Dutch disease

How countries see uneven growth due to the sudden discovery of natural resources

Dutch Disease in economics refers to a phenomenon wherein a country witnesses uneven growth across sectors due to the discovery of natural resources, especially large oil reserves. According to the concept, when a country discovers natural resources and starts exporting them to the rest of the world, it causes the exchange rate of the currency to appreciate significantly and this, in turn, discourages the exports from other sectors while encouraging the import of cheaper alternatives.

While the idea was first proposed by economists Peter Neary and Max Corden in 1982, the term ‘Dutch disease’ was first coined by The Economist in 1977 to describe the decline of the manufacturing industry in the Netherlands.

In the 1960s, the Netherlands discovered gas reserves in the North Sea. The subsequent export of oil and the appreciation of the Dutch currency made Dutch exports of all non-oil products less competitive on the world market. Unemployment rose from 1.1% to 5.1% and capital investment in the country dropped. Following this, over the years, the country witnessed a downfall in the industrial sector.

According to a recent research paper titled “40 years of Dutch Disease literature: lessons for developing countries”, by Edouard Mien and Michael Goujon, the framework of the model of the phenomenon is based on three sectors: energy (traditionally oil, gas or mining resources), tradeables, and non-tradeables of a small economy. As labour and capital are immobile internationally, the Dutch disease is a “purely domestic phenomenon” which cannot be “exported.”

The model is concentrated on the spending and resource-movement effects. 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.

However, there are theories that contradict this model. For instance, Fredrick van der Pleog in 2011 explained that if the trade or manufacturing sector is more capital-intensive than the service sector, then the boom in the energy sector will be shifted to the trade sector resulting in an absolute fall in the service sector.

 Mien and Goujon also focus on what the developing resource-rich countries should do to avoid the occurrence of the Dutch disease.