The Political Value of Internal Devaluation in the Euro Area Crisis

Early View Article - The Political Value of Internal Devaluation in the Euro Area Crisis

To overcome the euro area (EA) crisis, the core pushed the periphery to cut labour costs. However, this paper documents that internal devaluation (ID) only mildly improves exports and it can significantly harm firms’ non‐price competitiveness factors. This raises the question of whether ID entered the bail‐out conditionality only for economic reasons or also with political motivations. We argue that the economic crisis reignited a trust‐confidence crisis between the core and periphery countries, with the latter emerging as non‐credible reformers. While some adjustment to regain competitiveness was necessary in the periphery, it is hard to conceive that the policy mix adopted was the outcome of taking all costs into account. Political reasons appear to have exerted a notable influence and this may undermine the effectiveness, ownership and sustainability of present and future reforms.

Policy implications

  • Policy responses to recover competitiveness in the euro area by recommending the periphery engage in strong forms of internal devaluation are suggestive of political motivations by the core. Crisis resolution plans involving the core‐periphery divide will be unavoidably politically charged, but crisis management should put careful analysis ahead of ideology and combine internal devaluation with the appropriate fiscal and monetary policies.
  • The economic crisis that started in 2008 reignited another crisis: a core‐periphery trust‐confidence crisis, as the periphery governments emerged from the crisis as non‐credible reformers during the first years of the EMU. Any successful attempt to reform the economic governance of the EA and the EU requires that the periphery first improves their credibility by adopting genuine reforms.
  • Under this proviso, a smart policy to facilitate the economic convergence across the EA and the EU and to sustain political stability in the region would be to emphasise the importance of structural reforms aimed not only at moderating wages, but also enhancing ‘non‐price/cost’ factors, such as investing in innovation capacity and the education system, and improving the quality of institutions.


Photo by Pixabay from Pexels