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Avoiding Dutch Disease
With rising gold prices and production, coupled with the firm conviction that the massive oil deposits – black gold – off our shores will soon be flowing, maybe it is time that we look ahead and consider the phenomenon called “Dutch Disease”.
It is primarily associated with natural resource discovery and originated from a crisis in the Netherlands in the 1960s that resulted from discoveries of vast natural gas deposits in the North Sea. Unlike what had been expected, the Dutch economy soon headed downwards than up. In general “Dutch Disease” now refers to negative consequences arising from large increases in a country’s income.
The Dutch economy stagnated because they failed to create an environment where services and manufacturing can flourish — not because they happened to have a gas deposit. In general it has been shown that mineral rents are actually a barrier to an environment where manufacturing can flourish, even without coups or civil wars (and in fact mineral rents encourage growth in services). That is the essence of Dutch Disease.
There are at least two purely economic mechanisms by which mineral rents (high income from mineral extraction) make the establishment of a flourishing manufacturing industry extremely difficult. The first is the exchange-rate mechanism. Large mineral rents (or any rents, actually) lead to a rate of inflation in the rentier economy that exceeds the rate of inflation elsewhere.
Even in our economy with its “floating” exchange rates, the differential inflation amounts to an overvalued real exchange rate, which makes imports cheaper and exports more expensive. That makes local manufacturing really uncompetitive since exports are artificially expensive to foreign consumers, and domestic consumers would rather buy artificially cheap imports. We have seen that our garment manufacturers have been unable to compete with countries that are supposed to have a much higher per capita GNP’s than us. The deck is stacked against a vibrant manufacturing sector.
The second mechanism has to do with the labour market in the rentier economy. Large mineral rents, again, lead to inflation. But the inflation is higher for non-tradable goods and services than it is for tradable goods and services. This is because tradables face international competition, which keeps prices relatively contained (a flatter supply curve). Wages follow prices, and as a result the wages rise faster in the non-tradable sector than in the tradable sector. And, as we all know from the present experience of Guysuco, workers follow wages. Since virtually all manufactures are tradable, workers will move out of manufactures and into non-tradables, mostly services.
Do kleptocratic regimes exploit natural resources to pad their bank accounts, buy off opponents, and purchase weapons to intimidate holdouts? Of course they do. Exploiting, padding, bribing and bullying are what kleptocrats do best. But they are equal-opportunity exploiters. If natural resource rents aren’t available, they’ll find something else — and maybe do something worse to get it. Happily for those countries stuck atop piles of diamonds or lakes of oil, then, it turns out the resource curse must have been enchanted by a pretty feeble witch. Once you look at the evidence more carefully, the usual argument is turned on its head. Countries that rely on natural resources for a large part of their output are indeed cursed — by poor quality government and an institutional environment that stifles the growth of manufacturing and services.
That’s why the most heralded talisman against the resource curse — improving institutions through greater transparency and oversight — makes sense regardless. In fact, because so much of the revenues from extractive industries flow through governments, improved oversight might be a particular help after a mineral find. The Extractive Industries Transparency Initiative, for example, publishes audited statements regarding payments from industry to government in royalties and taxes.
But at heart, they are good ideas because all governments should be more transparent and increase the flow of resources to communities, no matter what is under their land. Blaming gold or oil wealth for poverty, though, is like blaming treasure for the existence of pirates.
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