Q. Explain why the European Union's current combination of rapid capital migration with limited labor migration may actually raise the cost of adjusting to product market shocks without exchange rate change.
Answer: If the Netherlands undergo an unfavourable shift in output demand Dutch capital is able to flee abroad leaving even more unemployed Dutch workers behind than in the case of government regulations that were to hinder the movement of capital outside the Netherlands. Harsh and persistent regional depressions could result worsened by the probability that the relatively few workers who did successfully emigrate would be precisely those who are most reliable, skilled, and enterprising. This is another instance of the theory of the second best.