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Populism in the European Periphery: the Great

Financial Crisis and the Politics of Austerity and

Currency Devaluation

MSc Political Science: Political Economy

MSc Thesis Research Project: The new protectionism and the end of multilateral cooperation

Author: A. J. Tiller

Student number: 10678344 Date: 26-06-2020

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Table of content

Abstract 5

List of figures and tables 6

List of abbreviations 7

Chapter 1: Research Design 8

1.1 intro 8

1.2 literature review 10

1.2.1 Rules of the Game 10

1.2.2 Supply-side of Populism 11

1.2.3 Demand-side of Populism 13

1.3 Theoretical Framework 15

1.3.1 BoP Crises & Mitigation Strategies 15

1.3.2 Asymmetrical Distributional Effects of Internal & External Devaluation 17

1.3.3 Demand-side of Populism: Economic Anxiety 22

1.3.4 Supply-side of Populism: Narratives and Policy 24

1.3.5 The Politics & Internal and External Devaluation 27

1.4 Hypotheses 28

1.5 Research Design 28

1.6 Sample & Case Selection 29

1.7 Data 30

Chapter 2: Supply-side of Populism: Narrative 31

2.1 Societal Cleavage 31

2.2 The ‘People’ & the ‘Elite’ 34

2.3 Subquestion 1 41

Chapter 3: Causes & Asymmetrical Effects of BoP Adjustment Strategies 42

3.1 Prelude 42

3.1.1 Two Growth Models 42

3.1.2 Current Account Deficit 43

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3.1.4 Nominal Exchange Rate 45 3.1.5 Household Debt, Foreign Currency Debt, and Mortgages 46

3.2 BoP Adjustment Strategies 49

3.2.1 Fiscal Consolidation 49 3.2.2 Currency Devaluation 50 3.3. Asymmetrical Effects 52 3.3.1 Internal Devaluation 52 3.3.2 External Devaluation 55 3.4 Subquestion 2 63

Chapter 4: Supply-side of Populism: Economic Policy 64

4.1 Quantitative Analysis: State-interventionism, Regressive & Progressive Policies 64 4.2 Qualitative Analysis: Debt Relief for Middle Income Households 68

4.3 Subquestion 3 71

Chapter 5: Conclusion 72

5.1 Summary (1): Research Design 73

5.2 Summary (2): Empirical Results 74

5.3 Limits to Research 75

5.4 Policy Implications & Suggestions for Further Research 76

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Abstract

This research explores the surge in populism during 2008-2015 in four European periphery countries: Iceland, Ireland, Hungary, and Greece. Firstly, this research argues that the Progressive Party, Sinn Fein, Fidesz, and Syriza exploited an economic cleavage and envisioned an antagonistic struggle between ‘debtors’ and ‘creditors’. Secondly, this research argues that balance of payment crises and subsequent adjustment strategies asymmetrically affected particular constituencies. Internal devaluation strategies in Ireland and Greece disproportionately affected poorer households through fiscal consolidation. External devaluation strategies in Iceland and Hungary asymmetrically affected middle income households through currency depreciation in the presence of household debt denominated in foreign currency. Thirdly, this research argues that these asymmetric economic shocks incentivized the selected populist parties to offer differentiating economic policies. Sinn Fein and Syriza offered progressive economic policies to cater to poorer households disproportionately affected by fiscal consolidation, while the Progressive Party and Fidesz offered regressive economic policies to cater to middle income households.

Keywords

Economic populism; European periphery; fiscal consolidation; currency depreciation; Great Financial Crisis

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Figures & Tables

Table 1: The politics of internal and external devaluation 28

Table 2: Primary Cleavage 34

Table 3: Debtors and Creditors in the Periphery 40

Table 4: Current Account Balance during 2005-2007 44

Table 5: Inequality and poverty in Greece 55

Table 6: Inequality and poverty in Ireland 56

Table 7: Percentage of Icelandic households in negative equity 57 Table 8: Distribution of FX-denominated mortgages in Hungary 59

Table 9: Debt service to net income ratio in Hungary 59

Table 10: Inequality & poverty in Iceland 61

Table 11: Inequality & poverty in Hungary 62

Table 12: State-interventionist preference 66

Table 13: Redistribution 66

Figure 1: Cultural and Economic Salience 32

Figure 2: Average yearly increase of the REER in all countries 45 Figure 3: Appreciation of domestic currency against major funding currencies 46 Figure 4: Average yearly increase in household debt to GDP during 2003-2008 47 Figure 5: Total household debt vulnerable to exchange rate depreciation in 2008 48 Figure 6: Fiscal consolidation as a percentage of GDP during 2009-2012 50

Figure 7: Depreciation during 2008-2009 51

Figure 8: Households with Total Debt Service Ratio by Income 56 Figure 9: Households with Total Debt Service Ratio by Currency Denomination 56 Figure 10: Distribution of household debt per income quintile in Iceland & Hungary 57

Figure 11: Homeowners in Negative Housing Equity 58

Figure 12: Homeowners in Financial Distress and Negative Housing Equity by Income 58

Figure 13: Economic orthodoxy 67

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List of abbreviations

AE Advanced Economies

AMR Alert Mechanism Report BoP Balance of Payment ECB European Central Bank

EC European Commission

EFSM European Financial Stability Mechanism EFSF European Financial Stability Facility

EM Emerging Market

EMU European Monetary Union

EU European Union

EZ Eurozone

FDI Foreign Direct Investment GDP Gross Domestic Product GFC Great Financial Crisis GVC Global Value Chain

IMF International Monetary Fund

ISB Islands Sedla Banki (Central Bank of Iceland) MNB Magyar Nemzeti Bank (Central Bank of Hungary) OCA Optimum Currency Area

REER Real Effective Exchange Rate SNB Swiss National Bank

SOE State Owned Enterprise SGP Stability and Growth Pact SNB Swiss National Bank

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Chapter 1: Research Design

1.1 Introduction

The election of Trump in the US and the victorious leave vote in the UK represented a climax in the departure of established party politics for the Western world. From 2016 onwards, populists were in charge of the executive branch of the world’s largest economy, while Brexit constitutes the largest overt challenge to the post-war European project (Norrlof, 2018). Nonetheless, aside from the UK (in which Brexit received more than 50% of the vote) and Italy, populist have had relatively little success in reaching the presidential palace, prime ministers’ office, or participating in a coalition government inside the Western European core. However, a closer look at Europe’s periphery reveals a surge in populism in the wake of the GFC. In Iceland, the Progressive Party captured 24.4 percent of the vote in 2013 and entered government with a platform of economic nationalism and debt relief for the middle class (Bergmann, 2014). In Ireland, Sinn Fein increased its vote share in every consecutive national election post-GFC on a nationalist progressive platform (O’Malley & Fitzgibbon, 2015). Fidesz unseated the ruling Hungarian Socialist Party in a landslide victory in 2010, garnering 52.7 percent of the vote on an economic nationalist platform (Johnson & Barnes, 2015). In 2015, political upstart Syriza unseated the ruling centrist government and won 36.8 percent of the vote in Greece on an anti-austerity platform (Stavrakakis & Katsambekis, 2014).

Populism in all four case countries is defined as either economic or cultural (Kyle & Gulchin, 2018). However, the two main theories concerning populism leave considerable gaps in explaining the surge in the European periphery. The ‘losers of globalization’ theory, primarily focused on trade, cannot properly explain populism in Iceland, Ireland, Hungary and Greece. Rightwing populism in Hungary is linked to cultural factors, while leftwing populism in Ireland and Greece is linked to non trade-related socio-economic factors (Adam, 2019) (O’Malley & Fitzgibbon, 2015) (Pappas & Aslanidis, 2015). In addition, countries such as Hungary have benefitted from globalization in the form of increased FDI and increased manufacturing capacity (World Bank, 2020). Moreover, the ‘cultural backlash’ cannot explain leftwing populism in Greece and Ireland, despite a large stock of migrants (Manow, 2018). Furthermore, in countries with rightwing populism such as Hungary and Iceland, the populist surge predates the refugee crisis (Adam, 2019) (Bergmann, 2015) (Mudde & Kaltwasser, 2017).

This research attempts to explain the surge in populism in all four countries by examining the asymmetric affects of BoP crises and subsequent mitigation strategies in the wake of the GFC on specific constituencies: the politics of external and internal devaluation. It is the finding of this

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research that all selected populist parties exploit an economic cleavage and envision an antagonistic struggle between debtors and creditors in the wake of the GFC. Furthermore, this research documents that poorer households in Ireland and Greece were disproportionately affected by fiscal consolidation. In Iceland and Hungary, the middle class was disproportionately affected by a balance sheet crisis, instigated by a sharp depreciation of the national currency. Finally, it is the finding of this research that Sinn Fein and Syriza offered progressive state-interventionist policies to cater to poorer households, while the Progressive Party and Fidesz offered regressive state-interventionist policies to cater to middle income households.

This research describes a political backlash against the effects of austerity and currency depreciation in four periphery countries. This is especially relevant, given the current ‘Corona Crisis’. Southern Europe has been disproportionately affected by the direct (amount of corona cases and deaths) and indirect (economic fallout) effects of the pandemic. One could envision the same dynamic that played out post-GFC: Southern states apply for external loans in return for stringent austerity measures. Moreover, the ‘Corona Crisis’ has caused an unprecedented capital flow reversal in various EMs, ranging from Turkey to South Africa. This has resulted in sharp depreciations of EM currencies, while the US dollar has surged due to its safe haven function (IMF, 2020). A large amount of EMs, including Turkey, Chile, and Indonesia, have a significant stock of foreign currency-denominated household debt (IMF, 2020). A prolonged currency depreciation could result the same balance sheet stress described in this research.

The core of this research revolves around the relation between the GFC and the surge of populism in four European periphery countries: Iceland, Ireland, Hungary, and Greece. The populist parties selected are the Progressive Party (Iceland), Sinn Fein (Ireland), Fidesz (Hungary), and Syriza (Greece). The following research question has been formulated: “How has the GFC affected populism in Iceland, Ireland, Hungary and Greece during 2008-2015?”. Three subquestions have been formulated, around which three corresponding chapters have been built:

1. How is populism defined by the selected populist parties in Iceland, Ireland, Hungary, and Greece during 2008-2015?

2. What are the causes and asymmetric effects of the specific BoP adjustment strategies utilized in Iceland, Ireland, Hungary, and Greece during 2008-2015?

3. How is economic policy defined by the selected populist parties in Iceland, Ireland, Hungary, and Greece during 2008-2015?

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Subquestion 1 deals with two factors: the exploited societal cleavage and the antagonistic relationship between the ‘people’ and the ‘elite’, formulated by the selected populist parties during the research timeframe. Subquestion 2 explores three factors: the causes of macroeconomic imbalances, the specific BoP strategies utilized in all four countries, and the asymmetric affect on different constituencies. Subquestion 3 deals with two factors: the preference for state-interventionist policies and a preference for regressive or progressive policies. The summarized answers to the three subquestions form a comprehensive answer to the main research question.

1.2 Literature Review

Research points to three factors to explain the rise of populism. Firstly, the institutional characteristics of the political system. Simply said, the institutional rules of the game can determine the margin of success of a populist party. Secondly, the supply-side of populism. This category entails that populist parties and leaders strategically position themselves within the party system, utilizing existing cleavages in society. Thirdly, the demand-side of populism. This category focuses on the changing attitudes of voters, primarily driven by economic or cultural grievances (Inglehart & Norris, 2016: 9) (Rodrik, 2018).

1.2.1 Rules of the Game

Norris (2005) makes a distinction between the nomination stage (rules that determine party registration, and ballet access), the campaign stage (access to political broadcasts, state funds, and subsidies) and the election stage (type of electoral system). Evidence suggests that laws governing ballot access and party registration can severely hinder or galvanize populist parties. European examples includes Germany and Spain: constitutional provisions and court decisions prohibit extremists or anti-democratic political parties that are linked to violence or terrorism from participating in elections (Fennema, 2000) (Norris, 2005). Other regimes severely limit the success margin of challenger parties by restricting the ballot access and utilizing campaign rules to ensure the status quo is maintained. Examples include Belarus, in which challenger parties do not have the same access to state funds and state media platforms (Korosteleva et al., 2004). The type of electoral system is crucial for the margin of success of challenger parties. Evidence suggests challenger parties are more successful in a proportional representative system (in which the party is awarded a correlated amount of seats corresponding to its total share of votes), coupled with low legal thresholds (the minimum amount of votes a party must receive to get a seat in parliament) (Norris, 2005: 124). The Dutch electoral system is an example of the above, allowing small political

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parties to enter parliament with relative ease (Cox, 2006). The electoral performance of UKIP within the UK political system is an illustrative example of the opposite. Within the ‘first past the post’ system, UKIP won one seat in the House of Commons in 2015. In this particular election, UKIP got 12.6% of the total vote share in the UK, but within the British electoral system, UKIP only received a little over 0.15% of the number of seats (Schmitt et al., 2017).

1.2.2 Supply-Side of Populism

Hooghe and Marks (2009) state an issue does not get politicized due to its intrinsic importance but due to the active involvement of a political actor. This is the essence of the supply-side of populism. Assuming politicians are rational actors, they will seek to politicize an issue if the salience of this particular issue is expected to create an electoral advantage (Hooghe & Marks, 2009: 19) (Inglehart & Norris, 2016: 9). Hooghe and Marks (2009) list three limitations for politicization. Firstly, the internal cohesion of a party. Party leaders are more reluctant to raise an issue if the party is internally divided, as evidence suggests that weak internal cohesion is the most frequent cause of party dissolution. Secondly, the ideological character of a party. Political parties are organizations with enduring engagements and members. These commitments will constrain renewed strategical positioning. Furthermore, parties use ideological identity to attract voters. Constant repositioning will depress voter turnout. Thirdly, the party’s position in comparison to the wider political party system. A particular issue may be underrepresented by mainstream parties (Hooghe & Marks, 2009: 19). Populism revolving around the push against neoliberal economic policies and liberal immigration policies is therefore to be expected, as mainstream political parties have largely converged on both issues, relinquishing strategic space for upstart populist parties (Hopkin & Blyth, 2019). Rodrik (2018) adds that elections are contests about which issue is perceived as most salient. The author states the ‘host’ ideology of populism is determined by the narrative created by populists, utilizing existing societal cleavages. Populists use economic cleavages (inequality) and cultural cleavages (ethnic or religious conflicts) to shape a narrative: “here is what is happening, this is why, and these are the people who are doing it to you” (Rodrik, 2018: 23).

1.2.3 Demand-Side of Populism

Research points to two major demand-factors that contribute to the surge in populism: a backlash of ‘losers of globalization’ and a ‘culture backlash’, instigated by a threatened cultural majority (Rodrik, 2018). However, both approaches leave considerable gaps in explaining populism in Europe’s periphery.

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Losers of Globalization


The ‘losers of globalization’ theory points to a strategic shift in electoral behavior, driven by deep-seated changes to society and the workforce in post-industrial economies. The theory alleges this is caused by the rise of the knowledge industry, mirrored by the collapse in manufacturing and amplified by technological innovation and globalization, defined as the free movement goods, services, capital and people. This is compounded by the effect of a macroeconomic regime that is characterized by smaller role for government and labor, and a bigger role for capital (Inglehart & Norris, 2016: 2). Two fundamental gaps of this economic approach to populism hinder its explanatory ability in the European periphery: the emphasis on trade and the emphasis on Western-core constituencies.

The distributional effects of trade were documented early on through the Stolper-Samuelson theory (Stolper & Samuelson, 1941). This theory (and later additions) pointed to the inherent contradiction of trade liberalization: overall gains to the economy are mirrored by localized distributional challenges. These often affect specific constituencies (Rodrik, 2018: 15). Ample studies have shown the distributional impacts of trade liberalization on particular constituencies in the West. Examples include the impact on US labor constituencies due to NAFTA and China’s entry into the WTO (Hakobyan & McLaren, 2016) (Autor, Dorn & Hanson, 2013). In addition, research has directly connected the detrimental distributional effects of trade to specific voting behavior. Examples include decreased support for political incumbents in US counties with a high degree of employment in low-skilled manufacturing and increased electoral support for ‘Leave’ in the Brexit referendum in areas disproportionately affected by the Chinese import shock (Jensen, Quinn & Weymouth, 2017) (Colatone & Stanig, 2018). The theoretical and empirical research listed above finds a correlation between trade (independent variable) and voting behavior (dependent variable) in post-industrial societies like the UK and US that have seen their manufacturing industry gutted by imports from developing countries.

However, this research seems theoretically less applicable in explaining voting behavior in non-Western regions containing the supposed ‘winners’ of globalization such as Hungary that have generally seen their economic complexity rise (measured by the complexity of the products they export), have retained a high level of added value of manufacturing to GDP, and have retained a high level of employment in the industrial sector (World Bank, 2020) (Atlas of Economic Complexity, 2020). Moreover, scarcely little research has been devoted to the link between trade and a rise of populism in European periphery such as Iceland, Hungary, Ireland, and Greece. In Hungary, populism has been linked to cultural and ethnic issues, while populism in Greece and

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Ireland has been linked to austerity (Adam, 2019) (O’Malley & Fitzgibbon, 2015) (Pappas & Aslanidis, 2015).

There is ample academic evidence that suggests that the core argument of the political economy of trade still holds true in the European periphery: economic liberalization creates negative market externalities that subsequently can create political discontent. However, research does not point to the flow of manufactured goods that creates detrimental distributional effects resulting in high political turnover in the European periphery, but to the flow (or sudden stop) of capital that leads to macroeconomic shocks and subsequent distributional effects on various constituencies (Mudde & Kaltwasser, 2017) (Kose et al, 2020). Moreover, the lack of established institutions that deal with the negative externalities of financial liberalization in developing countries has been linked to increased inequality and increased macroeconomic instability (Cassimon et al, 2010). Furthermore, Broner & Ventura (2016) claim financial globalization emphasizes the weakness of domestic institutions and debt-enforcement mechanisms and causes a paradoxical uphill flow of capital (capital flows from capital-poor regions to capital-rich regions in times of macroeconomic instability) that inhibits developing nations from financing their budget and current account deficits. Furthermore, the GFC has shown that developed countries are not immune to these causal phenomena (Kose et al, 2020). In addition, there is a strong empirical correlation between financial openness and financial crises (Reinhart & Rogoff, 2009) (Kose et al, 2020). Moreover, Furceri et al (2017) link financial openness to increased inequality, as they observe a statistically significant decline of the income share of labor and an increase in the income share of the top 1%, top 5% and top 10%.

Culture Backlash

The ‘culture backlash’ theory explains electoral support for populists in Western societies as a reaction to cultural and social change. Due to high levels of existential security, post-war generations in the West developed post-materialist values. Society moved in a more progressive direction via new political parties such as green parties and through progressive movements campaigning for equality of minorities and environmentalism (Inglehart & Norris, 2016: 3). Furthermore, increased support for multiculturalism and cosmopolitanism were mirrored by increased immigration into Western Europe in the form of guest workers, migrants from former colonies, and asylum seekers. The failure of mainstream parties to curb migration numbers and protect the national identity increases support for populist parties that claim to protect an ethnic and cultural ‘silent majority’ against non-traditional values and outsiders (Inglehart & Norris, 2016: 15).

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The main demographic deemed most susceptible to this demand-side of populism is the former culturally and ethnically dominant group: older, white, and less-educated men (Inglehart & Norris, 2016: 16).

Like the economic argument, the cultural approach emphasizes a uniquely Western inter-generational shift and subsequent conflict. A variant of this approach seems to have the most explanatory ability in Eastern Europe, where rightwing populist parties have responded to the electoral strength of ethnic minority parties, essentially describing a culture backlash by the ethnic majority (Bustikova, 2014: 20). Moreover, populist parties in ethnically homogenous countries like Hungary and Poland are framing the threat to national identity around cosmopolitan values and the threat of immigrants (Bustikova & Kitschelt, 2009: 471). However, these approach fails to explain populism in other European periphery countries. Greece and Ireland have a high level of ethnic diversity and a large international migrant stock but did not have rightwing populist reaction post-GFC, as compared to Hungary (Manow, 2018). Moreover, Hungary has a significantly lower stock of international migrants (4.4% as compared to Ireland’s 15.8% in 2010) (World Bank, 2020). In addition, the migrant crisis, which is linked to the radicalization of rightwing populist parties such as the German AfD, occurred in 2015 (Dilling, 2018). This predates the rightwing populist surge post-GFC in periphery countries like Hungary (2010 and 2014) and Iceland (2009 and 2013) (Adam, 2019) (Bergmann, 2015).

Cultural and ethnic populism is associated with increased nationalism. However, cosmopolitan values and immigration do not explain the particular kind of nationalism expressed by leftwing and rightwing populist parties during 2008-2015. Leftwing and rightwing populist parties differ significantly in their stance on immigration and national sovereignty (Mudde & Kaltwasser, 2017). However, sovereignty expressed in financial terms featured prominently in the manifestos of Sinn Fein (Ireland), Syriza (Greece), Fidesz (Hungary) and the Progressive Party (Iceland) during the research timeframe (Sinn Fein, 2011) (Syriza, 2015) (Adam, 2019) (Bergmann, 2015). The surge in nationalism, framed in financial terms, correlates with countries that have received an international bailout by international creditors. Post-GFC, Financial support in the European periphery has been explicitly linked to conditionality. In return for much needed financial assistance, Iceland, Ireland, Hungary, and Greece submitted to a significant reduction in financial sovereignty (Tooze, 2018).

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1.3 Theoretical Framework

This section forms the theoretical framework that is needed to expose the causal mechanisms that link financial crises and the response to said crises to the populist surge in the case countries during the research timeframe. The theoretical framework consists of five sections. Section one describes the theoretical characteristics of a BoP crisis and the two main policy pathways to correct the macroeconomic imbalance, namely internal devaluation and external devaluation. Section two documents the asymmetric distributional effects of internal and external devaluation on certain constituencies. Section three details the demand-side of populism: economic anxiety caused by internal and external devaluation. Section four details the supply-side of populism: populist parties react to economic anxiety expressed by voters and strategically offer a narrative and state-interventionist policies to protect vulnerable constituencies. Section five summarizes all sections presents a model to explain the narrative and policies offered by the selected populist parties in all case countries during the research timeframe: the politics of internal and external devaluation.

1.3.1 BoP Crises and Mitigation Strategies

The BoP is a unit of account that measures all economic transactions between residents of a country and the rest of the world economy. The BoP includes three parts: the current account balance, the financial account balance, and the official settlement balance. The first balance measures the net flow of goods and services between the nation in question and the outside world. The second balance measures the net flow of assets between the nation in question and the outside world. These include equities, bonds, and loans. The final balance registers the change in a country’s official foreign reserves. The sum of all balances must be zero. The two most important balances in economic analyses are the current account balance and the financial account balance. In practice, both balances need to balance to zero (Cecchetti & Schoenholtz, 2018).

Two groups of nations dominate BoP analyses: countries that exhibit current account surpluses and corresponding capital account deficits and countries that show a current account deficit and a corresponding capital account surplus (Cecchetti & Schoenholtz, 2018). A current account deficit typically implies a country is importing more than its exporting in terms of goods and services. Simply said, the country in question consumes more that it produces. In addition, domestic savings are smaller than domestic investments. The capital account in this country typically registers a surplus, as foreign capital flows into the country to finance the difference between imports-exports and investments-savings (Walters, 2013: 4). Countries which import less than they export and save more than they invest have a current account surplus and a financial

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account deficit. This entails capital is flowing out the country (Walters, 2013: 4). The core of this thesis examines countries with a structural current account deficit. If foreign capital flows seize, the difference between imports and exports and savings and investments can no longer be financed. Since the current account balance and the financial account balance need to sum to zero, a sudden stop of capital flows must be equaled by a similar drop in imports of goods and services, since the excess consumption of the country in question is no longer financed by capital from abroad. Theses ‘sudden stops’ of capital flows negatively affect the financial and real economy of the country in question. Financially, the currency depreciates, foreign exchange reserves decline, and asset prices fall (ranging from house prices to equities). Non-financially, GDP falls by roughly 4% year on year during the first four quarters post-BoP crisis, while investments disproportionately decline in relation to GDP (Eichengreen & Gupta, 2016: 6).

A ‘sudden stop’ of capital indicates a country’s macroeconomic policy is no longer sustainable. Governments have two policy choices to address the ‘sudden stop’: finance the shortage of capital with foreign currency reserves or structurally adjust the economy to rebalance the current account balance and the financial account balance. The former is a solution to a temporary disturbance in the current account balance, caused by sudden change in the price of a vital good imported or exported, a natural disaster that temporary blocks exports, or a temporary dip in international capital flows. A prerequisite for a targeted sterilized foreign reserve sale by central banks to offsets pressure on the domestic currency is sufficient foreign currency reserves or access to international institutions that can provide the necessary funds to finance the deficits (Walters, 2013: 5).

Overvalued exchange rates, structural budget deficits, an uncompetitive export sector, and excess consumer demand driven by credit cannot be solved by temporary selling foreign currency reserves. To decrease the yearly need for foreign financing of excess consumption, two mitigation strategies can be utilized: internal and external devaluation. Internal devaluation entails tighter fiscal policies and structural reforms that aim to increase the domestic competitiveness of the economy. Lower government spending and higher taxes result in a lower demand for imports. As a result a lower amount of foreign capital is needed to finance the difference between consumption and production. Moreover, structural reforms such as more flexible labor markets or wage moderation increase the productivity of domestic firms in comparison to foreign competitors, potentially raising exports and decreasing imports (Walters, 2013: 6). The aim of an external devaluation strategy is to increase the competitiveness of the domestic economy in comparison to the outside world through a currency depreciation. The currency depreciation reduces the

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purchasing power of residents, while it increases the purchasing power of outsiders. This results in lower consumption of internationally tradable goods by residents and higher demand for (domestically produced) tradable goods by foreigners (Walters, 2013: 7). The choice between internal and external devaluation is limited by economic and political factors. Labor market flexibility, openness to trade, and GDP size influence the degree to which external or internal devaluation can be effectively implemented. OCA theory states internal adjustment is less costly for small, open economies while external adjustment costs are lower for large, less open economies (Taylor, 1993) (Frankel, 1999). Moreover, political commitments, such as (desired) membership of a currency area, predetermine the mitigation strategy. EZ member states do not have the agency to unilaterally devalue their currency (short of leaving the currency area), which leaves internal devaluations as the only mitigation strategy to deal with structural current account deficits (Cecchetti & Schoenholtz, 2018).

1.3.2 Asymmetric Distributional Effects of Internal and External Devaluation

Internal and external devaluation are both associated with negative distributional effects (Walters, 2013). However, the economic damage of both strategies affects different constituencies asymmetrically. Internal devaluation, primarily consisting of fiscal tightening and structural reforms, disproportionately hits the bottom of the income distribution (Woo et al, 2013) (Agnello & Sousa, 2014) (Ball et al, 2013). External devaluation, in the presence of large private debts denominated in foreign currency, disproportionately hits the middle and upper-middle class (Walters, 2013).

Internal devaluation

Internal devaluation consists of tax increases, spending cuts, and structural reforms. The asymmetric distributional effects of internal devaluation work through two channels: the direct and indirect channel. The direct channel focuses on specific tax increases, spending cuts, and structural reforms while the indirect channel focuses on the regressive effects of a drop in aggregate demand.

The direct distributional effects of fiscal consolidation are a result of the specific nature of the tax increases and cuts in public spending. In general, if tax increases are administered progressively, their effect ought to compress inequality (Ball et al, 2013). Increasing the rate of the top income tax bracket while lowering the lowest tax bracket or keeping the lowest tax bracket unchanged can be defined as progressive and reduces inequality, all other things equal. Naturally, this progressive effect can be diminished by administering tax increases regressively, such as

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lowering the top bracket while raising the lowest bracket by introducing a flat tax (Woo et al, 2013: 13). Moreover, progressive taxation can be offset by naturally regressive taxes, such as sales taxes and VAT. Sales taxes and VAT are indirect taxes and are naturally regressive because households in the bottom of the income distribution have a higher propensity consume more of their disposable income, as compared to the top of the income distribution (Ball et al, 2013).

While tax increases can be administered progressively, spending cuts are generally associated with higher income inequality (Woo et al, 2013). Households in the bottom of the income distribution disproportionately rely on public schools, public healthcare, public pensions and receive more social transfers (Klein & Winkler, 2019: 90). Moreover, the receding state is associated with higher structural inequalities, as low income households cannot easily replace the public goods with more expensive private goods. Lower quantity and quality public education and healthcare result in lower human capital in low income households, which is associated with lower expected income (Heimberger, 2017). Privatization can also have detrimental effects for poor households. The drive to reduce the government deficit can result in the sale of SOEs. Privatizations of SOEs like utilities or social housing estates can result in higher prices for utilities and rent. As poor households spend more of their disposable income on utilities and rent, they absorb a disproportionate amount of this fiscal consolidation (Oxfam, 2013). However, some cuts in public expenditures are naturally progressive, such as reducing public sector wages or dismissals. Since public sector workers are generally located higher up income distribution, wage cuts or dismissals have a progressive effect (Matsaganis & Leventi, 2014). Other direct distributional effects include structural reforms. Labor market liberalizations are associated with internal devaluation and are meant to increase competitiveness by lowering costs for companies. However, labor market liberalization measures such as a lower minimum wage or an undermining of collective bargaining are also associated with lower wages and less job security (Walters, 2013: 46). This disproportionately affects poor households, as they primarily rely on wage income (Klein & Winkler, 2019: 90).

The composition of fiscal consolidation determines what part of the income distribution is directly affected by higher taxes or lower transfers. Subsequently, fiscal consolidation can be designed to work progressively or regressively. However, fiscal consolidation also increases inequality between rich and poor households indirectly through lower aggregate demand. Fiscal consolidation has been extensively linked to decreased economic growth. Increased taxes and decreased government spending lowers aggregate demand, as firms and households reduce

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spending and investment in response to higher taxes and lower transfers and spending. (Matsaganis & Leventi, 2014) (Ball et al, 2013) (Klein & Winkler, 2019) (Woo et al, 2013).

Crucial is the fiscal multiplier, which measures the total output lost due to fiscal consolidation. A fiscal multiplier of 0.5 indicates that for every 10$ billion of fiscal consolidation, only 5$ billion will be subtracted from aggregate demand. Conversely, a fiscal multiplier of 1.5 indicates that for every 10$ billion of fiscal consolidation, 15$ billion is subtracted from aggregate demand. A fiscal multiplier below 1 indicates that fiscal consolidation can be a strategy to lower the government deficit and debt with a relatively smaller damage to aggregate demand. A fiscal multiplier above 1 indicates the cure to treat the disease is worse than the disease. If aggregate demand (GDP) falls more than the amount of fiscal consolidation, public debt will continue to increase arithmetically, as the denominator (GDP) falls faster than the numerator (public debt) (Blyth, 2013). In the wake of the GFC, a plethora of research has pointed to underestimated fiscal multipliers. In the EZ, fiscal multipliers were wrongly assumed to be 0.5, indicating fiscal consolidation is a rational strategy of decreasing government deficits and debt while leaving enough space for aggregate demand to grow (Blanchard & Leigh, 2013). However, updated estimates put the fiscal multiplier in some EZ states as high as 2.1: for every 10$ billion of fiscal consolidation, 21$ billion was subtracted from GDP (Heimberger, 2017). Numerous factors in the EZ increased the fiscal multiplier. Fiscal consolidation undertaken during recessions increases the natural multiplier by 0.6-0.8 (Gechert & Rannenberg, 2014). Furthermore, large fiscal consolidations, defined as larger than 1.5 percent of GDP, are associated with higher fiscal multipliers (Woo et al, 2013). In addition, fiscal consolidation during rapid private sector deleveraging due to an asset price bubble result in a multiplier in excess of 1 (Woo et al, 2013). Moreover, fiscal consolidation collectively executed increases the fiscal multiplier, as a drop in aggregate demand in key trading parters reduces the ability to increase aggregate demand through the export channel (Heimberger, 2017) (Dell’Erba et al, 2018). The effect of recessions on employment is a crucial channel through which inequality is increased, as loss of employment is associated with a drop in income. Subsequently, the distributional effects of economic downturns are felt hardest at the bottom of the income distribution. These groups generally are associated with lower levels of skills and education and enjoy less legal protection on the labor market, which makes them disproportionately vulnerable for dismissal and uncompetitive compared to other potential employees (Carpenter & Rodgers, 2004).

In sum, internal devaluation disproportionately affects households at the bottom of the income distribution. Tax increases can be designed to work progressively. However, this can be

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offset by increasing (naturally) regressive taxes. Moreover, internal devaluation is associated with lower aggregate demand, which disproportionately hurts households at the bottom of the income distribution.

External devaluation

External devaluation causes asymmetric distributional effects through two channels: the direct channel and the indirect channel. The direct channel includes the loss of purchasing power and balance sheet effects. The indirect channel includes the indirect effect on aggregate demand.

A depreciation of the currency increases the price of imported goods and thus affects the purchasing power of local households. Purchasing power is especially affected if households consume a high amount of tradable goods that cannot easily be substituted by domestically produced goods (Baker, 2005). Another direct effect of depreciation is the effect on the balance sheets of households. Balance sheets are statements that list an entity’s assets and liabilities (Bruno et al, 2018). In the case of households, a mortgage would be a liability, while the property would be an asset. In a closed economy, all assets would be denominated in the same currency. However, due the systematic lowering of capital barriers in EMs and AEs, foreign currency denominated assets and liabilities have become common (Kose et al, 2020). Economic actors are incentivized to engage in foreign currency-denominated liabilities if domestic financial institutions cannot satisfy total loan demand. This is a phenomenon often observed in EMs, as these countries have high capital needs but underdeveloped capital markets and low saving rates (Kose et al, 2020). Moreover, foreign currency-denominated loans can be economically attractive due to lower interest rates, as compared to loans denominated in local currency.

During a currency depreciation, the relative value of foreign currency-denominated liabilities rises. If the appreciating value of the foreign currency-denominated liabilities is not compensated by increasing revenue from foreign currency assets it will diminish the ability to service the debt and pay the principal (Bruno et al, 2018). A balance sheet crisis causes asymmetric distributional effects because liabilities are asymmetrically distributed throughout the economy. Most debt is held by households near the top of the income distribution, as a great majority of household debt finances assets (primarily residential property). These assets are concentrated near the top of the income distribution (Mason, 2018: 4). Furthermore, the middle and upper-middle class have higher debts due to better access to financial products. Firstly, these income groups can pledge more collateral due to higher quality and quantity revenue streams (higher income based on long term contracts) (Mason, 2018: 4). Secondly, upper and middle class households have more

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savings and other starting capital as compared to working class households, which improves their ability to absorb more debt (Rötheli, 2010: 5). Thirdly, this dynamic reinforces itself: higher quality and quantity collateral and income reduces financing needs, which results in the satisfactory payment of the principal, which leads to satisfactory credit histories, which result in lower financing needs for future debt (Mason, 2018: 4). Fourthly, low income households disproportionately suffer from financial illiteracy, which decreases financial inclusion (Sahay et al, 2015). Lack of awareness and financial literacy prevents low income households from using suitable financial products (Zottel et al, 2014). Moreover, financial illiteracy causes higher non-performing loans in this category, as borrowers do not fully understand the financial risk of the particular financial product. This in turn results in a risk premium on financial products aimed at poor households, which further inhibits their access to affordable financial products (Heukelom & Sent, 2010: 29).

An external devaluation strategy can also cause indirect asymmetric distributional effects through lower or higher aggregate demand and supply. The structural characteristics of a particular country determine if the overall effect of devaluation is positive or negative. General economic theory states depreciations can result in economic expansions, because the lower exchange rate makes exports more competitive, which would increase aggregate demand through spillover effects (Krugman & Wells, 2012). Countries with a sufficiently large export sector that is non-reliant upon large inputs can in theory benefit from a devaluation (Krugman & Wells, 2012). However, these positive effects can be offset by rising input costs, as intermediate goods have become more prevalent due to GVCs (BIS, 2017: 10). An other characteristic that determines a positive or negative effect is debt exposure to international funding currencies. If a particular country is heavily exposed to foreign currency-denominated liabilities, a depreciation can depress aggregate demand by depressing purchasing power. Increased liabilities not offset by increasing revenue from foreign currency assets or hedging forces indebted households and companies to deleverage, which reduces their disposable income (Walters, 2013: 39). Moreover, the immediate effect of the depreciation of the currency can create balance sheet problems in the financial sector. If financial institutions show currency mismatches, a depreciation can cause solvency problems that can result in a banking crisis. However, the size of the depreciation, the extend of the foreign currency mismatch, and the location of the currency mismatch determine how severe a potential banking crisis would be (Avdjiev et al, 2018). Moreover, the government response to a potential banking crisis determines the distributive effects. Governments can decide to absorb the losses of the financial sector on their balance sheet, which would increase the need for fiscal consolidation, potentially affecting the bottom of the income distribution disproportionately. However, governments can also choose to let banks

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(partially) default, which would disproportionately affects (international) creditors (Walters, 2013: 41).

In sum, external devaluation in the presence of large foreign currency-denominated liabilities, disproportionately affects the middle and upper class through a balance sheet shock. The indirect effects of external devaluation are determined by the macroeconomic characteristics of a particular country. A country that exports price-sensitive products (primary goods) that use comparatively little inputs can increase its exports and aggregate demand through spillover effects. However, a comparatively high exposure to foreign currency-denominated debt can decrease aggregate demand as households and companies are forced to deleverage. Moreover, the government response to a currency crisis and subsequent recession determines the effect on different constituencies.

1.3.3 Demand of Populism: Economic Anxiety

This section examines the first assumption that is crucial to the causal link between financial crises, mitigation strategies, and populism: economic anxiety translates into decreased political support for incumbent political parties. Firstly, this section documents evidence of economic voting in general. Secondly, this section shows evidence of economic voting due to internal devaluation. Thirdly, this section details evidence of increased economic anxiety due to external devaluation in combination with foreign currency-denominated debt.

The central thesis behind economic voting is the reward-punishment hypothesis. In sum, when the economy is performing well, voters reward the incumbent with their votes, as the incumbent political party is seen as responsible for the economic performance. When the economic performance is judged to be insufficient and economic anxiety is high, voters punish the incumbent political party through the same principle (Lewis-Beck & Stegmaier, 2007: 518). This thesis is best applied in cases in which responsibility for the economy is clearly assigned. Democratic countries with a majoritarian electoral system and clearly defined opposition and government parties fall in this category (Lewis-Beck & Stegmaier, 2007: 523). Logically, this makes economic voting harder to analyze in multi-party democracies, as responsibility for the economy is diffused due to coalition governments and a less clearly defined opposition. However, due to unique circumstances surrounding populist parties, economic voting is especially powerful in explaining a surge in populism. Converging policy platforms of mainstream parties, a collective effort by mainstream parties to keep populist parties out of government, and the association of mainstream parties with

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the GFC enhances the clear division between government (mainstream parties) and opposition (populist parties) (Hopkin & Blyth, 2019).

The correlation between fiscal consolidation and a decrease in political support for incumbents (the parties that administer the fiscal consolidation) has been extensively studied (Armingeon & Giger, 2008) (Lewis-Beck et al, 2013). Statistical analysis of voting behavior in 24 European democracies in 2014 shows that fiscal stimulus increases the electoral support for the incumbent, while fiscal consolidation decreases support for the incumbent (Talving, 2017: 573). Furthermore, fiscal expansion or consolidation ranked among key predictors of political support in 2014, including ideological identification (Talving, 2017: 574). Analysis indicates fiscal consolidation set off post-2010, explaining the limited effect of fiscal consolidation in 2009, as European countries applied fiscal expansion in 2009 to combat the fallout of the GFC. Conversely, no conclusive evidence was found for public endorsement of fiscal consolidation (Talving, 2017: 575). Finally, the study acknowledges the role of external enforces such as the EU, ECB, IMF and the financial markets. These external actors explicitly forced national governments to administer fiscal consolidation. This potentially diffuses the responsibility of national incumbents in steering the economy and thereby potentially undermines the reward-punishment dynamic. However, the statistical analysis finds no evidence for this, as the statistical relationship between fiscal consolidation and decreased electoral support for the incumbent was maintained in bailout countries (Talving, 2017: 576).

Limited research has been conducted to explicitly link balance sheet crises caused by foreign currency-denominated debt to decreased electoral support for incumbents. However, there is evidence that statistically links increased economic anxiety to large exposure to foreign currency-denominated debt in combination with a depreciating currency. Given the reward-punishment dynamic described in this section, it is reasonable to assume that economic anxiety, caused by balance sheet crises, also decreases electoral support for political incumbents. Walters (2013) uses the Eurobarometer of 2009 to point to higher economic anxiety expressed by residents of countries that have a high stock of foreign currency-denominated debts and have experienced a currency depreciation. European countries that had disproportionately high foreign currency-denominated debt and experienced a significant depreciation of the national currency against the euro (defined as over 10 percent) registered statistically significantly higher economic anxiety (Walters, 2013: 66). Moreover, countries that experienced an appreciating currency agains the euro in combination with foreign currency-denominated liabilities registered significantly less economic anxiety in the same model, suggesting currency depreciation linked to the presence of foreign currency-denominated

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debts (balance sheet stress) is a crucial determinant of economic anxiety (Walters, 2013: 67). Specifically, the probability that a respondent living in a country with high foreign currency-denominated liabilities (defined as 79.2 percent of private loans currency-denominated in foreign currency) reported negative economic efffects was 55 percent higher than a respondent living in a country with low foreign currency-denominated exposure (defined as 7.4 percent or lower) (Walters, 2013: 68).

Economic voting has been extensively documented throughout the democratic world (Lewis-Beck & Stegmaier, 2007). Moreover, evidence shows that fiscal consolidation in Europe is specifically correlated with decreased electoral support for the political incumbent (Talving, 2017). While there is limited research directly linking balance sheet stress to decreased electoral support, there is statistical evidence that specifically links balance sheet stress to increased economic anxiety (Walters, 2013). This theoretical framework identifies internal and external devaluation (in combination with a high stock of foreign currency-denominated debts) as causes for decreased electoral support for incumbents, given the negative relationship between economic anxiety and support for incumbents (Lewis-Beck & Stegmaier, 2007).

1.3.4 Supply-Side of Populism: Narratives and Policies

This section examines the second assumption that is crucial to the causal link between financial crises, mitigation strategies, and populism: populists respond to economic anxiety expressed by voters by offering specific narratives and policies. Firstly, this section details a definition of populism. Secondly, this section explains the narratives of populists in the context of financial crises. Thirdly, this section details the policies of populist parties.

The precise definition of populism is disputed. However, the definition of populism overlaps in key areas. Firstly, populism is defined as an ideology that separates society into two factions: the morally virtuous ‘people’ and the corrupt establishment or ‘elites’. Secondly, the dynamic between these factions is antagonistic. Thirdly, populism argues that politics should be an expression of the general will of the people, or popular sovereignty. Fourthly, populism has a ‘Manichean’ worldview: a positive valorization of ‘the people’ versus the denigration of the ‘elite’ (Krisie & Pappas, 2015: 4) (Mudde, 2004: 543). Populism is the result of the dynamic between demand and supply. Demand is defined as voter anxiety, which is expressed culturally or economically. This is supplemented by the supply-side: a specific narrative and specific policies offered to mitigate specific vulnerabilities of voters (Rodrik, 2018).

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The populist narrative describes the societal conflict, the ‘people’ that suffer in this particular societal conflict, and the ‘elite’ that is responsible for said suffering. (Rodrik, 2018: 23). Two types of societal conflict, or cleavage, exist within politics: economic and cultural. The economic cleavage refers to economic inequality, while the cultural cleavage describes ethnic and cultural conflict. Populists exploit economic or cultural cleavages for electoral gain and define the ‘people’ and the ‘elite’ according to the societal cleavage (Rodrik, 2018: 23). Cultural populism uses identity, religion, ethnicity, and race to separate the ‘people’ from the ‘elite’. The ‘people’ are defined as members of a native group and outsiders threaten the internal cohesion of the native group. This is primarily expressed in debates regarding immigration, ethnic diversity and identity politics. Members of mainstream political parties are branded as the ‘elite’ that is facilitating and encouraging the progress of non-natives through accommodative immigration policies, cultural multiculturalism, and cosmopolitanism (Kyle & Gulchin, 2018: 23). Socio-economic populism defines the antagonistic struggle between the ‘people’ and the ‘elite’ as a struggle between economic classes. The ‘people’ are defined as a particular class that is suffering economically, while the ‘elite’ is defined as the economic and political establishment that encourages and facilitates an unequal economic dynamic between the classes. Traditionally, the ‘people’ are defined as the working or middle class, while the ‘elite’ is defined as (foreign) international institutions, state elites, capital owners, and big business (Kyle & Gulchin, 2018: 24).

In the context of financial crises, populists exploit the antagonistic relationship that exists between creditors and debtors. Human nature, due to bounded rationality and the inability to translate individual decisions into collective consequences, drives the pro-cyclical nature of financial markets: “the economic system’s reaction to a movement of the economy amplify the movement: inflation feeds upon inflation and debt-deflation feeds upon debt-deflation” (Minksy, 1992: 2). Due to a liquidity crunch, creditors tighten credit conditions or recall outstanding loans, which puts pressure on debtors, which reinforces the cycle (Reinhart & Rogoff, 2009). Politically, financial crises result in antagonistic political standoffs between coalitions of creditors and debtors that try and capture the state to resolve the impasse. This plays out within nations and between nations (Blyth & Matthijs, 2017: 220). In the context of financial crises that result in (international) political standoffs between creditors and debtors, populist parties as diverse as Syriza and Fidesz are considered to be in the same category: anti-creditor, pro-debtor coalitions. Conversely, the elite is judged by populists to only advocate for creditors and thus advocates policies that are only beneficial to the ‘elite’ (creditors) and detrimental to the ‘people’ (debtors) (Blyth & Matthijs, 2017: 220). The mainstream political parties that advocate for neoliberal policies are branded by populist

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parties as part the ‘elite’ that supports the creditors: international financial conglomerates and international organizations and sovereigns that reduce the financial sovereignty of debtor nations and households. In sum, the populist parties position themselves as the true vanguard of the debt-ridden ‘people’, while the mainstream parties are portrayed to only advocate for the creditor ‘elite’ (Blyth & Matthijs, 2017: 220). This ‘financial’ populism thus forms a subcategory of economic populism.

Populist parties offer a clear policy alternative to mainstream parties that reject the activist policies of public good creation and redistribution in favor of protecting the market and private property from market distortions caused by government interference (Hopkin & Blyth, 2018: 207). The neoliberal macroeconomic regime resulted in externalized policy commitment by mainstream political parties through loosening the direct grip over the economy through central bank independence, devolution of political responsibilities to local and supranational governmental layers, privatization of SOEs, and reducing the quality and quantity of government capacity through the reduction of the overall government apparatus (Hopkin & Blyth, 2018: 203, 204). This is a phenomena also experienced in the periphery, as social democratic parties in post-communist states embraced economic liberalism (Bustikova & Kitschelt, 2009). Populist political parties reject this governing philosophy and see the state as a crucial instrument in addressing the distributional effects of capitalism (Brubaker, 2017: 370). This is defined as economic illiberalism: the ambition to protect the population against inequality and insecurity by shaping and redefining the market through economic and social policies (Hopkin & Blyth, 2018: 208). Analysis of party manifestos disproves the misconception that all populist parties exhibit illiberal, authoritarian or nativist characteristics. These are characteristics that primarily describe a significant group of rightwing populist parties (Mudde, 2007). However, analysis of party manifestos shows all populist parties do share one common illiberal trait: economic illiberalism, expressed as a skewed preference for state intervention (Hopkin & Blyth, 2018: 204).

While all populist parties fall in the economically illiberal category, limited research exists that explains why some populists advocate for regressive state-interventionist policies and why some populist parties advocate for progressive state-interventionist policies. In the context of the GFC, this research states the content of state-interventionist policies offered by populist parties is determined by the BoP mitigation strategy. Internal devaluation disproportionately affects poorer households and thus incentivizes populist parties to offer progressive policies. External devaluation asymmetrically affects middle and upper-middle income households, thereby incentivizing populist parties to offer regressive policies.

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Populist parties respond to societal anxiety by offering specific narratives and policies. In the context of financial crises, populist parties seize upon the conflict between debtors and creditors. Moreover, populist parties have a skewed preference for state-interventionism. Furthermore, this research argues that the content of said state-interventionist policies is determined by the particular BoP adjustment strategy. Section 3.5 summarizes all previous theoretical sections and details a predictive model that attempts to explain the occurrence of (regressive and progressive) populism in the European periphery.

1.3.5 The Politics of Internal and External Devaluation

Governments have two policy routes to mitigate a structural current account deficit: internal or external devaluation (Walters, 2013). Internal devaluation disproportionately affects households at the bottom of the income distribution, as they suffer the most from lower social transfers, lower aggregate demand, and regressive tax increases (Woo et al, 2013) (Agnello & Sousa, 2012) (Ball et al, 2013). External devaluation, in the presence of large foreign currency-denominated liabilities, disproportionately hurts the middle and upper class. This is because the middle and upper-middle class hold a disproportionate amount of (foreign currency-denominated) debt (Walters, 2013) (Mason, 2018). The asymmetric distributional effects of both mitigation strategies results in economic anxiety. Increased economic anxiety is associated with decreased electoral support for political incumbents (Lewis-Beck & Stegmaier, 2007). Populist parties use existing anxieties in society and create specific narratives and policies to address the vulnerabilities of voters (Rodrik, 2018). In the context of financial crises, populists claim to represent and protect the ‘debtors’ against the ‘creditors’ (Hopkin & Blyth, 2018). Moreover, populist parties offer economically illiberal policies to protect vulnerable voters from the market (Hopkin & Blyth, 2018). In the context of the GFC, the content of these policies is determined by the BoP adjustment strategy.

Given the causal links listed above, I formulate a predictive model for explaining populism in Iceland, Ireland, Hungary, and Greece during 2008-2015 (Table 1).

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Table 1: The politics of internal and external devaluation

1.4 Hypotheses

The predictions in the model constitute the hypotheses of this thesis. The following three have been developed. Economically illiberal is defined as a preference for state-interventionist policies. Populism defined in financial terms is defined as a narrative that specifically puts the ‘people’ and the ‘elite’ in financial categories: the ‘people’ are defined as debtors while the ‘elite’ are defined as creditors that interact in a antagonistic dynamic.

H1: BoP crises caused by structural macroeconomic imbalances result in economic populism, defined in financial terms.

H2a: Internal devaluation asymmetrically hurts poorer households, which results in state-interventionist progressive policies offered by populist parties.

H2b: External devaluation, accompanied by a large exposure to foreign currency-denominated debt, asymmetrically hurts the middle and upper-middle class, which results in state-interventionist regressive policies offered by populist parties.

1.5 Research Design

This thesis utilizes a comparative case study research design. In absence of a perfect experimental design, a comparative case study enables one to isolate the causal links of social phenomena in cases with similar characteristics (Bryman, 2012: 72). The predictive theoretical model developed in the theoretical framework predicts internal devaluation results in progressive populist policies, while external devaluation culminates in regressive populist policies. A comparative case study of

Internal devaluation External devaluation Measures Tax increases, public spending

cuts, structural reforms Currency depreciation

Asymmetrically affected Working class Middle & upper-middle class

Cleavage Economic/financial Economic/financial

The people/elite Debtors/creditors Debtors/creditors

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countries that share key characteristics but differ in one key aspect (internal or external devaluation) allows one to isolate the effect of internal or external devaluation on populism.

1.6 Sample and Case Selection

The aim of this research is to examine the effect of the GFC and its aftermath on populism in the European periphery. More specifically, this thesis aims to examine countries that have experienced a BoP crisis during the GFC. Close examination of Europe’s current account structure reveals two sets of countries pre-GFC: ‘core’ countries that structurally export excess capital and ‘periphery’ countries that structurally import capital. The core primarily consists of Scandinavia, the ‘Benelux’, and German speaking countries. The periphery is far larger and encompasses Iceland, the Anglo-Celtic region, Southern Europe, and Central & Eastern Europe (World Bank, 2020). Collectively, the periphery group experienced a reversal of capital flows and sharp GDP contractions post-GFC (IMF, 2009). The periphery group is academically relevant, as these countries experienced BoP issues and responded with diverging mitigation strategies.

To find appropriate cases a criterion sampling technique was utilized (Bryman, 2012: 419). The criteria to find an appropriate case are as follows. The particular country must have clearly used internal devaluation or external devaluation in the presence of significant foreign-denominated currency debt to correct the structural BoP imbalance. However, it is extremely difficult to create a research design with a randomized sample in an experimental setting with a country as unit of analyses that is able to fully isolate the causal mechanisms that link a dependent and independent variable (Bryman, 2012). Subsequently, it is unattainable to find cases that purely used internal or external devaluation strategies, as the implementation of public policy was not in a controlled experimental setting. However, it is attainable to find cases that used mitigation strategies that were skewed towards internal devaluation or towards external devaluation.

The next step is to select countries that share similar characteristics, as to attempt to isolate the causal link between the independent and dependent variables (Bryman, 2012: 74). This resulted in a comparative case study, examining Iceland and Hungary versus Ireland and Greece. Iceland and Ireland have a remarkable symmetry: both nations had domestic banks several times the size of their GDP, both experienced a sharp rise in private debt to GDP pre-GFC, both are established liberal democracies, and both had similar growth trajectories and income levels (IMF, 2020) (Tooze, 2018) (EIU, 2020). Hungary and Greece also share similarities: both nations are developing democracies, both had large public deficits in the run-up to the GFC, GDP per capita of both nations is below the EU average, and both experienced a surge of private debt (financed by foreign capital)

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