Vicky Pryce: Papandreou has gambled – and if he loses, it spells disaster for Europe

The decision to stage a referendum on the EU bailout package has come as a shock to the markets and apparently Europe's other leaders. So what is going on and what has motivated the Prime Minister George Papandreou?

The first thing to bear in mind is that approval for the rescue deal never carried the guarantee that it would be successfully implemented. There was some spectacular success after the first Greek bailout was approved two years ago; Athens slashed its deficit-to-GDP ratio by 5 per cent in one year. But with the very sharp decline in GDP that followed, this was not sustainable. Greeks cut back, just stopped spending or found other ways to avoid paying tax.

Second, although Greeks appreciate that the entirety of their inefficient and corrupt system needs to change, they are seeing a very sharp decline in their living standards and public opposition has been severe, especially from the unionised sectors. The economy is being paralysed by general strikes, along with protests and stoppages from the many professions the government wants to liberalise, from pharmacists to taxi drivers. Mr Papandreou knows that taking people with him is the only way to achieve progress. Indeed the protests outside the Greek parliament in the centre of Athens and elsewhere have not abated since the Brussels deal was struck. I grew up in Greece and family members there told me they watched their television screens in horror last week as tomatoes and eggs were hurled at officials during the annual parades to celebrate one of Greece's proudest moments during the Second World War. This is unheard of. For the first time a number of ceremonial military processions had to be halted to prevent more serious violence from erupting. What it suggests more widely, is that the government has lost control and a real mandate to govern. It also underlines that getting Greeks to passively accept years more of painful cuts was impossible unless something was done.

The third problem is that with a very slim parliamentary majority, the Prime Minister knows more detailed austerity measures would simply not be passed. Having seen a sharp drop in his popularity and that of his party, Mr Papandreou has also experienced active rebellion from his deputies and has even been forced to expel some senior politicians. Finally, it is possible that events have just become too much for Mr Papandreou. The pressures are intense and he needs to either win backing for what he is trying to do or bow out gracefully. But in the process he has left himself and Greece in a very risky situation and raised doubts over whether Athens is serious about reform and staying in the euro after all.

He is gambling – assuming the vote of confidence this week goes in his favour – that the threat of a referendum will allow him to negotiate a package of measures which in the end offers some hope to Greeks that better times may be around the corner.

Otherwise the referendum, if it ever comes, will be surely lost and the consequences for Greece and Europe disastrous.

Vicky Pryce is Senior Managing Director at FTI Consulting. She was previously Joint Head of the Government Economic Service and was born in Greece