Bruegel’s Shahin Vallée, Guntram Wolff: What kind of banking union for Europe?
The Impact of the Introduction of the Euro on Firm`s Expectations
The Euro and Firm Restructuring
One of the main drivers of European integration was the idea that a more integrated European economy would promote economic efficiency, allowing countries to fully exploit their competitive advantages, fostering factor mobility and increasing allocational efficiency (European Commission 1993).
The euro was a crucial milestone along this path. Ten years after its launch (2009), we can start to assess the effects of such a radical institutional change. We focus on whether the introduction of the euro-narrowly defined as the end of competitive devaluations-has induced significant changes in the productive structure of the euro area (EA) member states.
When the euro was introduced in 1999, the European productive structure was sharply differentiated across member states, with a group of southern countries specialized in traditional, low human capital activities. Firms in these countries took advantage of recurrent devaluations to cope with international competition, especially from the low- wage economies.
The basic idea underlying our analysis is that the end of competitive devaluations should have had differential effects by country and sector. For one thing, before the introduction of the euro, countries had adopted different strategies in terms of devaluation vis- à- vis the deutschemark (DM; Giavazzi and Giovannini 1989). Second, in some sectors, competition is mainly in prices, so changes in the terms of trade are a fundamental determinant of performance; in other sectors, product differentiation is more pronounced, so prices are just one factor of competitiveness, alongside product quality, brand name, technological content, and so forth. Our initial hypothesis is that the euro should have been a greater shock for the sectors competing mostly in prices and the countries that made a more intense use of competitive devaluations. We therefore expect that restructuring has been more intense in these country- sectors.
We analyze restructuring along two dimensions. First, we consider whether there has been a reallocation of factors away from the sectors that presumably had relied more heavily on devaluations (between-sectoral reallocation process). Second, we consider to what extent the reallocation has occurred within sectors. As the recent body of literature on trade and productivity has shown (Melitz 2003; Bernard, Jensen, and Schott 2006a), most of the productivity gains from trade opening are achieved via the reallocation of production from less to more efficient firms within the same sector.
The between-sectoral analysis is based on standard techniques of convergence/ divergence of productive structures. We find very weak support for the proposition that the euro has induced a reallocation of activities between sectors. Specifically, Krugman dissimilarity indices show that intersectoral reallocation in the post euro era has been almost nil for most of the EA countries and modest for the rest. Although a finer sectoral classification might give a somewhat different picture, we think it is plausible that a substantial process of reallocation should be visible, even using the twenty-two two-digit manufacturing sectors of the Nomenclature générale des Activités économiques dans les Communautés Européennes (NACE) revision 3 classification system.
We then move on to consider whether there is evidence of within- sectoral reallocation. Ideally, one would like to test this hypothesis directly with firmlevel data. Unfortunately, such data are not available at the cross- country level. Our analysis is therefore based on sectoral data and on indirect measures of restructuring-in particular, productivity growth. We follow the approach introduced by Rajan and Zingales (1998). We rank countries by how heavily they relied on devaluations, considering both nominal and real devaluation vis-à-vis the DM over the 1980 to 1998 period. We classify sectors according to how important devaluations were for competitiveness using a series of indicators of the sectoral skill content, with the idea that low- skill content implies more price competition. An alternative ranking is to look directly at the importance of emerging economies in world trade in each sector. The variable we track is China’s export share. The interaction between the country- level devaluation measure and the sectoral skill content measure constitutes the indicator of how much a country- sector should have been affected by the euro.
We find clear support for the hypothesis that the euro has induced relatively strong intrasectoral restructuring. Productivity growth has been fastest in the sectors with low- skill content and in the countries that had relied more on competitive devaluations. This result is robust to a series of checks.
In particular, to address potential omitted- variable bias, we not only include country and sector dummies but also a control group of countries that are broadly similar to the EA countries, except for adoption of the euro-namely, Denmark, Sweden, and the United Kingdom. We also show that our results are not driven by some underlying auto correlated process independent of the euro. Moreover, restructuring seems to have had little negative effect on employment. The exception is when we rank sectors according to the Chinese export share, in which case a clear negative effect on employment emerges. Note that this is only a within- country and sector comparison, so it does not allow us to draw conclusions on aggregate growth differentials between the countries or the sectors. All we can say is that relative to the country and sector averages, the productivity growth differential between low- and high- skill sectors was higher in a high- devaluation country than in a low-devaluation one.
To obtain direct evidence on the restructuring process, we then turn to firm-level evidence from Italian manufacturing. We first review a series of forty in-depth interviews with entrepreneurs conducted by researchers at the Bank of Italy in 2007, in the spirit of the National Bureau of Economic Research (NBER)/ Sloan “pin factory” project (Borenstein, Farrell, and Jaffe 1998). The interviews offer soft evidence on the restructuring process. They suggest that since the adoption of the euro, firms have shifted their business focus from production to upstream and downstream activities, such as research and development (R&D), product design, marketing, and distribution. These activities in fact can procure a certain degree of market power and enable firms to escape the pure cost competition. Moreover, the shift is more dramatic in traditional low-tech activities, in line with the aggregate evidence. Finally, it emerges that restructuring is an ongoing process, not a single episode with a beginning and an end. The insights from the interviews are corroborated by the hard, quantitative evidence provided by a database of manufacturing firm’s representative of the population of firms with at least fifty employees. First, the cross-sectional dispersion in both productivity and profitability has increased steadily since 1999, as one would expect during restructuring episodes. And there is a marked decline in the share of blue- collar workers, consistent with the thesis that firms are shifting the focus away from production. The lower the technological content of the sector, the sharper the decline. Interestingly, in the pre-euro era, the opposite was the case: low- tech firms used devaluations to recoup price competitiveness and intensified their reliance on low-skilled workers. We do not find that job flows intensified after the introduction of the euro; the restructuring process seems to entail a reallocation of workers within rather than between firms.
To close the circle, finally we consider whether the restructuring firms actually perform better than the others, regressing value added and productivity growth on indicators of restructuring at the firm level derived from ad hoc questions on the importance of trademarks and of changes in the mix of goods produced. We also include the share of blue- collar workers. The results confirm that the firms that undertook restructuring recorded higher growth rates, both in value added and in productivity.
A number of papers are considering the effects of the euro on member countries ten years after its inception. Alesina, Ardagna, and Galasso show that the common currency has contributed to building political consensus for restructuring in the product markets-markedly through liberalization in the energy and communication sectors-but not in the labor market. Bertola (2007) finds an association between the euro adoption and the improvements in terms of employment and equilibrium unemployment. Our work is more broadly related to the growing body of literature that considers the effects of international competition on national productive structure (Chen, Imbs, and Scott 2007). The paper closest to our sectoral analysis is that of Auer and Fischer (2008) on the effects on U.S. industry of import penetration from emerging economies. They also find that the U.S. sectors most exposed to competition from emerging countries recorded higher productivity growth, as well as lower price inflation.
The same result on productivity is found by Bugamelli and Rosolia (2006) on Italian data. Using U.S. fi rm- level data, Bernard, Jensen, and Schott (2006a) find that industries’ exposure to imports from low- wage countries is correlated positively with the probability of plant death and negatively with employment growth. In a companion paper, Bernard, Jensen, and Schott (2006b) show that a reduction of inbound trade costs is positively associated with industry productivity (TFP), the probability of plant death, the probability of entry of new exporters, and export growth by incumbent exporters. For Italy, Bugamelli, Fabiani, and Sette (2008) show that greater exposure to Chinese export penetration has diminished the pace of firms’ output price increases.
Competitive devaluations are in principle a possible option, even in the post euro era. Nevertheless, the euro has put an end to the possibility of trade advantages with respect to the rest of the EA, which accounts for a significant fraction of exports for all members. Further, as the euro is a stronger currency, the risk of sharp devaluations is lower.
The end of competitive devaluation is not the only channel through which the euro could have stimulated factor reallocation. A trade integration channel within the EA countries must also be acknowledged. The benefits from the use of a common currency-lower transaction costs, no exchange rate risk, better price and cost transparency-are expected to enhance openness to trade and investment, as well as to foster competition. Indeed, since the launch of the euro, bilateral trade among EA members has expanded far more rapidly than trade with other EU countries (European Commission 2008; Baldwin 2006; de Nardis, De Santis, and Vicarelli 2008). Our results suggest that these channels too have had little impact on sectoral reallocation.
