In memory of Dr. Andreas Höfert

Euro crisis: Why the inflation of summits?

The summer break is over. European politicians have returned to find the euro crisis as they left it. The weeks until the next EU summit on 18–19 October in Brussels will be crucial.

Last week already, German Chancellor Angela Merkel, French President François Hollande, Greek Prime Minister Antonis Samaras and Eurogroup President Jean-Claude Juncker performed diplomatic ballet. Mrs. Merkel will meet the Italian Prime Minister Mario Monti in the coming days and the Spanish Prime Minister Mariano Rajoy in early September.

Also in early September, the troika of the International Monetary Fund, European Central Bank and European Union will visit Athens again to assess how well or poorly Greece is implementing reforms agreed under its second bailout. Both Mrs. Merkel and Mr. Hollande have made clear that they won’t decide on anything regarding Greece before this assessment. Only then will the next tranche of Greek aid be paid. The European finance ministers will also have to approve the terms of a loan of up to 100 billion euros for Spain (the definitive amount will emerge only in September) to recapitalize its banks.

Given the forceful “whatever it takes” of ECB President Mario Draghi, and then the non-event of the August meeting of the ECB, market participants now eagerly await the next official ECB meeting on 6 September. Then on 12 September, the German Constitutional Court decides whether the European Stability Mechanism is legal in Germany. The same day, the Netherlands elects a new parliament, after its government was brought down last spring due to the euro crisis.

Bailout fatigue is an important topic there now, as well as with German, Finnish and Austrian politicians. Then the EU Heads of State convene in Brussels on 18–19 October. British Prime Minister David Cameron expressed his frustration already before the last EU summit about the meeting inflation, and after 100 days in power, French President François Hollande said he was surprised at how much time he needs to devote to the euro crisis. Indeed, the next EU summit, by our count, will be the 20th since the beginning of the euro crisis back in early 2010. We therefore ask, what is the purpose of so many summits?

One can see the euro crisis as a prisoner’s dilemma between “weak” and “strong” countries. In a nutshell, the prisoner’s dilemma goes like this: The police catch two suspected criminals but don’t have enough evidence for a full conviction. Thus, if both criminals decide not to cooperate with the police, they will each face one-year prison terms. If one criminal decides to talk while the other doesn’t, the talker will go free and his accomplice will get a ten-year sentence. If both decide to cooperate, they will each get five years in jail. Studies show that despite the advantages of stonewalling, each individual sees a clear incentive to cooperate. Each acts in an apparently rational, self-interested way, but the outcome, a five-year prison term for both, is far from optimal.

The optimal common strategy to solve the euro crisis for the weak and for the strong countries would be for the former to comply with the austerity measures imposed upon them and for the latter to bail out the former. However, an individual more dominant strategy for the “weak” countries would be to get the bailout money and not to comply with austerity, while an individual more dominant strategy for the “strong” countries would be to have the weak countries comply while not bailing them out. Hence we are confronted with a typical case of the prisoners’ dilemma: Pursuit of individual optimal strategies by each party leads to a worse outcome than if both parties had pursued a common optimal strategy.

The only way to avoid the pitfalls of such a dilemma and ensure that individual parties will work towards the outcome optimal for both parties taken together is to repeat the game. This explains why we are poised to see many more summits of last chance from European politicians over the next couple of months and even years before the euro crisis gets solved.