There is absolutely nothing particularly wrong with theocracy, any more than there is with a republic. A republic still has a constitution, based on some articulation of moral lines to which even the state must adhere.
What did medieval European theocracies demand? That the ruler be Christian. What did it mean to be Christian? That you be obedient to the rules of moral life. What were those rules of moral life? Those that were understood and investigated by many Christian scholars on the morality of everyday life, such as the Scholastics.
That there is a system of establishing moral rules under which the ruler must be held back, not merely by his own will, but by the passion for justice inherent in all his subjects and all those who guide him is something that was the idealistic view of both the republic and the theocracy.
In the days of theocratic monarchies in Europe, the king was merely a subject to greater powers to which he had to be obedient. He was a delegated servant of handling law and order.
Thus, the removal of those greater powers, the need for the ruler to be Christian, paves the way for absolute power of the ruler.
Now, when you consider the strong road cut across liberty in the modern age, does it come from moral rulers or amoral rulers? Is Obama a moral ruler for ordering assassinations in which 1,400 Pakistanis are killed? Is Blair a moral ruler for ordering his own citizens kidnapped and tortured in dark rooms? Is Sakaashvilli a moral ruler for ordering Russian and Ossetian civilians killed?
Can you look at these men and call them Christians?
Could they have been able to show their face to the Church in those days and be able to say that they will do whatever they want, and not care if the Pope withdraws his support for his nation? Could his Christian subjects have accepted him after that?
Nationalism was the greatest evil of our times. None of us must forget that Christianity was the one thing that successfully prevented the rise of the evil, amoral, all-empowered thing that we call the nation-state.