The current negotiations between Greece and its creditors are entering the final stages – cue the involvement of Angela Merkel and François Hollande. The positions are still far apart – mostly on labour market and pension reforms that not only Syriza but also the previous Greek government refused to implement. The crucial deadline is now June 30th, when Greece promises to pay €1.6 billion to the IMF, after bundling repayments at the end of the month, followed by a €3.4 billion repayment to the ECB in July.
A deal on these reforms and fiscal targets will probably be reached in the end: neither Alexis Tsipras and Syriza, nor Merkel and the eurozone have an interest in Grexit. However, a deal will be a short-term fix rather than a long-term solution. Instead, Greece must formulate a long-term, cross-party package that addresses its institutional problems and is supported across Greek civil society. The creditors, on the other hand, need to back such a long-term plan, and put more sensible fiscal targets and debt relief on the table. If both come together, we may move toward a solution, not just a deal.
The politics of a deal
The key political question is: can Tsipras, Merkel and the leaders of other wary eurozone governments sell a deal to their own parliaments and electorates?
If Syriza were to reject a deal along the lines currently discussed, the party would probably split, opening the way for new elections, and excluding the more radical part of Syriza from power. While the polls currently suggest that Syriza has a comfortable lead, the consequences of rejecting a deal – which could result in bank closures and capital controls – might convince voters to give more moderate voices another chance. After all, polls still suggest that a majority of Greeks want to keep the euro, and want a deal in the end. Syriza is therefore likely to back Tsipras when he decides to put a deal to a vote.
Merkel frets about the wider risks of Grexit – the stability of the euro, the EU’s standing, but also the geopolitical implications of weakening a state at Europe’s crucial south-eastern border. She will not let it happen unless something forces her hand. Could that something be her finance minister, Wolfgang Schäuble, alongside CDU rebels? The answer has to be no: reports of a Schäuble-Merkel split are overblown. Schäuble can play the hawkish finance minister, which boosts his domestic popularity, because he knows that Merkel will step in to broker the compromise needed to prevent Grexit. The CDU is with reason dubbed the Kanzlerwahlverein – the “Chancellor’s supporters’ club” – by the German press. In the end, they will back Merkel, minus a few rebels.
Other eurozone countries will probably agree if Germany agrees, as they either tend to align with Germany, such as Finland, or have a less hawkish stance than Germany, such as France and Italy. For Portugal and Spain, it is important that the deal is not seen as an easy way out for Greece, as the governments in Lisbon and Madrid, which both have pushed through harsh adjustments and reform packages, are up for re-elections later this year.
The economics of a deal
The most controversial issues in the negotiations are labour market and pension reforms, and the pace of fiscal consolidation. Greece has liberalised its labour market considerably since 2011, and it is now more flexible than Germany’s, according to the OECD. Partly as a result, Greek labour costs and prices have fallen considerably (see Chart 1). And yet, exports other than tourism have largely failed to grow – contrary to those of other countries in southern Europe. Labour market inflexibility is thus unlikely to be holding back the Greek economy.
Greece’s labour market is already more flexible than Germany’s
Chart 1: Unit labour costs and GDP deflator in Greece and the eurozone
Even Sweden failed to consolidate its public finances in the early 1990s before economic growth resumed.