Greek Election Turmoil for Europe

Europe is in for months of turmoil after Sunday’s Greek election results. The strongly left-wing Syriza Party (roughly translated as the “Coalition of the Radical Left”) won the most votes (36% of the total versus 28% for New Democracy, a center-right party). This brought them the 50 seat bonus that goes to the largest party, raising their total to 149, just shy of the 151 they needed for an absolute majority. Within hours, they announced a coalition with the Independent Greeks, a right wing anti-austerity party, giving their government a clear majority.

From a U.S. perspective, the key question is whether the election results will reignite the euro crisis, producing recession in Europe and some level of financial instability and slower growth here. This remains unlikely, although still possible. However, Sunday’s election results were almost the worst possible outcome from the point of view of the rest of Europe, and there will be considerable turmoil in the months to come, even though terrible outcomes will likely be avoided.

This large a victory leaves Syriza with few internal political constraints on its negotiations with Greece’s European funders. (An absolute Syriza majority would have been even less constraining, although perhaps not by much.) Alexis Tsipras, Syriza’s leader, will face very difficult pressures from within his party once he begins to confront the challenging external and economic constraints. Syriza has committed to rejecting key elements of the deals negotiated by the previous government with the so-called “Troika” that has provided massive funding to Greece in exchange for commitments to economic and institutional changes. (The troika consists of the European Commission, the European Central Bank and the International Monetary Fund.) The Troika, and the national governments in the rest of Europe that stand behind it, want to reach a mutually acceptable agreement with Greece on next steps. However, they are not prepared to accept radical revisions of the actions taken or committed to under the previous agreements, as Syriza demands.

Tsipras probably recognizes the need to compromise considerably with the Troika, and has been visibly moving his party away from the left fringes of the political spectrum and somewhat closer to the center. However, substantial parts of his party do not view the situation the same way and may make it difficult to compromise after Syriza’s resounding victory. Syriza is historically a coalition of protest, anger, and demand for radical change, not a party focused on governing. Virtually no Syriza member of Parliament has previous parliamentary or government experience and many members have been comfortable spending their political lives standing on principle, without compromise. The transition to the real world of politics and foreign negotiations may be very rough.

There are two routes by which the elections could reignite the euro crisis. First, a dramatic breakdown of negotiations with the Troika could, with serious mismanagement on both sides, lead Greece to fall out of the Euro. Second, the new Syriza government might instead “win” the negotiations with Europe and, either as a result or by coincidence, experience a strong economic recovery. This outcome could sharply bolster other anti-establishment parties across the troubled “periphery” of Europe and lead to a breaking of the already stressed consensus that has held the Eurozone together thus far. Strongly increased tensions could lead to a renewal of the sovereign debt crisis, with potentially very negative outcomes economically and politically.

Both paths are improbable, since a series of events would all have to play out in a particular manner. For a start, either route to euro crisis would require Syriza to hold a stable government together. Such a scenario is not assured. There is a real possibility of the new government falling apart under stress, either by losing its coalition partner or by losing the support of many individual members of parliament. Syriza was formed from a number of smaller parties and has never been through the stresses and temptations of power. Some members of parliament may desert the party or fail to support it on key votes once a coherent set of decisions is required, as opposed to the easier task of agreeing on what they do not like. Further, Syriza’s new coalition partner is a clearly right-wing party that agrees with the radical left on essentially nothing except standing up to Europe and opposing austerity. Important issues outside of this realm could arise that would tear the coalition apart.

Assuming the new government holds together, then one needs to analyze the two routes to euro crisis separately. The only way a failure of the Troika negotiations would be likely to have major effects in the rest of Europe would be if it produced an exit of Greece from the Euro. Short of that, Greece might refuse to fully repay some of its government debt. This default would produce some turmoil in Europe, but 80 percent of Greece’s government debt is now owed to other official bodies across Europe, plus the IMF, and such a loss could be managed without significant economic pain when spread across these countries. Syriza would likely continue to pay out on debt owed to other parties, since it already took a large haircut on private debt several years ago and wants to be able to continue to borrow in the markets.

Withdrawal from the euro would be much more serious, because it would set a precedent that might be used by other countries in the future. However, none of the other Eurozone members seem at all inclined to follow Greece anytime soon if it exited. That fact would reduce financial market pressures in Europe resulting from a Greek action. Even in Greece, Syriza does not want to withdraw from the euro and polls show almost three quarters of voters believe Greece should stay in the Euro, even if it entails significant sacrifice. If Greece exits, it will almost certainly be a policy accident resulting from major misjudgments by both Greece and its European partners. It is unlikely that either side would allow it to reach that point, and there will be various decision points where the parties can walk back from the cliff edge.

In the unlikely event of a Greek exit, there would be significant damage to the European economy for at least the first year or so, but much of this could be offset by stepped up action by the ECB and by individual European governments. Europe has developed institutions such as the European Stability Mechanism and the new Banking Union that considerably increase stability in a time of crisis, not to mention a much greater freedom and willingness of the ECB to act when necessary. Further, Europe’s leaders are now battle tested and have a better idea of how to find the necessary solutions to problems such as Greece may pose.

For its part, Greece would almost certainly dive back into a severe recession, due to major capital flight and huge uncertainties that would crush business investment and household spending. The disparity between the severities of the outcomes for the two sides is a major constraint on Syriza’s bargaining position.

To be clear, Syriza’s big victory may well mean one or more major breakdowns in its negotiations with the rest of Europe as the Greeks demand what Europe will view as radical changes to previous agreements. The reason for optimism is that such breakdowns would almost certainly cause the swift onset of economic and financial problems in Greece, and to a much lesser extent the rest of Europe, that should drive the two sides back to the negotiating table with greater realism. A return to negotiations would then largely reverse the economic problems created by the initial breakdown.

The second route from Greece to renewed euro crisis is longer and potentially less severe. It is also unlikely, although not as improbable as a Greek exit from the Euro. In this scenario, a new and stable Syriza government manages to “win” the negotiations with the Troika, forcing substantial and visible concessions. If the economy then picks up sharply, for any reason, Syriza could be covered in glory. This outcome would doubtless strengthen and embolden the Podemos party in Spain and other anti-austerity parties in the troubled parts of the Eurozone who want to force a major change in how the Brussels institutions, the ECB, and the stronger nations in Europe interact with the more troubled nations. There would be any number of potential flash points that could conceivably result in a new fragmentation, whereby the stronger economies refuse to provide the needed back-stop for the weaker ones unless they take measures that those nations are no longer willing to accept. In such a circumstance, financial markets would sharply increase interest rates in the troubled nations, creating a host of problems, including potential further defaults on government debt.

There are many forces that hold the Eurozone together economically and politically, so it is important not to over-estimate the danger of an anti-austerity government looking as if it successfully defied the stronger powers. However, the biggest obstacle to this scenario occurring is the low likelihood of Syriza having such tangible success in the first place. The Troika, and key national governments led by Germany, appear determined to avoid this kind of political contagion by sticking fairly firmly to their existing negotiating positions. They are bolstered by (a) the political weakness of Syriza, which does not have a majority of the seats on its own; and (b) a strong belief that Eurozone institutions and economies are now strong enough to handle the consequences even of a euro exit. That said, the Troika and Germany do not want a complete breakdown of the negotiations and they will have some room to tangibly reward Greece for reaching a new agreement. In the end, both sides are likely to display a level of brinksmanship in the negotiations that will be scary, but each has strong reasons for wanting a new agreement.

Overall, expect turmoil and volatility for a while in European politics, but the odds are high that a Greek tragedy for Europe will ultimately be avoided once again. For a somewhat more pessimistic view, it’s worth reading this blog post from my colleague Thomas Wright, who focuses more on the political incentives that could lead to a failed negotiation between Greece and the Troika. Kemal Dervis and Daniel Speckhard have each also written analyses recently on the Greek situation that provide further perspective.