Will the Greek Elections Ultimately Break the Euro?

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When Greece goes to the polls on January 25, the voters will choose between a continuation of current policies or a confrontation with their European funders. Current polls show the strongly left-wing Syriza party as the likely victor, which would lead to very difficult negotiations between Greece and the so-called "Troika" of the European Commission, the European Central Bank (ECB), and the International Monetary Fund (IMF). The Troika has directly or indirectly provided Greece with well over 100 billion euros of funding, in exchange for implementation of economic policies in Greece that the Troika believes to be essential to restore the country to long-term stability.

From a U.S. perspective, the key question is whether the election will reignite the Euro Crisis, producing recession over there and some level of financial instability and slower growth here. Some predict this, but it seems quite unlikely, although it cannot be ruled out. There are two routes by which it could happen. First, a Syriza victory and dramatic breakdown of negotiations with the Troika could, with serious mismanagement on both sides, lead Greece to fall out of the Euro. Second, a 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 non-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 a victory by Syriza that was sufficiently strong for the party to form, and hold together, a stable government. Such a scenario is possible, but far from assured. Polls consistently show Syriza in the lead by a few percentage points, but generally not by enough to govern without a coalition partner. Further, Greece has shown some tendency in the past for undecided voters to break towards the status quo parties when they actually vote.

If Syriza does manage to form a government, it will not have a large majority, and therefore there is a real possibility of the government falling apart under stress, either by losing its coalition partner or by losing the support of 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.

Assuming Syriza passes these hurdles, 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 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 very 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. 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 severity of the outcomes for the two sides is a major constraint on Syriza's bargaining position.

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 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 will have, at best, a slim majority of the seats; 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.

Elliott is a Fellow in Economic Studies at the Brookings Institution and author of the recently released book Uncle Sam In Pinstripes

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