Did EMU membership cause the “Dutch disease” in the PIGS nations?

Abstract

This paper analyzes the effect on the relatively poorer peripheral European nations of capital inflows resulting from entry into the EMU. A two-sector model of an open economy facilitates a study of the structural effects arising out of entry into the fraternity with the richer European core. It is observed that the vastly increased capital inflows to the so-called PIGS group of nations due to EMU entry did create conditions in the labor and goods markets, which are reminiscent of those observed when the Dutch disease, or deindustrialization phenomenon develops. The impact of EMU capital on the government sector was also studied. It is noted that for a non-deterioration of the government budget balance, a traded sector that is large relative to the nontraded sector will be required, as will be a large private nontraded sector relative to the government sector. The authenticity of these derived conditions for non-deterioration of the budget balance seems to be borne out by cross-country data on the PIGS nations.