In economics, Dutch disease is the apparent causal relationship between the increase in the economic development of a specific sector (for example natural resources) and a decline in other sectors (like the manufacturing sector or agriculture).
The presumed mechanism is that while revenues increase in a growing sector (or inflows of foreign aid), the given economy's currency becomes stronger (appreciates) compared to foreign currencies (manifested in the exchange rate). This results in the country's other exports becoming more expensive for other countries to buy, while imports become cheaper, altogether rendering those sectors less competitive.
While it most often refers to natural resource discovery, it can also refer to "any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment".[2]
Modeledit
The classic economic model describing Dutch disease was developed by the economists W. Max Corden and J. Peter Neary in 1982. In the model, there is a non-tradable sector (which includes services) and two tradable sectors: the booming sector, and the lagging (or non-booming) tradable sector. The booming sector is usually the extraction of natural resources such as oil, natural gas, gold, copper, diamonds or bauxite, or the production of crops, such as coffee or cocoa. The lagging sector is usually manufacturing or agriculture.
In the "resource movement effect", the resource boom increases demand for labor, which causes production to shift toward the booming sector, away from the lagging sector. This shift in labor from the lagging sector to the booming sector is called direct deindustrialization. However, this effect can be negligible, since the hydrocarbon and mineral sectors tend to employ few people.[3]
The "spending effect" occurs as a result of the extra revenue brought in by the resource boom. It increases demand for labor in the non-tradable sector (services), at the expense of the lagging sector. This shift from the lagging sector to the non-tradable sector is called indirect deindustrialization.[3] The increased demand for non-traded goods increases their price. However, prices in the traded good sector are set internationally, so they cannot change. This amounts to an increase in the real exchange rate.[4]
Simple trade models suggest that a country should specialize in industries in which it has a comparative advantage; thus a country rich in some natural resources would be better off specializing in the extraction of those natural resources.
However, other theories suggest that this is detrimental, for example when the natural resources deplete. Also, prices may decrease and competitive manufacturing cannot return as quickly as it left. This may happen because technological growth is smaller in the booming sector and the non-tradable sector than the non-booming tradable sector.[5] Because that economy had smaller technological growth than did other countries, its comparative advantage in non-booming tradable goods will have shrunk, thus leading firms not to invest in the tradables sector.[6]
Also, volatility in the price of natural resources, and thus the real exchange rate, limits investment by private firms, because firms will not invest if they are not sure what the future economic conditions will be.[7] Commodity exports such as raw materials drive up the value of the currency. This is what leads to the lack of competition in the other sectors of the economy. The extraction of natural resources is also extremely capital intensive, resulting in few new jobs being created.[8]
Minimizationedit
There are three basic ways to reduce the threat of Dutch disease: (1) slowing the appreciation of the real exchange rate, (2) boosting the competitiveness of the adversely affected sectors, and (3) demographic adaptation. One approach is to withhold the boom revenues, that is, not to bring all the revenues into the country all at once, and to save some of the revenues abroad in special funds and bring them in slowly. In developing countries, this can be politically difficult as there is often pressure to spend the boom revenues immediately to alleviate poverty, but this ignores broader macroeconomic implications.
Another strategy for avoiding real exchange rate appreciation is to increase saving in the economy in order to reduce large capital inflows which may appreciate the real exchange rate. This can be done if the country runs a budget surplus. A country can encourage individuals and firms to save more by reducing income and profit taxes. By increasing saving, a country can reduce the need for loans to finance government deficits and foreign direct investment.
Investments in education and infrastructure can increase the competitiveness of the lagging manufacturing or agriculture sector. Another approach is government protectionism of the lagging sector, that is, increase in subsidies or tariffs. However, this could worsen the effects of Dutch disease, as large inflows of foreign capital are usually provided by the export sector and bought up by the import sector. Imposing tariffs on imported goods will artificially reduce that sector's demand for foreign currency, leading to further appreciation of the real exchange rate.[10]
Diagnosisedit
It is usually difficult to be certain that a country has Dutch disease because it is difficult to prove the relationship between an increase in natural resource revenues, the real-exchange rate, and a decline in the lagging sector. An appreciation in the real exchange rate could be caused by other things such as productivity increases in the Balassa-Samuelson effect, changes in the terms of trade and large capital inflows.[11] Often these capital inflows are caused by foreign direct investment or to finance a country's debt. However, evidence does exist suggesting that unexpected and very large oil and gas discoveries do cause the appreciation of the real exchange rate and the decline of the lagging sector across affected countries on average.[12]
Examplesedit
Gold and other wealth imported to Spain and Portugal during the 16th century from the Americas.[13][14]
Analysts have argued that the United Kingdom's increasing reliance on the financial sector since the 'Big Bang' in 1986 is preventing manufacturing growth.[18][19][20] A similar argument has been made regarding London's booming property market.[21] This financial sector growth has been concentrated, almost exclusively, on the City of London exacerbating regional economic differences such as the North–South divide – the North previously having a strong industrial and manufacturing base. Paul Krugman (among others) has written about the effect of a strong financial sector on UK manufacturing and a potential readjustment following Brexit, should the financial sector reduce its reliance on London.[22][23][24]
Nigeria and other post-colonial African states in the 1990s.[25]
Venezuelan oil for certain periods throughout its history. A notable case occurred during the first presidency of Carlos Andrés Pérez when he established Venezuela as a rentier state.[26]
Post-disaster booms accompanied by inflation following the provision of large amounts of relief and recovery assistance such as occurred in some places in Asia following the Asian tsunami in 2004.[27]
Canada's rising dollar due to foreign demand for natural resources, with the Athabasca oil sands becoming increasingly dominant, hampered its manufacturing sector from the early 2000s until the oil price crash in late 2014/early 2015.[28][29]
Nauru's heavy reliance on phosphate mining, combined with a lack of taxes and large government expenses, caused issues after the depletion of much of its reserves. The country came close to bankruptcy in 2000, and the unemployment rate rose to 90% in 2004. Nauru was for a time the world's richest country (GDP per capita), but has since fallen in ranking to 117th place (Worldbank, 2022).[40][41][42][43]
^"The Dutch Disease" (PDF). The Economist. 26 November 1977. pp. 82–83.
^Ebrahim-zadeh, Christine (March 2003). "Back to Basics – Dutch Disease: Too much wealth managed unwisely". Finance and Development, A quarterly magazine of the IMF. IMF. Archived from the original on 4 July 2008. Retrieved 17 June 2008. This syndrome has come to be known as "Dutch disease". Although the disease is generally associated with a natural resource discovery, it can occur from any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment. Economists have used the Dutch disease model to examine such episodes, including the impact of the flow of American treasures into sixteenth-century Spain and gold discoveries in Australia in the 1850s.
^ abCorden WM (1984). "Boom Sector and Dutch Disease Economics: Survey and Consolidation". Oxford Economic Papers. 36 (3): 362. doi:10.1093/oxfordjournals.oep.a041643.
^Corden WM, Neary JP (1982). "Booming Sector and De-industrialisation in a Small Open Economy" (PDF). The Economic Journal. 92 (December): 825–48. doi:10.2307/2232670. JSTOR 2232670. S2CID 154188130.
^Van Wijnbergen, Sweder (1984). "The 'Dutch Disease': A Disease After All?". The Economic Journal. 94 (373): 41–55. doi:10.2307/2232214. JSTOR 2232214. S2CID 154545481.
^Krugman, Paul (1987). "The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Thatcher". Journal of Development Economics. 27 (1–2): 50. doi:10.1016/0304-3878(87)90005-8.
^"It's only natural". The Economist. 9 September 2010.
^Karl, Terry Lynn (1997). The paradox of plenty : oil booms and petro-states. Berkeley: University of California Press. ISBN 9780520918696. OCLC 42855014.
^Drelichman, Mauricio (1 July 2005). "The curse of Moctezuma: American silver and the Dutch disease". Explorations in Economic History. 42 (3): 349–80. CiteSeerX10.1.1.195.9994. doi:10.1016/j.eeh.2004.10.005.
^Shehabi, Manal (July 2020). "Quantifying Dutch disease effects and asymmetry in economic responses to oil price volatility in Kuwait". The Oxford Institute for Energy Studies.
^McCawley, Peter (March 1980). "Indonesia's New Balance of Payments Problem: a Surplus to get rid of". Ekonomi Dan Keuangan Indonesia. 28 (1): 39–58.
^Bjørnland, Hilde (1998). "The Economic Effects of North Sea Oil on the Manufacturing Sector". Scottish Journal of Political Economy. 45 (5): 553–585. CiteSeerX10.1.1.580.6055. doi:10.1111/1467-9485.00112.
^Evans-Pritchard, Ambrose (10 October 2016). "Britain should embrace weaker pound and it needs to fall further, says former BoE governor and currency guru". Telegraph. Retrieved 26 March 2017.
^Christensen, John; Shaxson, Nick; and Wigan Duncan (5 January 2016). "The Finance Curse: Britain and the World Economy". The British Journal of Politics and International Relations.
^Kaminska, Isabella (12 October 2016). "Brexit and Britain's dutch disease". The Financial Times.
^Mody, Ashoka (18 November 2016). "Unwinding of the pound carry trade". voxeu.org
^Krugman, Paul (11 October 2016). "Notes on Brexit and the Pound". The New York Times. Retrieved 13 October 2016.
^MacAskill, Andrew (24 March 2017). "How banks lost the ear of Britain's government over Brexit". Reuters. Retrieved 26 March 2017.
^Armstrong, Angus (14 October 2016). "Pound in your pocket". National Institute of Economic and Social Research. Archived from the original on 1 July 2020. Retrieved 26 March 2017.
^"Our Continent, Our Future" Archived 16 April 2007 at the Wayback Machine, Mkandawire, T. and C. Soludo. "In most recent attempts to explain Africa's performance with growth and investment regressions, studies find that inaccessible location, poor port facilities, and the 'Dutch Disease' syndrome, caused by large natural-resource endowments, constitute serious impediments to investment and growth".
^Sisira Jayasuriya and Peter McCawley (2008), "Reconstruction after a Major Disaster: Lessons from the Post-tsunami Experience in Indonesia, Sri Lanka, and Thailand", ADBI Working Paper No 125.
^Lee Greenberg (20 July 2011). "Growing Equalization Payments to Ontario Threaten Country". National Post.
^Michel Beine; Charles S. Bos; Serge Coulombe (January 2009). "Does the Canadian economy suffer from Dutch Disease?" (PDF).
^"Strong forex inflows now hurting economy", GMANews.TV.
^"Archived copy" (PDF). Archived from the original (PDF) on 15 March 2012. Retrieved 2 December 2010.{{cite web}}: CS1 maint: archived copy as title (link)
^Peter Martin (30 August 2012). "Warning: After the boom it'll be Dutch and go". Sydney Morning Herald.
^Paul Cleary (11 November 2007). "Mining boom could bust us". Melbourne: The Age.
^Peter Ker; Ben Schniders (6 September 2011). "Labor woeful on economic reform, Says Argus". The Sydney Morning Herald.
^"Dutch Disease Hits Russia" Archived 28 September 2007 at the Wayback Machine, Latsis, O. (2005). Moscow News, 8–14 June.
Buiter, Willem H.; Purvis, Douglas D. (1983). "Oil, Disinflation, and Export Competitiveness: A Model of the 'Dutch Disease'". In Bhandari, Jagdeep S.; Putnam, Bluford H. (eds.). Economic Interdependence and Flexible Exchange Rates. Cambridge: MIT Press. pp. 221–47. ISBN 978-0-262-02177-7.
Elkhan Richard Zada. 2016. Oil Abundance and Economic Growth. Berlin: Logos Verlag.
External linksedit
The dictionary definition of Dutch disease at Wiktionary