Inversely, a decline in tradable sectors can occur with no strong evidence of RER appreciation. As an example, this result emerges from Mainguy (2011)’s study of a gold boom in Mali which was followed by a drop in cotton production, but with no specific RER appreciation (compared to the other WAEMU countries). Dutch disease is a concept that describes an economic phenomenon where the rapid development of one sector of the economy (particularly natural resources) precipitates a decline in other sectors.
- Inversely, a decline in tradable sectors can occur with no strong evidence of RER appreciation.
- The impact of North Sea oil on industrial sectors in Norway and the United Kingdom from 1970 to 1990 resulted in energy booms that harmed manufacturers.
- The same political economy factors, however, also make the application of this idea difficult.
- Economists have long known that large resource discoveries could be harmful to economies in the long-term, a phenomenon that was named Dutch disease following the effects of the Netherlands’ gas discovery in the North Sea.
The study focusses on the efficient use of revenues coming from taxation to compensate for the adverse effects of the Dutch disease. Among the very few works on the impact of DD on agriculture that use panel data, Apergis et al. (2014) study a sample of oil-dependent Middle East and North African countries for 1970–2011. Using a dynamic Error Correction Model (ECM), they observe negative correlation between oil rent and agricultural value-added in the long term.
Indeed, the crash in international oil prices during the year 2020 led to a significant drop in export earnings and public revenues in oil-exporting countries, precisely when these countries most needed public expenditure to help them deal with the consequences of the pandemic. The conjunction of DD and commodity price volatility can also generate exchange rate volatility, reducing exports and discouraging foreign investments (Gylfason, 2008). Nevertheless, while integration into globalization is a commonly followed process, the reasons why structural change patterns differ across countries are still not fully understood.
When labor is imperfectly mobile across sectors, it can result in unemployment and increasing poverty in the declining sectors. Thus, DD remains a threat, at least from the point of view of the losing sectors, and must be taken into consideration by public authorities. In 2014, economists in Canada reported that the influx of foreign capital related to exploitation of the country’s oil sands may have led to an overvalued currency and a decreased competitiveness in the manufacturing sector. In 2016, the price of oil dropped significantly, and both the Canadian dollar and the ruble returned to lower levels, easing the concerns of Dutch disease in both countries. That’s not to say that oil wealth is strictly bad for the U.S. economy, but it does imply that we should follow our own advice regarding a national response to Dutch Disease.
There is a large literature relative to the role of fiscal policy in preventing (or at least reducing) the adverse effects of DD. The main questions are usually related either to the adequate level of resource taxation, or to the most efficient use of the revenues coming from this taxation (investment, current expenditures, subsidy for declining sectors, savings, etc). This section covers the evolution of this literature, by first describing the arguments in favor of public redistribution across sectors and second by presenting the debate on the optimal equilibrium between spending and saving. In contrast with the model of Corden and Neary, Buiter and Purvis (1980) adopt an external perspective (focusing on the external competitiveness of exports compared to imports) rather than the internal perspective (focusing on the relative incentives to produce tradables versus non-tradables). Accordingly, they use an external RER, defined as the ratio of import (foreign) prices to domestic non-resource tradable prices.
Business & economics
It’s usually connected with countries whose economies rely significantly on natural resource exports. However, upon detection, slowing the real exchange rate’s appreciation and increasing the competitiveness of the adversely impacted industries are the two most fundamental approaches to lessen the threat of Dutch disease. A natural resource boom comes dangerously close to becoming a curse in this literature because specialization in natural resource-intensive industries can be deleterious to long-term growth. Following the oil price shocks of the 1970s, numerous oil-exporting countries had similar “diseases,” adding to the increasing literature on the issue. First, all exporting industries will suffer declining demand for their output as the exchange rate rises. Thus, compared to the situation before the arrival of oil, oil exports rise, but at the expense of non-oil exports.
Trumpism and the New Economy
Based on an ARDL model, they find a positive impact of the real effective exchange rate on the manufacturing sector, but a negative impact of oil price on the manufacturing sector, both in the short and in the long term. They explain these results by the possibility that only a resource-movement effect might have occurred and hence that Algeria suffered only from a “partial” Dutch disease. However, they remain cautious regarding this conclusion and underline that other causes than the DD can explain this negative relationship between oil price and growth in the manufacturing sector. This section presents the results of a sample of empirical studies which investigate the impact of natural resource revenues on the exchange rate. One major issue when estimating Dutch disease relates to the definition of the variables selected for the analysis. Most studies exploit the real effective exchange rate defined as the ratio of domestic to foreign prices (or the opposite).
Their model stresses the role of exchange rate movements on foreign exchange markets in the presence of sticky domestic prices, which was not considered in Corden and Neary’s model. First, oil production does not require labor, implying that starting oil production does not directly affect the other sectors’ production through workers’ movement (contrary to Corden–Neary’s resource-movement effect). Second, consumption follows the permanent income hypothesis, meaning that oil revenues are not fully consumed during the exploitation period but partly saved to smooth consumption over time, affecting the long-term steady state of the economy.
Sovereign Wealth Funds (SWF) have emerged over recent decades as useful institutions for saving. For instance, Anne (2019) finds a total of 63 SWFs in 39 countries (either still in operation or not). Most of them manage revenues from hydrocarbons, but others are for mining resources such as diamonds (like the Pula Fund in Botswana) or copper (the Economic and Social Stabilization Fund and the Pension dutch disease Reserve Fund in Chile). Wills et al. (2016) review the literature on SWF and conclude that fighting against DD is one of their 6 main goalsFootnote 3. For instance, in Ghana, the Ghana Stabilization Fund (aimed at smoothing oil revenue over time), the Heritage Fund (to save revenue for future generations,) and the Ghana Infrastructure Investment Fund (to finance infrastructure projects) coexist.
Examples of Dutch Disease
As it happens, even in the event of an appreciation, the GCC countries do not have any substantial exporting manufacturing industries that will contract, meaning that Dutch disease is a non-issue in the GCC. A survey of the best investment strategies would be off-topic here since it is highly country-specific. However, we can briefly underline the balance between investment in physical capital (such as public infrastructure) and in human capital (education or health).
It is also often characterized by a substantial appreciation of the domestic currency. https://1investing.in/ is a paradoxical situation where good news for one sector of the economy, such as the discovery of natural resources, results in a negative impact on the country’s overall economy. That is, exports of energy generate additional revenue for the factory owner and the government (through taxes), hence increasing the demand for tradeable and non-tradeable products in the country. The boom in the energy sector forces labour to move out of trade and service sectors, creating a shortage of manpower in these two sectors. This reduces the output in the trade and service sector due to the gap between supply and demand. At the end, output in the trade sector declines and the service sector stagnates, resulting in the downfall of the economy in the long-run.
What a persistently low oil price does to oil-rich countries is like what a long, cold winter does to people. Without a diversified export base, these countries’ macroeconomic performance quickly worsens and their residents experience income losses. The main remaining question is whether resource revenues which are not used for current expenditure should be saved or invested.
Even though some predictions of this model are specific to the Chadian economy (which suffers from inefficient water management and insufficient food availability), it shows that adequate public investment in the declining sector should be considered. Similarly, Indonesia is often presented as having avoided a decline in non-oil tradable sectors partly through efficient public investment in industrial and agricultural sectors and has been used as a benchmark for many countries (Mogotsi, 2002; Pegg, 2010). Theoretical and empirical studies reveal the role of fiscal and monetary policies to avoid, or at least mitigate, DD, but conclusions on what these policies should be remain mixed. Similarly, it is unclear whether fixed or flexible nominal exchange rates should be preferred to avoid real exchange rate appreciation.
Should We Fear Dutch Disease?
With manufacturing becoming uncompetitive due to higher exchange rate and higher wages, output will fall, and there will be a decline in investment, leading to lower growth. If a country discovers substantial amounts of oil, gas or another natural commodity, it will begin to export these goods causing a substantial increase in GDP; this will improve tax revenues, improve the current account and create employment opportunities. However, countries that have discovered such natural resources have profited far less than we might think. Also following an external perspective, but using a dynamic portfolio model, De Macedo (1982) puts forward the first known DD model specifically dedicated to analyzing a developing country, namely Egypt. He considers the specificity of a multiple foreign exchange system, with an official market rate for oil and a parallel (“gray”) market rate for other tradable goods, allowing for financial flows and holding of foreign money by the residents.
Why Do Some Countries Develop and Others Not?
We describe in this section the lessons that can be drawn from the theoretical and empirical literature relative to the role of macroeconomic policies. Based on two VAR, Kablan and Loening (2012) investigate the impact of oil production and oil prices on manufacturing and on agricultural value-added in Chad. They do not observe any significant impact of oil booms or of oil price variations on the manufacturing sector, but a significant negative impact of energy booms on agriculture after one year, concluding that there was the presence of a disease only for agriculture. Based on annual data for Algeria for 1960–2016, Gasmi and Laourari (2017) test for the presence of a cointegration relationship between the Algerian real effective exchange rate and a set of parameters that includes international oil prices.
The main thematic areas of economic effects from the countries identified in the literature synthesis were then analyzed using trend analysis from a time series of economic variables for each country to represent the respective thematic areas. The trend analysis was then extended to the country of Guyana which is on the verge of an oil boom, primarily to identify if the synthesis can provide any possible indications of potential Dutch Disease effects for the country. The synthesis predominantly showed the impacts of Dutch Disease to manufacturing which had a cyclical and downward trend in its contribution to Gross Domestic Product and impacts to the value of the agricultural sector. The synthesis also showed sporadic economic growth and varying effects on the exchange rate and wages in the country.