Today was another ‘crunch day’ in the negotiations between Greece and its creditors in the euro area.  The Greeks have made their proposal.  Now the Economics and Finance Ministers have to make a decision about whether to extend the Greek bailout That decision may require that the Greek government offer even more.  The Greek government is reluctant because it fears betraying the electorate that just voted it into office.  The German government is reluctant to concede more either because it has its own voters to worry about.  It also has to worry about its allies – like Finland, Slovakia, Portugal, Ireland, and Spain – who have supported a hard line on Greece, also for domestic political reasons.  Hence we are at a democratic impasse.  The two sides are close to an agreement, but close is still ‘no cigar’.

Worse, there is a scenario that plays out where neither side makes a concession.  The Harvard negotiations project people have even given this scenario a name (and an acronym): the best alternative to a negotiated agreement, or BATNA.  One of the things that the Harvard team teaches is that you can strengthen your negotiating position by improving your BATNA and so making it easier for you to walk away from the table.  It appears that was what the Germans (and others) were doing when they agreed to the European Stability Mechanism and the single supervisory arrangements for systemically important European banks.  The ECB also played a role with its comprehensive assessments.  Hence where the Greeks could hold Europe hostage in 2010 and even the Cypriots could push the ECB to announce that ‘there is no plan-B’ where Cyprus leaves the euro, now the Governing Council can engage in active contingency planning for a Greek exit.  Such planning is straight out of the Harvard negotiations project playbook.  So is leaking to the press that the contingency planning is under-way.

Still we are in a phase of ‘positional bargaining’, which is why I started off this piece talking about concessions.  The Greeks have one position, the Germans have another, and the twain may never meet.  But it does not have to be that way.  The Harvard negotiations people argue that the two sides should look at their objectives and then find common principles that will allow everyone to walk away a winner.  Such principled bargaining relies on a lot of trust – which seems to be largely absent – but it does offer a way forward.

The Germans and their allies have a reasonable set of demands.  They would like to see more market structural reform, not just in Greece but also elsewhere.  They worry – or so I am told – that the Greeks will not reform with proper incentives and that the other countries will not reform if the Greeks get to go their own way.  This is a long-term problem that requires a long term solution in the form of a coherent reform agenda coupled with a strategy for implementation.  The Germans and their allies say that this is what the ‘program’ attached as a condition to the bailout has to offer.  Now the Greeks need to implement that program as a sign of good faith.

For their part, the Greeks are focused on a much shorter time-frame.  They say that the country cannot handle any more austerity until output growth regains momentum and they complain that the sequencing of market structural reforms in the program creates a distribution of costs and benefits that cannot be defended politically.  Hence they want to reorganize how they undertake reform and they want to slow down the pace.  The Greek government has already conceded that they will pay back their obligations.  But they want to do that with a delay as well.

These are not irreconcilable positions.  That is why most commentators have insisted that we are close to an agreement.  Nevertheless they are temporally inconsistent.  The Germans want to focus on long-term problems; the Greeks want to find some more immediate relief.  This is where it becomes important to invoke some kind of ‘objective principles’ for assessing which of the two positions should warrant priority.  Again, I am drawing upon the Harvard negotiations playbook.  The question is whether it makes more sense to push the Greeks to implement a long-term reform agenda to address long-standing problems now no matter what the consequences either domestically or internationally, or whether it makes more sense to restore calm to the markets and growth to the economy so that the governments of Greece and elsewhere can  launch a more sustainable long-term reform agenda.

You should have a sense from how I phrase the question where my own thinking lies.  I believe that we should focus on creating short-term stability so that politicians can address long-term problems over the longer term rather than looking to lock in long term solutions today even at the cost of destabilizing the markets.  The reason I believe that derives from how I believe we got into this crisis in the first place.  The most important causal factor was not irresponsible borrowing or uncompetitive market institutions.  Those long-term problems were apparent in different countries to varying degrees, but they do not explain why any particular country or countries got into trouble.  As I argue in a recent paper for the European Investment Bank Institute, the common factor across all affected countries were short-term financial market dynamics.  Moreover, those short-term market dynamics remain a problem insofar as they could easily overwhelm Europe’s newly constructed (and as yet still incomplete and untested) defences.  Now is not the time to test whether I am wrong.

It is possible, moreover, to imagine a more robust framework of institutions for stabilizing financial market integration.  If this framework were in place, then governments and banks could be made more easily subject to market discipline.  That agenda is sketched in another study I published recently with Geoffrey Underhill for The SWIFT Institute.  If the Germans and their allies are serious about investing in more robust market institutions and shared governance arrangements, they could benefit a lot from studying closely how this was done in the United Kingdom, the United States and Canada.  The answers that arise from those national cases shed light both on the institutional requirements and the political consensus necessary to forge a stable arrangement.  The European Union and the euro area do not have to aspire to become a comprehensive federation to make significant progress in achieving that agenda.  Indeed they are well on their way.

A big euro crisis could easily reverse the progress that has been made.  It would not only damage Greece but also the whole European project.  Obviously trust is important in any political arrangement.  So is patience.  The deadline for requesting a bailout is useful in focusing attention but that is no reason to telescope long-term aspirations into a short, fraught negotiation.