Political Economy of the Sovereign Debt Crisis: The Limits of Internal Devaluation

This article makes three interrelated arguments: first, the sovereign debt crisis is more complex than a simple story about fiscally irresponsible governments which now are being forced by international financial markets to tighten their belts. Ultimately, it is the result of a political decision to create a currency union among economically non-homogenous countries without making any provision for the use of democratically legitimated fiscal transfers to correct asymmetric shocks. Second, the internal devaluation policy which is being imposed on Greece, Ireland, Italy, Portugal and Spain is ineffective and counterproductive. Internal devaluation depresses growth, and the absence of growth requires further austerity for government to regain their fiscal credibility, thus generating a vicious cycle. Third, while national governments continue to be held electorally accountable by citizens, they have lost any meaningful ability to choose among alternative policy options and, as a result, implement everywhere pretty much the same, deeply unpopular austerity package. This situation threatens not just the future viability of the Euro but of the European project as a whole.