Domestic or Systemic factors: Competing Explanations of the Eurozone Sovereign Debt Crisis.

The large debt imbalances that emerged in the Eurozone during the run-up to its sovereign debt crisis are commonly attributed to disparate “supply-side” conditions in the member states, in particular those conditions that impinge on unit labor costs.  Structural reform, in particular of labor markets, has therefore been at the forefront of the EU’s response, along with budgetary austerity measures. Focusing on Spain, Italy, Portugal and Ireland, this paper argues that there is little real evidence that labor market institutions (wage bargaining and employment protection systems) played a critical role in the “debtor” states rising current account deficits during the run-up to the crisis.  Systemic forces in the Eurozone, involving capital flows played the driving role, subjecting the debtor states to a demand-shock that had little to do with domestic institutions but was aggravated by the macro-institutional design of the Eurozone.  Without institutional reform of the Eurozone that can counteract the type of cross-border financial dynamic that took hold in the period 1996 – 2007, the currency area is likely to see future iterations of the same phenomenon.