This paper argues that deep economic integration, which includes the single market plus monetary union, leads to economic divergences if the integration process does not comprise an appropriate set of mutually complementary policies. The Eurozone is an example of an almost fully integrated area, which faces an extreme case of unbalanced integration. The paper argues that unless domestic structural reforms are adopted by the less competitive Member States, this is a policy framework that is unworkable without more political union. The gradual move to such an institutional setup would allow either the financing of chronic current account imbalances or the enforcement of the needed institutional changes at a Member State level to reduce those imbalances. The paper concludes that the new EU legislation, regarding budget deficits, current account disequilibria and banking, could even be counterproductive if it is only based on sanctions and does not incorporate positive incentive schemes.

JEL Codes: E02, F15, F36, O52

Keywords: European integration, financial integration, structural reform

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