Part of an article published in 2004, but it basically tells the story of our economy for the last 20 years. Will be posting this article as part of a series...articles and things that influence my thinking. 1. The Dutch Disease
In a strict sense, the Dutch disease refers to the crowding out of the traditional export sector by a new booming export sector and the non-tradable goods sector. However, in a broad sense, a country is said to have developed the Dutch disease syndrome when an income "windfall" in the economy leads to harmful or adverse consequences including a decline in the traditional sources of income in the country. The income windfall may come from sharp increases in the price (or production) of exportable (tradable) natural resources (e.g. crude oil, cocoa, coffee, diamond, gold, etc) and/or sharp increases in foreign aid or direct foreign investment or loans, resulting in sharp increase in foreign exchange earnings. The Dutch disease syndrome has existed, albeit in a benign form, since nations started trading with each other. However, it derives its current name from the experiences of the Netherland in the 1960s following the discovery and exploitation of large deposits of natural gas in the country's adjoining North Sea. This led to a significant increase in the country's revenue (foreign exchange) and appreciation of the country's currency (i.e. the Dutch guilder became stronger) which in turn led to a reduction in the competitiveness of the non-oil tradable goods sector of the economy. What was otherwise a positive development in the oil sector led to problems in other sectors of the economy including a depression in the non-oil export sector. It was not until the mid 1970s that the Dutch disease took a malignant form in many oil-exporting and some other mono-cultural developing countries as well as in some aid-dependent countries.
Corden and Neary (1982) have demonstrated how Dutch disease occurs in an economy. According to them, in a country experiencing "boom" in the export of a commodity, the economy can be divided into three sectors: the "booming" export sector, the "lagging' traditional export sector and the non-export sector. [b]The Dutch disease occurs when the traditional export (tradable goods) sector is crowded out by the booming export sector and the non-tradable goods sector. The lagging traditional tradable goods sector may include cocoa, palm produce, cotton, rubber, coal, copper, textiles and some manufactured goods while the booming export sector may be crude oil, coffee, gold, etc. The non-tradable (non-export) goods sector covers all those goods that are produced for domestic consumption only, e.g. staple food items, clothing, building materials, locally-assembled cars. Where crude oil (and gas) is the booming export sector, the non-oil export sector may be crowded out by the oil sector and the non-tradable goods sector of the economy. This can happen when the oil revenue windfall increases domestic demand for non-tradable goods and pushes up domestic prices leading to an appreciation of the real exchange rate which in turn reduces the competitiveness of the non-oil export sector. This will in turn lead to a reduction in non-oil exports in both quantum and value terms. The oil windfall may also lead to movement of the factors of production in the economy. For instance, capital and labor (and land) may shift from the non-oil export sector to the oil sector (in order to maintain or increase reserves and production) and the non-tradable goods sector (to take advantage of the growing domestic demand). This explains why the increase in oil prices and the subsequent oil revenue windfall in many oil-exporting countries have tended to depress their non-oil export sector while at the same time generating a boom in both the oil and the non-tradable goods sectors. With capital and labor shifting from the non-oil export sector to the oil-sector and non-traded goods sector, firms in the non-oil export sector are forced to either close down or reduce their scale of operation. The boom in the oil and non-traded goods sector increases the demand for imported goods. This may not be a problem in the short-term so long as the country has enough foreign exchange to pay for the imports. The depression in the non-oil export sector and the boom in the other two sectors have medium to long term implications for the economy because the oil windfall will not be permanent given the volatility, unpredictability and exhaustibility of crude oil. For instance, if there is a decline in oil prices and oil revenue, the lagging and collapsing non-oil export sector will not be able to compensate for the drop in oil revenue while domestic demand for the non-traded goods and imports remain sticky. Consequently, the country will be forced to borrow from the international financial market to compensate for the decline in oil revenue. Over time, external debts will increase and so will the debt service obligations. Even when oil prices go up later and there is another round of oil windfall, it is difficult to correct the earlier damage or distortions created by the initial or previous oil windfall. In some cases, the oil exporting country may be forced to adopt some form of structural adjustment program (SAP) to correct such distortions or imbalances. Some of these SAPs are painful and may increase the prevalence, depth and severity of poverty[/b].
In an extreme case, the Dutch Disease can lead to "Immiserising Growth" syndrome - a situation where increase in the output of exported commodity by a country leads to a deterioration of the country's welfare (Bhagwati, 1958). This happens when the effect of export-led growth on a country's terms of trade is strong enough to more than offset the direct benefits of growth. It is an extreme case of self-defeating growth. Although the theory of Immiserising Growth was not originally developed for oil-exporting countries, its tenets apply to many oil-exporting countries in the sense that despite the substantial increase in their export revenue, they have suffered significant decline in general welfare due largely to mismanagement of their oil revenue. Thus, the Dutch Disease syndrome confirms the assertion by a Spanish writer in the 16th Century that "the gratification of wealth is not found in mere possession or in lavish expenditure but in its wise application". Although the main manifestation of the Dutch disease syndrome in an oil exporting country is the decline or depression in the non-oil export sector, other "collateral" manifestations include appreciation of the real exchange rate at the onset, increase in corruption, increase in external debt and increase in poverty. However, an oil-exporting country must not suffer from the Dutch Disease. Furthermore, not all oil-exporting countries suffering from the disease have all "collateral" manifestations at the same time. Country experiences vary considerably depending on their political economy. The above is the story of our economy from 1973-82,(boom), 1983-2007(bust) 2008-14(boom), 2014-date (bust) Sauce |
