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Dutch Disease

  • liberatomilo
  • May 5
  • 2 min read

Introduction

Can a country be sick, and can increased exports and economic growth be detrimental to an economy? What happened in the Netherlands in the middle of the 20th century may be useful in answering this question, the lessons of which are still relevant today.


What is the Dutch disease and where does it come from?

We call “Dutch disease” the negative impact that the accelerated development of a particular sector (usually linked to the discovery of new endowments of a natural resource) can have on the rest of the economy. Its name goes back to the phenomenon that occurred in the Netherlands from 1959 onwards, when a large natural gas reservoir was discovered in Groningen, in the north of the country. To this day it remains the largest natural gas field in the world.


What is the mechanism like?

The mechanism by which the disease arrives and spreads is mainly through the exchange channel. How does it happen? Basically, the discovery of new endowments of a natural resource (such as gas, oil, or simply a technological discovery that allows for an exponential increase in exports of a particular product) generates an extraordinary inflow of foreign currency that leads to an appreciation of the exchange rate. As we saw in the section on “appreciations and depreciations”, an appreciation of the exchange rate implies - by definition - an increase in the price of all goods produced in the country in relation to those produced abroad. Sure, the newly boosted sector can probably sustain and even expand at a lower exchange rate, but it is also very likely that other sectors that were previously competitive at a given exchange rate, become much less competitive now that the exchange rate has fallen, losing markets. Moreover, when it comes to non-renewable resources (such as hydrocarbons), we know that at some point the fat cows are going to run out... and other sectors had better continue to exist to compensate!

Thus, what could originally be seen as a blessing for the country, which increases activity and exports, can become a problem if the exchange rate effects are not well managed. Especially when the activities that are resigned to a lower exchange rate are more labor or technology intensive.


Is Dutch disease curable? What can governments do?

Like many diseases we are familiar with, the main role that governments, and especially the monetary authority, can play to avoid the problems that Dutch disease can generate, is to prevent it. Basically, when faced with a massive and extraordinary influx of foreign currency resulting from the exponential growth of a particular export activity, what they can do is to make foreign exchange purchases in the foreign exchange market (either through their Central Bank or the Treasury) in order to prevent the exchange rate from appreciating too much. It can also implement a tax regime that can levy a tax on the most competitive activities in order to spread its revenue to other activities that are strategically convenient.


News related:

Guyana Doesn’t Have Dutch Disease, Says Minister, Blames Miners For Hiding Gold. https://www.thestkittsnevisobserver.com/guyana-doesnt-have-dutch-disease-says-minister-blames-miners-for-hiding-gold/


Norway’s North Sea Oil and ‘Dutch Disease’


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