By ESADE Professor Fernando Ballabriga and Associate Professor Carolina VillegasDepartment of Economics, Finance and Accounting The financial crisis reopened the debate about the long-run sustainability of the euro. Today, the monetary union is under scrutiny. Will the euro be sustainable in the long term? Are eurozone countries more exposed to financial risk? "Financial integration was expected to play a leading role in the potential success of the eurozone. Our article documents the failure to fulfill this expectation," the authors warn. "We provide evidence supporting the claim that progress in financial integration has not led to effective risk-sharing mechanisms across EU members. As a result, monetary union members face higher income fluctuation risk." Productivity split between North and South The current eurozone difficulties, the authors argue, seem to suggest that the euro has hampered structural reforms. It has also favored a split between countries specializing in high-productivity sectors and those specializing in low-productivity ones. "Southern European countries have been especially vulnerable to global competitors and the impact of the crisis. What we find is that specialization has been enhanced, but in the direction of increasing the productivity distance between North and South," says Prof. Ballabriga. After the introduction of the euro, Southern European countries like Spain, Italy, Greece and Portugal experienced, on average, an increase in sector specialization, yet mostly in low-technology industries. Northern European countries, on the other hand, experienced accelerated specialization growth in high-technology sectors. This specialization split between Northern and Southern European countries has negatively affected productivity in the South. Part of the lower productivity growth in Southern Europe is related to the boom in the construction sector and the shift of financial resources from traded to non-trade sectors. "Our results suggest that sectors with higher specialization in the eurozone are more productive, but this positive effect on productivity is lower in Southern European countries," says Prof. Villegas. Our results suggest that sectors with higher specialization in the eurozone are more productive Higher financial risk One of the expected benefits of the adoption of the euro was an increase in financial integration among eurozone countries. However, the expected financial integration has not led to improvements in risk-sharing. "In order to be helpful, financial integration has to be sufficiently deep. When it is just incipient and dominated by plain borrowing, integration may actually end up having negative results," the authors warn. "The euro initiated a process of financial integration that was mainly dominated by the South's borrowing of from the North, eventually leading to a highly indebted South. This is clearly not an integration process that would be expected to provide risk-sharing improvements." The findings point to a failure in the task of fulfilling financial integration Club of non-equals The findings point to a failure in the task of fulfilling financial integration. Progress in financial integration has favored a specialization split between countries with low- or medium-technology productive structures and those which are high-tech. As a result, monetary union members face higher income fluctuation risk without enhanced insurance protection. "Our evidence suggests that the specialization split has led to different impacts on sector productivity, negatively affecting those euro members specializing in low-medium technologies, thus helping to make the monetary union a club of non-equals." This article was originally published in the ESADE Knowledge Pills magazine by Executive Education.

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Are eurozone countries more prone to financial risk?

07/2018

By ESADE Professor Fernando Ballabriga and Associate Professor Carolina Villegas

Department of Economics, Finance and Accounting



The financial crisis reopened the debate about the long-run sustainability of the euro. Today, the monetary union is under scrutiny. Will the euro be sustainable in the long term? Are eurozone countries more exposed to financial risk?


"Financial integration was expected to play a leading role in the potential success of the eurozone. Our article documents the failure to fulfill this expectation," the authors warn.


"We provide evidence supporting the claim that progress in financial integration has not led to effective risk-sharing mechanisms across EU members. As a result, monetary union members face higher income fluctuation risk."


Productivity split between North and South


The current eurozone difficulties, the authors argue, seem to suggest that the euro has hampered structural reforms. It has also favored a split between countries specializing in high-productivity sectors and those specializing in low-productivity ones.


"Southern European countries have been especially vulnerable to global competitors and the impact of the crisis. What we find is that specialization has been enhanced, but in the direction of increasing the productivity distance between North and South," says Prof. Ballabriga.



After the introduction of the euro, Southern European countries like Spain, Italy, Greece and Portugal experienced, on average, an increase in sector specialization, yet mostly in low-technology industries.


Northern European countries, on the other hand, experienced accelerated specialization growth in high-technology sectors.


This specialization split between Northern and Southern European countries has negatively affected productivity in the South. Part of the lower productivity growth in Southern Europe is related to the boom in the construction sector and the shift of financial resources from traded to non-trade sectors.


"Our results suggest that sectors with higher specialization in the eurozone are more productive, but this positive effect on productivity is lower in Southern European countries," says Prof. Villegas.


Our results suggest that sectors with higher specialization in the eurozone are more productive


Higher financial risk


One of the expected benefits of the adoption of the euro was an increase in financial integration among eurozone countries. However, the expected financial integration has not led to improvements in risk-sharing. "In order to be helpful, financial integration has to be sufficiently deep. When it is just incipient and dominated by plain borrowing, integration may actually end up having negative results," the authors warn.


"The euro initiated a process of financial integration that was mainly dominated by the South's borrowing of from the North, eventually leading to a highly indebted South. This is clearly not an integration process that would be expected to provide risk-sharing improvements."


The findings point to a failure in the task of fulfilling financial integration


Club of non-equals


The findings point to a failure in the task of fulfilling financial integration. Progress in financial integration has favored a specialization split between countries with low- or medium-technology productive structures and those which are high-tech. As a result, monetary union members face higher income fluctuation risk without enhanced insurance protection.


"Our evidence suggests that the specialization split has led to different impacts on sector productivity, negatively affecting those euro members specializing in low-medium technologies, thus helping to make the monetary union a club of non-equals."


This article was originally published in the ESADE Knowledge Pills magazine by Executive Education.

More Knowledge
Specialization, risk sharing and the Euro
Ballabriga Clavería, Fernando; Villegas Sanchez, Carolina
Journal of Common Market Studies
Vol. 55, nº 6, 10/2017, p. 1380 - 1397
Capital allocation and productivity in South Europe
Gopinath , Gita; Kalemli-Ozcan, Sebnem; Karabarbounis , Loukas; Villegas Sanchez, Carolina
Quarterly Journal of Economics
Vol. 132, nº 4, 11/2017, p. 1915 - 1967
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