Dutch Disease

 

Dutch Disease

 

A discovery or exploitation of a valuable natural resource that leads to an appreciation in the value of a country’s currency is usually perceived as a good thing. But do long-term repercussions from the same exist?

Geologists have recently found huge lithium deposits in J&K and Rajasthan, whose value is estimated to be upwards of $410 billion. Can this discovery of ‘white gold’, if not for proper government intervention at the right time, prove to be paradoxically disadvantageous for the country?

The term ‘Dutch Disease’ was coined by The Economist magazine back in 1977 following a publication analyzing a crisis that occurred in the Netherlands following the discovery of huge amounts of natural gas reserves and deposits in the North Sea. The term then became widely used in economic circles to describe the paradoxical situation in which seemingly good news negatively affects a country’s economy.

Natural Gas reserves were discovered in the Netherlands in 1959. This discovery led to a significant spike in the price of the Dutch ‘Guilder’ relative to other currencies which caused an unfavorable impact on Dutch manufacturing which experienced de-industrialization as resources were diverted toward energy extraction activities.

The influx of foreign capital due to the discovery coupled with rising oil prices exacerbated this trend leading to a decrease in competitiveness for non-energy-related industries. As a result, many factories had to close or significantly reduce their production levels leading to job losses and economic decline.

The Dutch oil and gas industries started to grow in the 1960s but it wasn’t until the 1970s that the unfavorable effects of the Dutch disease started showing up in macro eco data. The unemployment rate increased from 1.1% in 1970 to 5.1% in 1977! This was caused by a sharp decrease in the manufacturing sector.

Manufacturing started the decade off at 23% of GDP. By the end of the decade, manufacturing had fallen to less than 16% of GDP.

But how can a country’s economy suffer due to the discovery of something as valuable as natural gas? It all comes down to the appreciation of the Dutch currency i.e. the guilder. Foreign customers needed to convert their currencies into guilders to buy Dutch gas and oil. This increased demand and caused the value of the currency to increase. Increased demand for the product caused the currency to increase.

 For reference, in 1970 it took around 3.5 guilders to buy 1 USD but by 1980 it cost only 2 guilders to buy 1 USD. This was an almost 50% appreciation!

So how exactly does currency value affect a country's manufacturing and export sectors? When a country’s currency value increases relative to other countries, the price of the goods and services of that country increases. Imports do become cheaper but this ultimately decreases the country’s export output due to high prices.

Taking the case of the Netherlands, the price of exports of almost everything other than the much-in-demand natural gas and oil shot up along with its currency. This led to shutdowns in factories and worker layoffs.

Other than the Netherlands, many other countries have also experienced the Dutch disease. Countries like Venezuela, Russia, and Nigeria rely heavily on natural resources for economic growth. The effects of this phenomenon can be seen in these countries in the form of reduced investment in manufacturing and servicing industries, temporary strengthening of their currencies, and an overall decrease in their competitiveness.

Another example is Great Britain. In the 1970s, the price of oil quadrupled, making it economically viable to drill for North Sea Oil off the coast of Scotland. By the late 1970s, Britain thus became a net exporter of oil even though it had previously been a net importer. Although the value of the pound skyrocketed the country fell into a recession as Britain’s other exports became uncompetitive and workers went on strikes, demanding higher wages.

In 2014, economists in Canada reported that the influx of foreign capital related to the exploitation of the country's oil sands may have led to an overvalued currency and decreased competitiveness in the manufacturing sector.

Fortunately, some measures can be taken to prevent or mitigate Dutch Disease from occurring. Governments should strive to diversify their economies by promoting investments in non-energy-related sectors such as agriculture or tech-based industries to reduce reliance on natural resources. Furthermore, they should also strive towards implementing sound Fiscal policies which promote long-term economic growth. Additionally, policies such as floating exchange rates and trade controls can help control the negative effects of the Dutch disease by increasing the competitiveness of domestic industries.

So are there any countries that were successful in avoiding this disease?

Much like the Netherlands, Norway has a large oil and gas extraction industry, rising oil prices in the 1970s resulted in an increase in their currency value and a shift in economic activity towards natural resources. The Norway government used the oil money to do 3 main things:

Firstly, they invested much of the oil revenue into a sovereign wealth fund. This pulled money out of the real economy and limited the appreciation of their industry. It also created investment returns that the government can use once their oil eventually runs out.

Secondly, they used some of the remaining oil revenue to subsidize non-oil industries including the agriculture and industrial sectors. These subsidies helped offset much of the lack of international competitiveness caused by currency appreciation.

Lastly, they spent the remaining money on social welfare programs including unemployment insurance and job training services. This softened the blow for people who did lose their jobs. Therefore even though they faced some negative effects, it was to a much lesser extent than what the Dutch faced.

Recently, Gulf countries such as Qatar Saudi Arabia, and the United Arab Emirates have spent 100s of billions of dollars of their oil money to subsidize their tourism industries. Qatar spending billions on the 2022 FIFA WC is a prime example of this. Saudi Arabia plans to spend upwards of $1 trillion to develop their new futuristic city, Neom. By subsiding non-oil industries they are trying to counteract the unfavorable impact of the Dutch disease in a way similar to what Norway did in the 1990s.

 In conclusion, the Dutch disease has had a significant impact on many countries around the world with some still struggling to recover from its aftereffects. Therefore governments need to be proactive in taking preventative measures. Governments can ensure that their countries are less susceptible to any potential damaging impacts of this economic phenomenon and can promote sustainable long-term growth.