The causes of Original Sin: An empirical investigation of emerging market and developing countries

International Original Sin is still a persistent and widespread phenomenon, especially in emerging market and developing (EMD) countries. The difficulties that may arise from the inability of countries to borrow internationally in their domestic currency, among other effects, can hamper EMD countries' efforts to achieve domestic economic stability. The phenomenon of Original Sin and some of its potential causes were examined by Eichengreen et al. (2002) and later Hausmann and Panizza (2003). According to their findings, merely the economic size of a country is significant in explaining the variation of Original Sin. This article, first, investigates empirically whether the rather orthodox explanations of Original Sin as examined by Eichengreen et al. (2002) and Hausmann and Panizza (2003) remain invalid, even when investigating a greater timeframe with different trends and, second, elaborates an alternative explanatory approach following Fritz et al. (2018) and de Paula et al. (2017, 2020). The empirical analysis confirms that rather orthodox theories have difficulties in explaining the increased exposure of EMD countries to Original Sin. However, the concept of a currency hierarchy sheds light on the phenomenon. Differences in the liquidity premium between northern and southern currencies and the liquidity preference of investors explain the constraints of southern countries to borrow internationally in their own currency. To climb up the hierarchy of currencies by increasing their liquidity premium is a lengthy and arduous undertaking. One way to achieve this could be by uniting with economic partners, especially in its ultimate form as a currency union.