issues facing EU policymakers.
“The common refrain that no country can ever be allowed to leave the EMU is altering the incentives for nations to take the actions necessary to maintain membership,” he argued in a speech in London.
“The incentive effects for a member country to remain in the EMU must be considered very carefully going forward. Policies should be designed with an eye toward these incentives, and can no longer assume that the political processes will back the EMU in all circumstances,” he said in a speech in London.
Bullard cited the work of economist Russell Cooper of the European University Institute, who has proposed creating a penalty called “Euroization” in which a delinquent state would stay in the euro but lose its voting rights and its access to the ECB’s lending window until its fiscal behavior improved.
That might satisfy the creditors’ wish to see fiscal “sinners” pay a penalty, but it will not hold the eurozone together.