Economics & Trade Policy Spanish Economy Minister meets Greek Finance Minister

Published on April 7th, 2015 | by Delfina Rossi

A Prisoner’s Dilemma: Why Spain and Portugal Won’t Support Greece

The Eurocrisis forced Spain and Portugal, like Greece, to ask Europe for financial support. In return, by mandate from their creditors these countries implemented budget cuts and unpopular structural reforms. As a consequence of these austerity measures, one out of two young people in Spain and Greece is unemployed; in Portugal, this number is nearly one in three. The median citizen understands that, far from solving the problem, austerity has dismantled the welfare state. 

As such one might expect fellow austerity victims in Spain and Portugal to side with the Greek government, which is currently demanding that debt and deficit objectives be relaxed. Greece’s demands are sensible and would lead to the creation of jobs and the reactivation of its national economy. But on the contrary, Portugal and Spain have been outspoken against Greece’s proposals. In return, the Greek Prime Minister openly accused them of conspiring against his government.

So why are Portugal and Spain failing to support Greece and its newly elected Syriza party? We can turn to game theory to help answer this question. Specifically, let’s consider the classic lesson of the prisoner’s dilemma. In this model two rational agents make their own choices but are incapable of communicating or predicting each other’s decisions. They receive the best outcome when they cooperate but the lack of possible communication makes this outcome unlikely. If one agent takes a risk and attempts to cooperate, that agent is punished if the other agent does not also cooperate. Ultimately, this risk means they end up not cooperating and endure a worse situation.

The table below summarizes the game in the context of Portugal and Spain’s current dilemma. Each country has two strategies: to support Greece in its demand to end austerity, or not. They play simultaneously without knowing how the other will decide. The payoffs range from -1 to 1, with -1 meaning harm to the agent’s economy and 1 meaning improvement to the agent’s economy.

Decision Matrix Spain – Do nothing Spain – Support Greece
Portugal – Do nothing (0,0) Economic status quo (1,-1) Spain punished, Portugal looks good
Portugal – Support Greece (-1,1) Portugal punished, Spain looks good (1,1) Better chance of end to austerity

Today, both countries are choosing the safest strategy: withholding support for Syriza. They receive a payoff of (0,0) and their national economies continue to suffer from the current economic status quo of austerity and slow-growth. This is a so-called Nash equilibrium, where no country has any incentive to move away from their current choice. There are several reasons why Spain and Portugal are willing to endure the Nash equilibrium, but let’s first explain the rest of the table.

What if Portugal supports Syriza and Spain does not? Then the EU might sanction Portugal by stopping economic development programs. Portugal could then be compared to Greece, worsening its debt refinance possibilities. On the other side, Spain could chose to withhold support and receive the benefits of being the best child in the classroom, leading to the (-1,1) outcome in the table above.

Alternatively, what if Spain supports Syriza and Portugal does not? Assume, as is necessary for such an outcome, that the anti-establishment party Podemos wins the upcoming general elections and gives support to Syriza. Then, given that Spain is the fourth largest economy in the EU, it’s unlikely that the EU would push it to exit the euro or default on its debt. But it’s also unlikely that such a decision from Spain alone could make the EU end austerity. More, the EU has imposed technocratic governments in Italy and Greece already, and that creates a threat in Spain that no government wants to face. In the end, Spain would probably receive some kind of punishment from the EU, and then Portugal would be the example of successful structural reforms. This leads to the (1,-1) outcome.

Finally, let’s imagine what would happen if both Spain and Portugal support Greece. Because of their combined economic magnitude, the potential cost to the EU of letting Spain and Portugal fall alongside Greece are enormous. In other words, Spain and Portugal can (and should) throw their weight around to help Greece and, ultimately, themselves. Supporting Greece opens the possibility of re-writing Spanish and Portuguese debt obligations. The payoff in this situation would be (1,1), which is the Pareto optimal solution of the game.

Unfortunately, there are at least four reasons why Spain and Portugal won’t move away from their Nash equilibrium. First, Greece owes both countries money. The Financial Times reported that, through the bailout loans, Greece owes about €26 billion ($28 billion) to Spain and €1.1 billion ($1.2 billion) to Portugal. If Syriza asked for debt restructuring and Portugal and Spain offer support, then the public finances of Spain and Portugal might be forced to endure extra stress.

Second, unlike France and Italy, Spain and Portugal undertook widely unpopular measures such as public sector layoffs, pension cuts, labor market reforms and tax increases, among others. The governments want to pretend that they worked, or else they risk losing political clout. In other words, support for Greece’s demands would be something like admitting a mistake.

Third, the electoral calendar means the incumbent parties in Spain and Portugal would rather play it safe. Podemos and Ciudadanos are challenging the established parties in Spain, and the People’s Party (currently in office) does not want to lose the November general elections. Portugal has elections in September, and the Social Democrat Prime Minister seems similarly unwilling to take risks.

Fourth, there are speculations that support for Syriza could hurt access to international markets. Specifically, there is an optical illusion of stability in the financial markets and thus a fear that a different agreement on Greece might result in the loss of confidence from international creditors. At the moment, these factors seem enough to prevent Spain and Portugal from taking the risk of supporting Greece.

This version of the prisoner’s dilemma makes the notable assumption that Spain and Portugal are rational agents and that they do not coordinate their decisions. It also simplifies the necessary debt negotiations that Syriza would have to undergo with the European Central Bank and International Monetary Fund. Nevertheless, the game serves as a useful tool in identifying the obstacles to ending austerity policies in Europe. Without coordination among countries, the power balance in the EU cannot be changed and austerity cannot be ended. It is simply too risky for only one country to attempt changing the balance on its own. The result is sub-optimal, Greece is alone in a game to end austerity.

Edited by Jon Brandt

Tags: , , , , ,


About the Author

Delfina Rossi

studied economics in Barcelona and Florence. She is formerly co-spokesperson of the Federation of Young European Greens (2010-2011) and she has been working as a policy adviser in the European Parliament for Green MEP Raül Romeva (2011-2014). She is in her first year pursuing a master's in Public Affairs at the LBJ School in the University of Texas at Austin.



Leave a Reply

Your email address will not be published. Required fields are marked *

Back to Top ↑