Dutch Disease in Eastern Mediterranean – A Theoretical Hypothesis

Abstract

Standard Dutch Disease is simply a case of difficult, longer lasting and therefore risky process of adjustment towards a new, favorable macroeconomic outcome. In this paper we present a modified version, where the scenario is more severe: additional to the induced inter-industry changes, the new general equilibrium itself could be worsened, as the sudden booming of a specific economic activity (especially in the extraction industry) causes permanent opportunity costs and externalities that adversely affect the production possibilities in other sectors. After reviewing standard theoretical literature and the part that focuses on the specificities of low-income economies, in the fourth section we conceptualize this hypothesis on the potential exploitation of Eastern Mediterranean hydrocarbons reserves. ‘Dealing’ and ‘cleaning’ costs generate a political and an environmental crowding out and thereby a worsening of the Production Possibilities Frontier, next to the existing, potential benefits from the discovered resources. We argue that the final outcome depends on the special characteristics of each region being decisive for the severity of the permanent harm to other industries, as well as on the degree of openness of domestic economy and the biasness of consumers’ preferences. The conclusions from the discussion of the specific hypothesis can be useful for a more accurate cost-benefit analysis of expansion in the extraction industry.