["The only mechanism through which troubled countries inside the EMU have been able to restore economic growth is so-called internal devaluation, i.e. cost-cutting in both the private and public sectors by shedding labour and reducing wages. Internal devaluation has resulted in high unemployment, falling household incomes and rising poverty – literally misery for tens of millions of people. Moreover, it is a recipe that cannot be applied in many countries at the same time because it undermines overall demand. If many countries cut their wages and lay off workers, nobody wins in terms of relative competitiveness but everybody loses."]
In fact, it's even worse. Since the core countries also run low inflation policies, the troubled countries only recourse, internal devaluation, forces them to run highly deflationary policies which not only kills demand, it also kills nominal growth.
Even low nominal growth (let alone zero, or even negative nominal growth) automatically increases the debt burden, this is the so called denominator effect.
Debt/GDP increases where debt increases by interest payments and deficits while the austerity and internal devaluation policies keep GDP growth minimal or even negative.
This is why Italy's debt/GDP has increased from 118% of GDP to over 130% of GDP in just a couple of years, despite (or better, because of) heroic austerity measures.
The demand destruction also produces long-term negative effects to the productive capacity of the economy (the hysteresis effect):
- Low demand reduces investment in productive capacity, reducing the future production capacity of the economy
- Low investment also slows down the adoption of new technology, reducing future productivity growth
- Low investment reduces the demand for labor, making a bigger part of labor supply economically obsolete through long-term unemployment.
We already argued this was a problem even in the US more than a year ago, but it recently turned out these effects are even bigger then we thought.