Dutch disease

The Dutch disease refers to the problems associated with a rapid increase in the production of raw materials causing a decline in other sectors of the economy. When the raw materials run out, the economy can be in a worse position than before.


If a country discovers substantial amounts of oil, gas or other 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. But, often countries who discovered oil have gained much less than you might expect.

These are the likely economic effects of discovery oil / gas.

1. Appreciation in currency. Due to the discovery of oil and increase in exports, the country will see an appreciation in the exchange rate. This is because higher demand for exports lead to increased demand for Sterling. For example, in the late 1970s, the UK saw a rapid appreciation in Sterling after the discovery of North Sea oil.

2. Decline in competitiveness. The problem of this appreciation in the exchange rate is that other trade-able sectors of the economy will become uncompetitive. Manufacturing industries will see a substantial fall in demand, due to the higher exchange rate. Therefore, the economy will shift from manufacturing towards the primary sector. In the early 1980s, UK manufacturing output fell significantly as a result of the appreciation in the Pound.

3. Growth in luxury imports. Higher output of oil will enable those who benefit to spend on luxury goods and luxury services. These luxury goods tend to be imported meaning that domestic firms gain little benefit.

4. Growth in real wages. Due to the increased wealth and spending on services, there will be higher demand for service sector workers (waiters, hairdressers, chauffeurs e.t.c). This will cause rising real wages in the economy, causing another problem for manufacturing firms as they have to increase real wages to retain workers. This will further decrease competitiveness of manufacturing exports.

5. Indirect-deindustrialisation. 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. These sectors will begin to lag behind other countries. It can be very difficult to catch up later.

5. Income inequality. Often the discovery of raw materials, such as oil benefits a relatively small percentage of the population. Those who own the oil fields can see huge wealth, but the benefits of oil and gas are often not equally distributed within society. Workers may benefit from rising real wages in the service sector, but the discovery of raw materials often creates a few billionaires, so the increase in GDP is often concentrated in the hands of a small number. In several developing economies, oil fields are developed by foreign multinationals, causing some of the wealth to be taken away from the country.

6. Tax revenue. High output of oil and gas can lead to substantial tax revenues for the government. The government has the ability to run a budget surplus and spend more on public services, such as infrastructure and education. But, the government will often cut other taxes and come to rely on oil tax revenues.

When the oil runs out

Many countries who produce raw materials may find the high output only lasts for a few years. But, when the oil runs out, the economy has been adversely affected and struggles to catch up where it left off.

Manufacturing export industries have shrunk and fallen behind. Because of declining output and investment, it can take many years for the exporting industries to catch up. Therefore, post oil economies can struggle with lower economic growth.

Current account deficit. With oil exports, countries can run a current account surplus, but when oil exports drop their old exporting industries have faded away so they are left with large current account deficits,

Falling tax revenue. With oil, governments find it easy to raise tax revenue. But, when oil revenues dry up, they need to raise taxes on income and spending which can lead to lower growth and lower living standards. Ambitious government spending patterns have to be curtailed.

Unemployment. With falling GDP, the demand for high end services will decline, causing unemployment amongst many service sector workers.

Examples

The term ‘Dutch disease’ was first coined by the Economist in 1977 to describe the decline in Netherlands manufacturing after the discovery of gas fields in the early 1960s. Many African countries have struggled to post rising living standards after the discovery of oil. The UK process of de-industrialisation was sped up by the discovery of North Sea oil and the appreciation in the Pound.

How to Prevent Dutch Disease

Limit the rise in the real exchange rate. For example, China limited it’s real exchange rate by purchasing US bonds to keep the value of the relatively Yuan lower.
Reduce foreign capital flows. If a country moved from a budget deficit to a budget surplus, it would attract less foreign investment to purchase the government bonds. Lower capital inflows would limit the rise in the exchange rate.
Spend proceeds of oil revenue on infrastructure and education. The government could earmark taxes from oil to be spent on improving the infrastructure of an economy – better public transport, better education, subsidies for investing in technologies with positive externalities. All these can help improve the competitiveness of manufacturing export industries and help them deal with higher wages and higher exchange rate.
Immigration. Many oil rich economies have encouraged immigration to provide service sector jobs, this keeps real wage growth down.
Sovereign wealth funds. A sovereign wealth fund is a government saving scheme, where income from oil revenues is not spent but saved to give a future income stream. E.g. Government pension fund in Norway.
Greater equality of distribution. This paper at the World Bank states that the ‘Dutch Disease’ effect is worse when wealth is concentrated in the hands of a few billionaires – because there is marked increase in luxury goods and luxury services. Greater income distribution enables a more diverse economy.
Higher tax on luxury services and luxury imports. This would prevent the economy becoming too skewed towards a luxury services which may not be sustainable in the long-term.

Nice.

Nigeria, which clocks in at 2 million barrels a day and is Africa’s largest exporter, clearly displays the damaging effects policy myopia can have on a resource rich country.

Beset by terrorism, both in the underdeveloped north where Boko Haram has managed to extend its control over a considerable chunk of territory, and in the oil-rich south, where insurgent militias have blackmailed government after government with attacks on key oil infrastructure, Nigeria has oftentimes seen just the flipside of its natural wealth. Worse, when oil was discovered in the 1950s, the country’s GDP/capita was equal to Indonesia. In 2000, Indonesia’s GDP/capita was actually twice as big as Nigeria’s – $377 versus $789. In spite of oil revenues estimated at some $350 billion over three decades, it seems that the average Nigerian was actually worse off in relative terms.

Nowadays, oil and natural gas account for 35% of Nigeria’s GDP, 80% of total government revenue and 90% of exports. The country’s 2015 budget balances out at $65 per barrel, a benchmark that looks unrealistic at this point, which has prompted the country’s finance minister to announce painful austerity measures. Even if the currency (the naira) lost 13% of its value last year and is expected to lose even more this year, slightly offsetting the fall in oil prices, the budgetary math simply does not add up. Nigeria ‘s finances are also in a vulnerable state. Unlike other resource-rich countries, its oil fund shrunk to just $4 billion in 2014 – a paltry figure for a $550 billion economy.

The spell of oil has transfixed the leaders and the rebels of this country alike. For the past two decades, presidential elections have been held in a general atmosphere of horse-trading, with the central government paying off the southern rebels in exchange for promises they will not sabotage its pipelines and refineries. A Presidential Amnesty Program, which pays monthly stipends to ex-militants, has been in place since 2010, after a series of debilitating attacks on Nigeria’s oil infrastructure.

But Nigeria still has much untapped economic potential. All 36 states in the country can boast at least three mineral resources, ranging from iron-ore to gold to rock salt. Under the current administration, the GDP expanded and overtook South Africa as the continent’s largest economy, powered in part by a sprawling services sector, which captured a share of 51% of the economy (up from 26%). The government has also put in place an ambitious agricultural policy that seeks to transform Nigeria into one of the world’s biggest rice producers. Taken together, these policies show that the country has enough assets to replace declining oil revenues.

Unfortunately, the country is bound to experience new episodes of political and social instability this year, against the backdrop of the February presidential elections. The two contenders, incumbent Goodluck Jonathan and opposition figure Muhammadu Buhari, a former military strongman from the 1980s, will square off on February 14. The latter is a contested figure in Nigeria’s history – from his commitment to Sharia law to his questionable ties with Boko Haram insurgents, who once named him as trusted mediator, to his flabbergasting electoral promise that he will stabilize world oil prices. The outcome of the election will be a litmus test for Nigeria’s democratic future.

The case for Nigeria to move away from its reliance on oil is quite compelling, as the country[b] is almost a textbook case of the Dutch disease[/b], coupled with oil-fueled political instability. It just needs the political will to see through structural reforms. Falling oil prices can do just that.

this has become useful for my tomorrows project so grateful .. kumoooo. thanks [color=#990000][/color]