The eurozone between Scylla and Charybdis

Syriza’s resounding victory in Sunday’s referendum was beyond anyone’s expectations and has profound implications for the eurozone’s strategy toward Greece. There are four principal reasons:

1. Europe’s political strategy has failed

The eurozone leaders’ strategy over the past several months had assumed that the alternative to a successful negotiation with Greece’s leaders was regime change. Germany and its allies calculated that a rapidly deteriorating economic situation in Greece—especially the closure of banks and capital controls—would drain Syriza’s electoral support and produce a change of government. After the referendum result, it is clear that this strategy has failed. Crises have their own dynamic and are difficult, if not impossible, to steer. Now, Syriza’s domestic position is stronger than ever. Before, the rest of the eurozone distinguished between Syriza and the Greek people; the large margin of victory means that they will now have to be dealt with as one and the same.

2. The eurozone will not back down

For some commentators, the referendum result is a wake-up call for the creditors and debt relief must follow. Others argue that Europe needs to forge a new grand bargain and build a more integrated and democratic European Union. We normatively agree with most of these recommendations, especially on the necessity of debt relief. But as analysts, we regard them as unlikely and bordering on a pipe dream. Beware the tendency to project one’s own views on others. Europe’s leaders are not a blank canvas. We know a great deal about how they are likely to react. The harsh truth is that this result makes it even less likely that the eurozone will offer debt relief, or offer Syriza other major concessions.

Greek leaders have called eurozone leaders economic terrorists and blackmailers. Any semblance of trust in Greece’s government has been destroyed. Even if eurozone leaders get over the insults, they will worry that such concessions would set a dangerous precedent for the rest of Europe and would empower populists in Spain, Italy, Ireland, and elsewhere. Hardliners like former German Finance Minister Wolfgang Schäuble will be widely perceived as fully vindicated. They believe Greece is being manipulated by demagogues and they are not going to back down, even if they should.

3. Europe’s choice between Scylla and Charybdis

Now that regime change has failed and an about-face is off the table, Europe faces unpalatable options. The first is to force Greece to exit the eurozone. Many European finance ministries favor this option, but Chancellor Merkel and other heads of government oppose it. There are obvious risks. Grexit would show that monetary union is reversible, with dangerous consequences for future crises. It would deepen the misery in Greece and increase the likelihood of a failed state in Europe’s least stable quadrant. As we wrote last week, Grexit cannot be a “quickie divorce”—Greece and Europe will have to deal with each other for a long time to come.

The second option is isolation. The rest of Europe would provide Greece with the minimum support to stay in the eurozone but nothing more. The goal would be to let Syriza stew in its own juices until the Greek people turn to more moderate options. In short, this option means doubling down on the regime change strategy by making it much more transparent, as well as taking away the facade of negotiations and the “soft” financial floor provided by the European Central Bank. Greece would be treated little better than the West treats a rogue state—through containment and unrelenting pressure. In our view, this is the eurozone’s most likely course of action, but it would also be a mistake of historic proportions. It would punish the Greek people, make the EU the enemy, empower populists, and it would likely not work on its own terms.

4. Angela Merkel to the rescue?

The size of the “No” victory places an enormous burden on Angela Merkel. The German chancellor finds herself desperate for a negotiated settlement but without a partner. Syriza is empowered by this weekend’s vote, and Merkel has lost trust in, and the trust of, Alexis Tsipras. There is little doubt that Merkel’s domestic political space for working the diplomatic front has continued to shrink. Seventy percent of the German public is opposed to further concessions to Greece, and that number is surely higher in Merkel’s own party, the Christian Democratic Union (CDU). Ironically, any path to an agreement would have to start with a major reversal in the rhetoric from Athens. If Tspiras can find the confidence and courage to take such a step, maybe, just maybe, the German chancellor (a great believer in Antonio Gramsci’s maxim “pessimism of the intelligence, optimism of the will”) will be able to find a path between Scylla and Charybdis.