How beneficial are capital inflows for economic catch-up? Lessons from the euro periphery

While the theory of intertemporal trade predicts large benefits for developing countries and emerging markets from opening up their capital account, empirical evidence has remained elusive. A number of authors have tried to explain this fact with insufficient institutional quality or lack of basic human capital in less developed countries. This paper argues that European Monetary Union (EMU) provides a natural experiment to check how relevant these arguments are as EMU countries in global comparison have high institutional standards and high levels of human capital. Looking at the empirics from 1999 to 2009, it is found that there have indeed been large capital inflows from the (developed) core of EMU to the (less developed) periphery of EMU. Nevertheless, capital inflows from the EMU core to the periphery have not yielded the benefits expected from textbook theory. This hints that there might be additional factors lowering potential benefits from capital inflows which might not have yet received sufficient attention.