Dutch Disease

What is the Dutch Disease?

The Dutch disease refers to economic problems that occur when a sudden increase in natural resources leads to a fall in other sectors of an economy. This economic disease is mainly associated with the sudden discovery of natural resources in a country, followed by the negative economic consequences. The resource-rich countries may experience economic decline or an imbalance due to the ill treatment of these natural resources.

In economics, Dutch disease occurs when a sudden increase in revenue from the exports of natural resources like oil, gas, or minerals leads to currency appreciation, making other industries less competitive. Other industries may include manufacturing and agriculture.

Historical Background

The Dutch disease phenomenon was observed in the 1970s. The term Dutch disease was used in 1977 by The Economist magazine, referring to the bad experience in the Netherlands when natural gas was discovered there in 1959. Due to this gas discovery, there was a huge increase in the exports of gas from the Netherlands. The Dutch currency appreciated due to the huge inflow of capital due to the exports of natural gas. As a result, other sectors of industry, especially manufacturing sectors, remained underdeveloped, leading to their decline. The Netherlands faced negative economic consequences in the form of currency appreciation, less competitive manufactured products, high unemployment, and a decline in other sectors of industry due to the Dutch disease.

Example 

Let’s take an example of a country that relies mainly on newly discovered natural resources (oil, gas, metals, or minerals) for its export revenue. This country earns revenue from exporting natural resources. When the demand for these natural resources is high in other countries, this country enjoys an increase in revenue from exports of natural resources. As a result, the value of this country’s currency increases. This currency appreciation makes other sectors, like agriculture and manufacturing industry, less competitive in the global marketplace. As a result, these sectors start to decline because they compete with cheaper imports. This country has become dependent on oil experts; hence, the economy of this country remains imbalanced and is exhibiting the symptoms of Dutch disease. 

Causes of the Dutch Disease

The following are some major causes of Dutch disease:

Discovery of Natural Resources

The main cause of the Dutch disease is a sudden discovery or an increase in the extraction of natural resources. A huge volume of exports of the natural resource sector will increase export revenue, leading to the appreciation of local currency. This will make other sectors less competitive in the global market. That is why, the Dutch disease if often considered as a natural resource curse.

Other Causes

The other causes of the Dutch disease may include the sharp increase in the prices of natural resources in the world market, financial aid or assistance from other countries, and an increase in foreign direct investment (FDI). All of these will lead to a huge influx of foreign currency into the economy, leading to currency appreciation.

Effects of the Dutch Disease

The following are some effects of the Dutch disease:

Economic Imbalance

The economic imbalance in a country’s economy occurs due to Dutch disease because the over-reliance or total reliance of a country on a specific booming sector negatively affects other sectors such as agriculture and manufacturing, which face a decline in economic growth in those sectors.

Currency Appreciation

When a country experiences a surge in revenue from resource exports, it can lead to currency appreciation. This makes non-resource sectors less competitive in the international market as their goods and services become more expensive.

Decline in Non-Resource Industries

As the resource sector becomes dominant, non-resource industries may struggle to compete. This will result in a decline in job opportunities, investment, and innovation of new products in these sectors.

Vulnerability to Price Volatility

Countries heavily dependent on resource exports are more vulnerable to price fluctuations in global markets. A decline in resource prices can have a significant impact on country’s revenue and overall economic stability.

Lack of Diversification

Dutch disease can hinder economic diversification, as the focus remains on resource extraction and export. This lack of diversification makes it difficult for a country to bear economic shocks due to the shift in global market conditions.

Higher Imports

Following the appreciation of domestic currency, imports become cheaper. Even the domestic producers find it difficult to compete with these imports. A higher volume of imported products, especially luxury goods and luxury services, means that domestic producers will not gain much.

Income Inequality

Higher revenue from the exports of natural resources (like oil exports or gas exports) will benefit a small percentage of the population, leading to income inequality.

Precautions for Dutch Disease

The following points explain precautions for Dutch disease:

Promote Economic Diversification

Encourage investments in non-resource sectors to reduce dependence on the resource sector and mitigate the impact of Dutch disease.

Develop Human Capital

Invest in education and skills training to develop a diverse and adaptable workforce capable of thriving in various industries.

Implement Effective Resource Management

Establish transparent and accountable resource management practises to ensure sustainable extraction and optimal utilisation of resource revenues.

Foster Innovation and Technology

Promote research and development, innovation, and technology adoption across different sectors to enhance productivity and competitiveness.

Strengthen Infrastructure

Improve infrastructure, such as transportation, energy, and telecommunications, to support the growth of non-resource sectors and facilitate economic diversification. This can be done by using the revenue from the exports of natural resource booms.

Encourage Export Diversification

Explore new markets and diversify export destinations to reduce reliance on a single market and minimise the impact of real exchange rate appreciation.

Foster Small and Medium Enterprises (SMEs)

Support the growth of SMEs through access to finance, training, and business development services, as they can play a crucial role in diversifying the economy.

Enhance Trade Policies

Develop trade policies that promote competitiveness and facilitate the export of non-resource goods and services.

Implement Countercyclical Fiscal Policies

Establish fiscal policies that save resource revenues during boom periods and use them wisely during downturns to stabilise the economy.

Strengthen Institutions and Governance

Foster good governance, transparency, and accountability to ensure effective management of resource revenues and promote economic stability.

Doctor’s Orders to Address Dutch Disease

The following are some orders given by the economists to address the Dutch disease:

Economic Diversification Prescription

Focus on diversifying the economy by investing in non-resource sectors and promoting innovation and entrepreneurship.

Currency Management Treatment

Implement measures to manage currency appreciation, such as monetary policies or currency controls, to support non-resource industries and maintain competitiveness.

Resource Revenue Stabilisation Therapy

Establish mechanisms to stabilise resource revenues, such as creating sovereign wealth funds or saving during boom periods, to mitigate the impact of price volatility.

Infrastructure Enhancement Prescription

Improve infrastructure development in non-resource sectors to enhance their productivity, efficiency, and competitiveness.

Policy Coordination Medication

Foster coordination among government agencies, policymakers, and stakeholders to develop comprehensive strategies that address Dutch disease and promote sustainable economic growth.

Development Implications of Dutch Disease

The following points explain the development implications of Dutch disease:

Economic Dependence

The dependence of a sector on specific resources can totally hinder the development of other industries; this will cause the Dutch disease. The economic dependence on only a single sector makes it difficult for an economy to bear economic shocks and price fluctuations (like a sudden decrease in the commodity prices).

Limited Diversification

The appreciation of the currency due to resource exports can make non-resource sectors less competitive. The limited diversification of a country’s economy reduces its ability to develop a powerful industrial base.

Job Market Challenges

Dutch disease can result in job losses in non-resource sectors as they struggle to compete with the resource sector. These job market challenges cause unemployment or underemployment in the labor markets, especially among different workers in different industries (labor-intensive industries), which was affected by the currency appreciation.

Inequality and Poverty

The concentration of wealth and economic activity in the resource sector can exacerbate income inequality. The uneven distribution of resource wealth can cause disparities in income and living standards among individuals in a country. This will cause poverty in that country.

Volatile Economic Growth

The reliance on resource exports can make the economy susceptible to commodity price fluctuations. This can lead to volatile economic growth with periods of boom and bust, which can hinder long-term development planning and stability.

Government Policies to overcome Dutch Disease

The following are some government policies that are implemented in sectors to reduce the impact of the Dutch disease:

Diversification Efforts

The development of non-resource sectors like those that provide incentives for investments, support entrepreneurship, and promote innovation can be encouraged by government policies to overcome the impact of Dutch disease on the economy.

Resource Revenue Management

Effective management of resource revenues is crucial. Governments can establish funds to save and invest resource revenues for the long term, ensuring that they are used wisely to benefit the economy and future generations.

Exchange Rate Policies

Governments can adopt exchange rate policies to prevent the currency from becoming overvalued. This can involve interventions in the foreign exchange market or implementing measures to manage currency fluctuations.

Skill Development and Education

Investing in human capital is essential to addressing the challenges of Dutch disease. The government introduces different training programs or education to train or equip the workforce with skills that are highly demanded in the market to accurately allocate resources.

Institutional Reforms

Strengthening institutions and governance frameworks is important to effectively manage resource wealth and promote economic diversification. Governments can implement measures to improve transparency, accountability, and the business environment.

Conclusion

In conclusion, Dutch disease occurs when a sudden increase in the revenue from resource exports, such as oil or gas, leads to the appreciation of the real exchange rate, making other industries less competitive. A sudden natural resource abundance is the main cause of the Dutch disease. Government policies such as institutional reforms, skills development, and education can overcome the negative impact of the Dutch disease.