Grexit Strategic Risks Trump Economic Ones

With Greece comprising just two percent of the European Union’s economy, one might wonder why policymakers are so troubled by the prospects of a Greek exit. The simple answer is that strategic risks greatly outweigh economic and financial ones.

On the economic front, EU countries are not overly reliant on the Greek market for their exports, so the economic loss would be marginal. Additionally, European banks are more insulated from a Greek default than they were in 2010, as most of the debt is held by foreign governments, the ECB and IMF. Financial contagion would be averted.

The strategic risks, however, may be pronounced. First, entry into the euro zone was considered permanent and inviolable. Smashing through this assumption would set a terrible precedent by rupturing this principle of inviolability. Fears that other highly indebted nations such as Portugal and Spain could exit during a future crisis would no longer seem irrational. This could adversely impact the euro’s strength and usage as an international currency.

But the more acute worry is strategic. A Grexit could damage the EU and NATO since Greece would remain a member of both. Having a disgruntled, resentful, economic basket case within the EU would prove cancerous, as it would inflame political divisions already present within the 28 nation bloc. An imploding and resentful Greece would also be susceptible to Russian influence, likely hindering NATO’s ability to act and threatening its unity. These strategic issues cannot be underestimated and make a Grexit truly worrisome.

The Intracies of International Trade Policy

Sometimes international trade policy is not just about international trade policy. Take the Trans-Pacific Partnership (TPP) being negotiated between the U.S. and 11 other nations, for example. While the deal may increase U.S. exports, the economic benefits to the U.S. will be fairly small. However, the deal’s true importance lies in its geostrategic effects.

China has been flexing its muscles in the region, both economically and militarily. For example, China has initiated unprecedented island reclamation projects, declaring sovereignty over those and other islands that have been contested by nations such as Japan, Vietnam and the Philippines. China has also extended its reach in international waters, declaring a wider swath of the sea belongs within its territorial boundaries. This too has alarmed its neighbors.

On the economic front, China successfully founded the Asian Infrastructure Investment Bank, much to the chagrin of the United States, which furiously lobbied its allies not to join. Unfortunately most joined anyway. The U.S. is concerned that this new bank will help China exert undue influence in the region due to its economic heft.

U.S. policymakers fear they are losing sway in the region. As a result, they hope a successful TPP will solidify American influence in the region by reasserting its economic leadership and extending its security umbrella to more nations. Sometimes a trade deal is more than a trade deal.

Debt Crisis Playbook

Believe it or not, today’s Greek financial crisis is hardly unique, as sovereign debt crises are fairly common. As a result, the policy prescriptions are fairly straightforward and well known. The bottom line? The crisis will persist unless the debt is partially forgiven. Any other method, such as extending the debt repayment schedule or lowering the interest rate, will merely prolong the nation’s economic misery. Of course, the most effective debt crisis resolutions include strict conditions for debt forgiveness; structural economic reforms such as product and labor market reforms are needed too. But until policy makers implement this tried and true formula for resolving sovereign debt crises, Greece’s economic malaise will continue.