It may start with a significant infusion of foreign finance to capitalize on a newly discovered resource. A rising currency value causes a reduction in exports and the loss of jobs to foreign nations as symptoms. Finally, empirical investigations are required to understand the impact of fiscal and monetary policies and how they can prevent DD, or at least offset its most negative effects, without ignoring a major source of revenue.
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. Both oil price increases and oil discoveries affect long-term non-oil tradable prices.
- But, we noticed, there was a contrast between “external health and internal ailments”.
- This is also confirmed by multiple time-series analyses which find evidence of DD in some countries but not others.
- When E is an input for N and T, a rise in price reduces profitability in N and T, limiting the spending effect.
- Inversely, a decline in tradable sectors can occur with no strong evidence of RER appreciation.
- 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.
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. Using an ARDL Bound Approach, they reject the hypothesis of a cointegration relationship among the variables, which they interpret as evidence that no spending effect occurred in Algeria, an oil-exporting country. They argue that this absence of spending effect can (partly) be attributed to the exchange rate regime which maintained a stable real exchange rate against a basket of currencies. The main remaining question is whether resource revenues which are not used for current expenditure should be saved or invested.
After the discovery of major natural gas resources in 1959, The Economist magazine used the phrase “Dutch Disease” in 1977 to describe the economic condition in the Netherlands. In this case, an increase in E prices encourages consumers to shift from E to N and T, reinforcing the RER appreciation. When E is an input for N and T, a rise in price reduces profitability in N and T, limiting the spending effect. 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 also struggled to enable rising living standards after the discovery of oil.
In several developing economies, oil fields are developed by foreign multinationals, causing some of the wealth to be taken away from the country. In economics, Dutch disease is the apparent causal relationship between the increase in the economic development of a specific sector (for example natural resources) and a decline in other sectors (like the manufacturing sector or agriculture). A rise in revenue from the exploitation of natural resources will cause the exchange rate to appreciate, making local products, particularly those from the manufacturing sector, less competitive in the international market. It is frequently difficult to determine whether a country has Dutch disease since the link between an increase in natural resource income, the real exchange rate, and a drop in the trailing sector is difficult to show.
Data availability
The deceleration of currency appreciation is an easier and more viable strategy to prevent the adverse effects of Dutch disease. It can sometimes be achieved by smoothing the spending of revenues earned from the export of natural resources. Dutch Disease is a word used in economics to describe the negative effects that might result from a sudden increase in the value of a country’s currency.
This disequilibrium either results in an excess demand for non-tradable goods (if excess supply of money), reinforcing the real effects of Dutch disease, or in an excess supply of non-tradable goods (if excess demand for money), counterbalancing them. However, in the long term, the trade balance and the money market are assumed to return to their equilibrium determined by real factors. Neary (1982) also investigates this impact of resources on the money market but focuses on the role played by exchange rates. Under flexible exchange rates, the additional income generated by resource exports results in an excess demand for money, hence in a nominal exchange rate appreciation.
Finance & economics August 12th 2017
First, it requires an efficient tax system, able to tax the resource sector and redistribute revenues to other sectors without losses during the process, which might not be possible in countries where governance is weak. If natural resource abundance tends to encourage corruption, then the corruption channel of RC might reduce the willingness or ability to mitigate DD effects, which in return may feed institutional corruption through redistribution of wealth and revenue across sectors. Second, redistribution requires the identification of the sectors that will suffer most from DD consequences, which necessitates an efficient information and analysis system.
Differing Approaches for Modeling Dutch Disease
The phenomenon of Dutch disease commonly occurs in countries whose economies rely heavily on the export of natural resources. According to the comparative advantage model, each country should specialize in the industry in which it possesses a comparative advantage over other countries. The term Dutch disease was coined by The Economist magazine in 1977 when the publication analyzed a crisis that occurred in The Netherlands after the discovery of vast natural gas deposits in the North Sea in 1959.
It describes the original model of dutch disease and some main extensions proposed in the theoretical literature, focusing on the ones that match developing countries’ conditions. It then reviews various empirical studies that have been conducted and provides evidence that the Dutch disease is still an issue for many developing countries. Finally, it discusses the gaps in the theoretical and empirical literature for understanding the suitable policy instruments to cope with Dutch disease.
Based on these observations, they conclude that there was no DD in Nigeria, and turn to other explanations for the RC, such as rent-seeking behaviors. 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.
It can be defined as “the resource-induced revaluation of the real exchange rate” (Paldam, 2013) and the subsequent decline in the non-resource tradable sector. DD was a popular explanation for the de-industrialization process experienced by several resource-rich developed countries in the 1970s and 1980s. Neary (1982) introduces monetary aspects and shows the impact of DD on nominal variables. He uses a simple monetary model, https://1investing.in/ firstly assuming flexibility of prices and wages where the real exchange rate is the relative price of N (services) to the price of T (measured by the nominal exchange rate when the foreign prices are fixed). Secondly, he assumes a boom in E leads to excess demand of N (through the spending and the resource-movement effects). However, the rise in income also raises money demand, decreasing prices if the money supply is fixed.
It may be easier to use macroprudential policies to rein in overlending to the commodities sector during the boom years. In the long run, when manufacturing jobs migrate to lower-cost nations, these factors may contribute to unemployment. Non-resource-based industries, on the other hand, suffer as a result of the greater income created by resource-based companies.
