What is dutch disease

The same political economy factors, however, also make the application of this idea difficult. The elites in these countries often cling to their monopoly power over the control of natural resources. Public service jobs, subsidies, and other forms of transfers are typically geared to ensure political clout and survival.

Therefore, in most cases, not only a sound macroeconomic framework, but also a deep transformation of the state-society relationship is paramount to curing the disease. How can such a fundamental transformation be achieved? That is the billion-dollar question. Transferring at least a share of the revenues directly to people would be a good start. Future Development. The Future Development blog informs and stimulates debate on key development issues.

This blog was first launched in September by the World Bank and the Brookings Institution in an effort to hold governments more accountable to poor people and offer solutions to the most prominent development challenges. Continuing this goal, Future Development was re-launched in January at brookings. The first two measures are adopted by virtually all countries, even though they do not admit that they are managing their exchange rate.

The third one is only necessary for countries that face the Dutch disease. The fourth one is a measure to be adopted only in situations of excessive pressure for appreciation of the local currency. Conventional economics naturally rejects the idea of managing the exchange rate. The countries that have international reserve currency are those that are less able to manage their exchange rate because this would reduce the confidence of financial agents.

Probably for that reason conventional economics attaches much less significance to the exchange rate than it actually has, and denies the possibility of managing the exchange rate in the medium term despite all historical evidence.

The neutralization of the Dutch disease can be completely achieved by two measures. First, a tax or contribution on the sale of the goods that give rise to it will do the job. This tax should correspond to the percent difference between the current equilibrium exchange rate provided by its lower cost and the industrial equilibrium exchange rate that opens the way for tradable sectors in state-of-the-art technology. Second, the neutralization is completed by the creation of an international fund with the resources derived from this tax; the fund will prevent that the inflow of the tax resources re-appreciates the exchange rate.

This was essentially what Norway did after it discovered and began to export oil from the North Sea. Great Britain, that discovered oil at the same time, did not neutralize the Dutch disease and its economy suffered the consequences Chatterji and Price, Chile also neutralizes adequately the Dutch disease by heavily taxing copper exports, but this is a partial neutralization, since the revenue from the tax is not directed to the establishment of an international fund.

Every oil-producing country taxes its exports, but usually at a level that is unable to neutralize the Dutch disease. Usui studied the cases of Indonesia and Mexico and showed that whereas Indonesia adequately neutralized the Dutch disease, Mexico did not.

Higher fiscal discipline in Indonesia made it possible for this country to buy and sterilize reserves in order to prevent an exchange rate appreciation, paying a very low interest rate for such acquisitions.

The direct way of neutralizing the Dutch disease is through a tax on sales and exports. The desired effect of the tax is microeconomic: it shifts upwards the supply curve of the good in order to bring up its marginal cost approximately to the level of the other goods.

I say approximately because there is no simple way of estimating the necessary rate of this tax. The tax rate, m, must be enough to cancel or to zero the Dutch disease. Therefore, it must be equal to the intensity of the Dutch disease divided by the ratio between the current equilibrium exchange rate and the industrial equilibrium exchange rate of this product:.

The tax or contribution on sales should, therefore, be different for each product according to the intensity of the Dutch disease it causes. Thus, to determine the tax q i for each product i, we should use the ratio between the market price and the necessary price of each good, which we have already seen that are proportional to the two exchange rates. We have, therefore,. Besides, it should vary in time, because the intensity of the Dutch disease will increase or decrease depending on the international price of the good.

The law that creates the tax should leave the task of defining this rate and varying it in time to the economic authorities that manage the tax. According to the above defined terms, neutralizing the Dutch disease appears to be a simple task, but actually it can be very difficult.

First, because the government will have to face the resistance of exporters of the commodities giving rise to the Dutch disease.

Assuming that this depreciation is obtained mainly by a transitory imposition of inflow controls, the export tax will later enable and ensure that the exchange rate stabilizes at the industrial equilibrium level. Of course, there is a problem here of transition costs from a position to another, which must be taken into account and offset by the government.

On the other hand, if the country has a significant weight market share in the international supply of the good, the tax can also have the effect of increasing its international price. This effect shall probably be small but cannot be neglected, because the increase in international prices due to the tax worsens the Dutch disease that the tax aims to neutralize.

Secondly, the tax faces a macroeconomic difficulty since it implies a transitory rise in inflation. A cooling down of the economy during transition may reduce this transitory increase in inflation, but will not cancel it. A third and fundamental problem is the decrease in wages caused by the depreciation of the local currency.

Effective depreciation minus inflation is by definition a change in the relative prices in favor of tradables, whose relative price increases as compared to the price of non-tradables.

Whereas currency is overvalued because of the Dutch disease, wages are artificially high because people is directly benefiting from the Ricardian rent. The country is producing all the goods with state-of-the-art technology, and there is no protection. The wage earners or consumers, however, lose in the short run in terms of well-being, because this is the condition for neutralizing the Dutch disease. The creation of a tax that neutralizes the Dutch disease by appreciating the domestic currency implies, therefore, the decrease in the actual returns on labor and on real property rents, even after corrected for inflation.

It also implies a relative decrease in the revenues of the producers of non-tradables, such as hotel industry, building industry, etc. When the tax is created, the Ricardian rents remain in the country, but they now become State revenue. We understand, therefore, that it is not easy to create this tax, from a political point of view. In the fourth place, not many countries have as Norway political conditions for allocating the whole revenue from the tax to set up funds abroad, as well a stabilization fund of exported commodities.

This is the case of Chile, for instance. However, although we should not confuse this fund with reserves obtained by countries with domestic indebtedness, the formation of those reserves is an indication that, after all, the creation of neutralizing funds is not as difficult as we could imagine.

It is understandable, therefore, that countries severely affected by the Dutch disease, such as Saudi Arabia or Venezuela, have difficulty neutralizing it. All the oil-exporting countries encumber oil export with taxes, but usually the tax has merely fiscal purposes and the tax rate is unable to compensate for the overvaluation caused by the disease. The state lacks power to levy a higher tax, whether because even the exporting companies of the goods resist, or because the population as a whole resists the increase in the prices of all tradables, both imported and produced locally, caused by the depreciation.

Once neutralized the Dutch disease by the tax and the creation of the international fund, the two equilibrium exchange rates become reasonably identical. The country will be living its everyday life as any other country, and will be using its Ricardian rents to set up a fund abroad that will yield future benefits. We may identify two situations of Dutch disease: the one that have always existed and prevented industrialization, as is the case with oil-producing countries; and the situation of the country that, for a while, succeeded in neutralizing the disease and therefore developed, but, from a certain time on, in the name of a radical liberalism, eliminated the mechanisms of neutralization and began to grow at very low rates, as is the case with Latin American countries that underwent liberalizing reforms without replacing the old system of duties and subsidies by a more rational system of taxes on sales of commodities giving rise to the disease.

The most important symptoms of Dutch disease are exchange rate overvaluation, low growth of the manufacturing sector, fast increase in the services sector, high average wages, and unemployment Oomes and Kalcheva, Notwithstanding unemployment, Dutch disease implies artificially high wages. However, wages may also be low, because the workforce is abundant and disorganized in the country.

The distribution of Ricardian rents involved in the Dutch disease will vary from country to country depending, therefore, on the pressure or rent-seeking ability of the various groups. Countries affected by the Dutch disease either have been exporting a natural resource for a long time but never achieved industrialization, or achieved industrialization for some time but later engaged in a process of premature de-industrialization.

In the first case, the country has never neutralized the Dutch disease, which takes on a relatively permanent quality. Its obvious symptom is the fact that this country does not produce other tradables but those benefited by the Ricardian rents of the Dutch disease. This is certainly the case of the country Z1 and probably of Z2. Saudi Arabia or Venezuela are good examples of this case. As a consequence of liberalization, the effective-effective exchange rate actually appreciates, if we take into account, when measuring the exchange rate before liberalization, the duties and subsidies that made it actually more depreciated.

The appreciation is not immediately perceived, since it is disguised by the fact that part of the appreciation results from the elimination of duties and subsidies. If the disease is not very intense, as in the case of country Z3, the symptoms of de-industrialization shall not be clear, although they would be reflected in the decreased participation of the manufacturing industry in the domestic product and in net exports in terms of value added.

Generally, however, the now overvalued exchange rate will gradually compromise the tradable sectors, one by one. Faced with the fact that their foreign sales are no longer lucrative, and that the import of competing goods is growing, enterprises will first redouble their efforts to increase productivity; then, they will reduce or suspend exports, or will increase the participation of imported components in their production, in order to reduce costs; ultimately, along this process, they will become mere importers and manufacturers of the good they re-export or sell on the domestic market.

De-industrialization is under way. The sales of manufacturing companies and even their exports may continue to present high values, but their value added will decrease, as well as their value added per capita, as we shall see later, because the components with higher technological content will be increasingly imported. They begin then to develop empirical demonstrations to deny the fact. More radical economists will declare that even if de-industrialization is taking place, it does not prevent economic growth.

Yet, not only the data but also the very logic of appreciation without a decrease in the trade balance surplus indicate that the Dutch disease is present and effective. Another symptom of Dutch disease and of premature de-industrialization, besides the decreased participation of manufacturing industry in the product, the increase in the imported component in production, and the relative decrease in exports of manufactured goods measured in terms of value added, is the gradual decrease in the export of high value-added goods.

As in the participation of exports of manufactured goods in general, the participation of manufactured goods with high technological intensity in imports is misleading, because the gross exports of companies in the process of transformation into " maquilas" remain high; what decreases is their participation in terms of value added, whose data are not always available.

The reason why goods with high technological content are more affected by the Dutch disease, however, will only become clear after we present the concept of extended Dutch disease. These two latter names clearly state that the division of labor at international level is not essentially a division between production sectors or between goods and services, but between workers. Through this process, tasks with higher value-added per capita and demanding more skilled labor, formed mainly by managers and communicators, are performed in rich countries, which have plenty of this kind of labor, whereas standardized or codified tasks are transferred to low-wage workers in developing countries.

This process of division of tasks that gives birth to " maquiladora companies" , such as those that have long been installed in the Mexican-American border, results from the low qualification labor available in the country. However, when the country begins to increase the quality of its labor, if the exchange rate overvalues on account of the Dutch disease this workforce will not find employment. And if the country, as was the case with Mexico and the remainder of its manufacturing industry, was already industrialized, but renounced the mechanisms of neutralization of the Dutch disease, the result is that this large group of enterprises will also gradually become " maquiladoras companies".

As it usually occurs, the developing country already has the necessary technological conditions to perform more complex activities in its territory, but does not achieve them or fails to achieve them because the Dutch disease is causing an overvaluation of its exchange rate. In this case, the country is limited to low technological content processes. Work processes that require more qualification are reserved to rich countries, on the assumption that developing countries lack this kind of labor, but this is often not true, and high unemployment rates of skilled personnel are observed in those countries.

The Dutch disease exists since the Commercial Revolution and the formation of an international market. Yet, it only was identified in the s, and only lately began to be really discussed. How can we explain, then, that countries that were its victims have been able to industrialize, when economists and politicians were not aware of it? To answer this question we must distinguish the role of the natural resources that give rise to it in two stages. In a first stage, the exploitation of natural resources is a blessing, because it enables the country to take part in international trade, to promote the original capital accumulation, to establish a minimum economic infrastructure, and enables the emergence of a capitalist entrepreneurial class.

It is the existence of those resources that makes it possible for a pre-capitalist economy or for an economy with an incipient mercantile capitalism to become a true capitalist economy. Yet, as the country develops conditions for industrialization, on the supply side, and, thus, potential conditions for the efficient production of manufactured goods, the Dutch disease becomes a fundamental obstacle.

In this second stage, the country faces the challenge of industrializing or, more generally, of developing a broad range of internationally tradable products with increasingly higher value-added per capita, the Ricardian rents derived from goods based on natural resources become the Dutch disease I described above.

If we abandon this oversimplified concept of two stages, and imagine that, when a country begins to develop, it will be gradually achieving technical competence, we may also reduce the requirement to characterize the Dutch disease. Dutch disease will exist whenever a country has manufacturing sectors with state-of-the-art technology, even though they are not high-tech.

On the other hand, we may presume that the more technologically advanced a sector is, the more depreciated will be the exchange rate necessary to make it possible. Once we define Dutch disease according to these terms, and once we accept the assumption above, the transition of a purely commodity-producing economy, using abundant and cheap resources, to a more advanced economy implies the recognition of the Dutch disease and the gradual adoption of mechanisms to neutralize it.

In all of them the neutralization of the Dutch disease through the imposition of a tax will be necessary; but the method of using the tax resources will be different. In more advanced stages, when serious problems no longer exist on the supply side and government prefers to reduce the degree of intervention in the economy, as in Norway, it will create an international fund in order to have no additional pressures on the exchange rate.

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Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Your Money. Personal Finance. Your Practice. Popular Courses. Economics Macroeconomics. What Is Dutch Disease? Key Takeaways Dutch disease is a shorthand way of describing the paradox which occurs when good news, such as the discovery of large oil reserves, harms a country's broader economy.

It may begin with a large influx of foreign cash to exploit a newfound resource. Symptoms include a rising currency value leading to a drop in exports and a loss of jobs to other countries. Article Sources. Investopedia requires writers to use primary sources to support their work.

These include white papers, government data, original reporting, and interviews with industry experts.