Southern Europe's Institutional Decline

41 Pages Posted: 23 Jun 2016

See all articles by Edouard Challe

Edouard Challe

Ecole Polytechnique

Jose Ignacio Lopez

Universidad de los Andes, Colombia - Department of Economics

Eric Mengus

HEC Paris - Economics & Decision Sciences

Date Written: June 9, 2016


The run up to the euro currency initiated a period of capital inflows into southern European countries, i.e., Spain, Portugal, Italy and Greece. We document that those countries, and only them among OECD countries, concomitantly experienced a decline in the quality of their institutions. We confirm the joint pattern of capital inflows and institutional decline in a large panel of countries. We show theoretically that this joint pattern naturally follows from a "soft budget constraint" syndrome wherein persistently cheap external funding undermines incentives to maintain good institutions - understood here as the degree of government commitment not to support inefficient firms. Low institutional quality ultimately raises the share of inefficient firms, which lowers average productivity and raises productivity dispersion across firms - the typical pattern of productivity in southern Europe over the period under consideration.

Keywords: TFP, Institutions, Current account

Suggested Citation

Challe, Edouard and Lopez, Jose Ignacio and Mengus, Eric, Southern Europe's Institutional Decline (June 9, 2016). HEC Paris Research Paper No. ECO/SCD-2016-1148, Available at SSRN: or

Edouard Challe

Ecole Polytechnique ( email )

Ecole Polytechnique
Department of Economics
Paris, 75005

Jose Ignacio Lopez

Universidad de los Andes, Colombia - Department of Economics ( email )

Carrera 1a No. 18A-10
Santafe de Bogota, AA4976
5713394949 (Phone)


Eric Mengus (Contact Author)

HEC Paris - Economics & Decision Sciences ( email )


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