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Forget about Exits: Europe's Choreographed Policy Outlook



Following the confrontation-driven agreement between Greece and its international creditors on July 12, Europe appears ready for its usual August torpor. European leaders deserve a break. Their numerous emergency summits have stabilized the continent's outlook for at least the next year, virtually eliminating the specter of a Grexit and lowering the prospect of a British exit from the European Union. In other words, Europe's near-term outlook is not as pessimistic as many experts say.

Why No Grexit

Greece will continue to generate a disproportionate number of headlines for a country that accounts for only 1.8 percent of euro area GDP. The relationship between Greece and its creditors has been inherently confrontational, although Greece, Europe, and other players will likely carry out the July 12 agreement without excessive drama because it is in their political interest to do so.

Prime Minister Alexis Tsipras' switch to pragmatism from left-wing anti-establishment rantings has sown discord inside his Syriza party. He is no longer able to campaign against austerity imposed by the so-called Troika of the European Commission, the European Central Bank (ECB), and the International Monetary Fund (IMF). In the short run, he remains politically popular, but in the medium term, he will need economic stability and ultimately growth to survive. He needs a deal with Greece's creditors more than ever, and he needs it to work. His previous rhetorical skepticism about the new program with the European Stability Mechanism (ESM) will surely not prevent him from claiming credit for its benefits to ordinary Greeks.

The design of the upcoming ESM program negotiation process meets the political needs of Tsipras and the euro area. To overcome their mutual lack of trust, its requirements will likely be front-loaded to take place later this year. The Greek parliament faces a lot of hard votes on reforms in coming months, but Tsipras can take advantage of the fresh memories of the crisis and accept the harsh medicine as a necessary evil.

Tsipras will also argue that a new stabilized economy, lifting the deposit withdrawal limit, and other steps are gains that need to be protected. He can also note that the financial situation remains precarious and the Greek banking sector normalization can easily be frozen again by the ECB in case of sudden Greek noncompliance. A new ESM program is likely to be completed soon, averting a pointless standoff over Greece's €3.5 billion payment to the ECB on August 20. With Europe's new bank resolution process for insolvent banks due to kick in on January 1, the Greek government must complete a restructuring and recapitalization of the banking system before that date or risk losses inflicted on large uninsured depositors that would cripple small and medium-sized businesses. Such a rapid recapitalization can only be done as part of a new ESM program in 2015.

Syriza's Godesberg Program?

Tsipras's political coalition will likely split apart as part of this process, but given that approximately 75 to 80 percent of Syriza members of parliament have backed Tsipras in the first two parliamentary votes, letting the utopian left wing go will work in the prime minister's favor. A small Syriza splinter faction would not likely be politically viable in the already crowded far left of Greek politics. It would also help Syriza replace the Panhellenic Socialists (PASOK) as the main center-left political force in Greece.

It is possible, though ultimately not likely, that Tsipras will be forced to call early elections. But because he would then decide which members of parliament get which place on the Syriza election list, the threat of early elections will surely dissuade dissidents from forcing a vote. Tsipras secured a mandate from the Syriza Central Committee—by such a large majority in a show of hands that no count was taken—to host an extraordinary congress in September (after the new ESM Program has been negotiated) to discuss party strategy. He will be able to include many newer party members there, who attracted by his personal popularity will be far more sympathetic to his new political line than Syriza's traditional left wing.

Right now, Tsipras also enjoys the support of the mainstream opposition, a coalition likely to hold, as the leaderless New Democracy (ND)1 does not want to bear political responsibility for killing a historic overhaul of the Greek economy.

Much Ado about a Temporary Exit

Much has been made of the political situation in Germany and Finance Minister Wolfgang Schäuble's proposal for a "temporary exit" for Greece from the euro area. This proposal was deeply flawed, and it cost Germany a huge amount of political goodwill. But the proposal serves important political functions. The very idea was naïve or perhaps disingenuous, aimed at letting Schäuble disavow responsibility for reversing 60 years of European integration by saying that Greece could rejoin at a later state. Yet the very utterance of "exit" by a senior European policymaker will remain a latent and useful political threat that Tsipras can also use to rally Greek citizens to help him fight the boogieman Schäuble.

Despite talk of a political split between Chancellor Angela Merkel and Schäuble, 79 percent of the Bundestag voted to authorize the new Greek program negotiations, well aware that down the line there will likely be votes on additional debt relief to Greece. The leader of the Christian Socialist Union (CSU) in Bavaria, Horst Seehofer, has backed Merkel's conditional approach. Simultaneously and related, the erstwhile political threat to Merkel (and especially Seehofer) from the new anti-euro party Alternative for Germany (AfD) has recently dissipated, as AfD's political line has shifted towards a more traditional and in Germany ultimately doomed right-wing anti-immigration platform. Thus the chancellor has the backing of her own Christian Democratic Union plus the CSU over Greece, even if it remains politically convenient to give the impression that a Schäuble-led rebellion remains possible.

For Germany and the euro area, there is nothing to gain from abandoning Greece after sinking so much into saving it with little hope of being repaid as the debt is currently structured. The biggest gain they have achieved, of course, is turning Tsipras from a radical anti-austerity and anti-establishment firebrand into an agent of reform and rules, as was predicted here in February. His reinvention took just months, whereas former baby boomer left-wing radicals like former German foreign minister Joschka Fischer took decades to become part of the establishment. The decline in public support for the left-wing Podemos party in Spain illustrates the political value of this development, as voters across the euro area have witnessed the perils of pursuing policies directly at odds with the rest of the euro area.

The IMF's Dance

Staying the course over Greece also benefits the IMF, which is on course to succeeding in its demands for further debt restructuring of the euro area holdings of Greek debt. By imposing financial losses on the euro area before committing to new loans, Christine Lagarde, the Fund's managing director, establishes her independence from her former colleagues and likely ensures herself another five-year term unopposed next year. The IMF's reputation as a global crisis fighting institution is similarly better served if it stays fully engaged in Greece, especially as Greece benefits from additional debt relief, a monetary policy easing, and a suddenly reformist prime minister.

With political stability, Greece has a decent chance to achieve growth of perhaps 3 percent, propelled by relatively lenient short-term fiscal targets (a likely small primary deficit in 2015), monetary easing from becoming eligible for ECB bond purchases, and a normalizing banking sector.

Why No Brexit?

The other main "European exit risk" in the potential for the United Kingdom leaving the European Union has also declined. The other members of the European Union oppose a Brexit. Because the EU legal framework is flexible, EU leaders can be creative in making Britain's stay easier. Everything except revisions of the EU Treaty, which would require reratification, will be on the table.

Prime Minister David Cameron can thus secure politically symbolic and legally binding changes to the EU laws governing the UK economy, such as offering a Danish or Irish style opt-out of specific issue areas to encourage a yes vote in a British referendum. These could include a renewal of the opt-out of the EU Working Time Directive (which puts restrictions on the maximum amount of overtime workers can perform).2 Other possible provisions might exempt Britain from EU rules for social benefits to the dependents of recent arrivals, or guaranteeing that the City of London will not be discriminated against as the euro area banking/capital markets union deepens, or perhaps even a symbolic UK opt-out of the "ever closer union" phrase at the beginning of the EU Treaty.

Cameron's chances of winning a yes vote on a referendum for continued UK membership have improved. UK business interests are certain to oppose an exit, and the dramatic move to the left by the Labour Party, reflected in the strong showing of Jeremy Corbyn3 in the leadership race, makes it far easier for Cameron to govern. With Labour willingly abandoning the center of UK politics to the Conservatives—an electorally suicidal move—Cameron will feel much less obliged to cater to the views of his anti-EU backbenchers. Even without their support, Cameron will have a clear and largely uncontested politically centrist path to continuing power and electoral dominance in the United Kingdom. His likely successor, George Osborne, will similarly be less threatened by anti-EU party rivals. There is no politically compelling reason why Cameron should not settle for a quick compromise with the other EU members later this year and, together with the other main political parties in the United Kingdom, successfully campaign for a yes in the referendum in generally favorable economic circumstances in the summer of 2016.

All told, Europe will soon be able to put the current fixation of exits behind it and, as the 2017 election cycles in France and Germany move closer, begin to discuss what the next stages of integration should look like.


1. Interim ND leader Evangelos Meimarakis is currently scheduled to remain in his position until the spring of 2016, after which presumably ND will choose a leader for the longer run.

2. Ironically, the United Kingdom was exempt from the Working Time Directive from the introduction of the Maastricht Treaty in 1993 until Tony Blair's government opted back in in 1998.

3. As a life-long Arsenal Supporter, a part of me feels sympathetic to Jeremy Corbin's strong anti-austerity views, as Emirates Stadium lies with his North Islington constituency. Arsenal supporters have for many years been suffering the effects of financial constraints imposed on us by a foreign manager and foreign owner.

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