Institutions, integration and divergence : lessons from Europe

Abstract

Economists frequently assume that deeper economic integration promotes the convergence of economic regions or countries. To address the connection between institutions, markets and economic development, I begin with the thesis that within an integrated area, two ‘institutions-culture’ conventions can co-exist. Deeper integration can raise the costs of exiting the weaker ‘Southern’ convention because the South benefits from gains from trade. The second thesis is that more integration brings economic advantages but it does not necessarily bring with it the reform of the underlying convention. The gains from trade mean the South specializes more in activities that reinforce its inferior convention. The third thesis is that strong institutions are the precondition for long term convergence and facilitate adjustment to shocks. To illustrate these theses, I use evidence from post-unification Italy, post re-unification Germany and from the economic integration of the Eurozone.