Dutch disease

In economics, the 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). The putative mechanism is that as revenues increase in the growing sector (or inflows of foreign aid), the given nation's currency becomes stronger (appreciates) compared to currencies of other nations (manifest in an exchange rate). This results in the nation's other exports becoming more expensive for other countries to buy, and imports becoming cheaper, making those sectors less competitive.While it most often refers to natural resource discovery, it can also refer to 'any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment'. In economics, the 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). The putative mechanism is that as revenues increase in the growing sector (or inflows of foreign aid), the given nation's currency becomes stronger (appreciates) compared to currencies of other nations (manifest in an exchange rate). This results in the nation's other exports becoming more expensive for other countries to buy, and imports becoming cheaper, making those sectors less competitive.While it most often refers to natural resource discovery, it can also refer to 'any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment'. The term was coined in 1977 by The Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of the large Groningen natural gas field in 1959. The classic economic model describing Dutch disease was developed by the economists W. Max Corden and J. Peter Neary in 1982. In the model, there is a non-tradable sector (which includes services) and two tradable sectors: the booming sector, and the lagging (or non-booming) tradable sector. The booming sector is usually the extraction of natural resources such as oil, natural gas, gold, copper, diamonds or bauxite, or the production of crops, such as coffee or cocoa. The lagging sector is usually manufacturing or agriculture. A resource boom affects this economy in two ways: In a model of international trade based on resource endowments as the Heckscher–Ohlin/Heckscher–Ohlin-Vanek, the Dutch disease can be explained by the Rybczynski Theorem. Using data on 118 countries over the period 1970–2007, a study by economists at the University of Cambridge provides evidence that the Dutch disease does not operate in primary commodity-abundant countries. They also show that it is the volatility in commodity prices, rather than abundance per se, that drives the resource curse paradox since the negative impact of commodity terms of trade volatility on GDP per capita is larger than the growth enhancing effects of commodity booms. A study of the resource-rich Australian and Norwegian economies has shown that a booming resource sector can have positive effects (or ‘spillovers’) on non-resource sectors, which have not been captured in previous analysis. Construction and services, and to a lesser extent manufacturing benefit from these spillovers. Simple trade models suggest that a country should specialize in industries in which it has a comparative advantage; so a country rich in some natural resources would be better off specializing in the extraction of those natural resources. However, other theories suggest that this is detrimental, for example when the natural resources deplete. Also, prices may decrease and competitive manufacturing cannot return as quickly as it left. This may happen because technological growth is smaller in the booming sector and the non-tradable sector than the non-booming tradable sector. Because that economy had smaller technological growth than did other countries, its comparative advantage in non-booming tradable goods will have shrunk, thus leading firms not to invest in the tradables sector. Also, volatility in the price of natural resources, and thus the real exchange rate, limits investment by private firms, because firms will not invest if they are not sure what the future economic conditions will be. Commodity exports such as raw materials, drive up the value of the currency. This is what leads to the lack of competition in the other sectors of the economy. The extraction of natural resources is also extremely capital intensive, resulting in few new jobs being created.