In any negotiation, a key variable influencing the protagonists’ behavior, hence the outcome, is what failure to reach an agreement would cost to each of them. In this case, the issue is the cost of Greece’s exit (“Grexit”) from the eurozone – a prospect that was widely discussed in the media throughout the recent negotiation, with considerable speculation about the stance of the various players, especially the Greek and German governments.
From Greece’s perspective, leaving the euro would be highly disruptive, which explains why there is very little support for it in the country. But what about Grexit costs for the rest of the eurozone? Ever since the question was first raised in 2011-2012, there have been two opposing views.
One view – dubbed the domino theory – claims that if Greece exited, markets would immediately start wondering who is next. Other countries’ fate would be called into question, as occurred during the Asian currency crises of 1997-98 or the European sovereign-debt crisis of 2010-2012. Disintegration of the eurozone could follow.
The other view – often dubbed the ballast theory – claims that the eurozone would actually be strengthened by Greece’s withdrawal. The monetary union would be rid of a recurring problem, and a eurozone decision to allow or invite Greece to leave would bolster the credibility of its rules. No country, it is claimed, could dare to blackmail its partners anymore.
Back in 2012, the domino theory looked realistic enough that the creditor countries ditched the Grexit option. Having reflected and pondered over the summer, German Chancellor Angela Merkel went to Athens in October and expressed her “hopes and wishes” that Greece remains in.
But the situation today is different. Market tension has eased considerably; Ireland and Portugal are not under assistance programs anymore; the eurozone financial system has been strengthened by the decision to move to a banking union; and crisis-management instruments are in place. A Grexit-induced chain reaction would be significantly less likely.
But it does not follow that the loss would be harmless. There are three reasons why Grexit could still seriously weaken Europe’s monetary union.
First and foremost, a Greek exit would disprove the tacit assumption that participation in the euro is irrevocable. True, history teaches that no commitment is irrevocable: according to Jens Nordvig of Nomura, there have been 67 currency-union breakups since the beginning of the nineteenth century. Any exit from the eurozone would increase the perceived probability that other countries may, sooner or later, follow suit.