To the best of my knowledge, only a few studies have explored the relationship between resource rents and the relative sectoral output ratio across a wide range of countries and over an extended time period. Although they employ remittance flows as a proxy for resource income, unlike my specification, both studies yield the same qualitative results. When looking at the seminal models of DD, it is striking that the question of fiscal policy is mostly related to the support of the tradable non-resource sector through redistribution (elaborated as industrialization policy). Corden (1984) argues that taxation of the resource sector to subsidize the tradable sector firms and workers (compensation) can help mitigate DD. He also discusses the case of the protection of tradable sectors but shows preference for the former strategy.
What Is the Difference Between the Resource Curse and Dutch Disease?
Moreover, the tax revenues of the economy were not on target as it had heavily relied on the commodity sector’s levies. The deceleration of currency appreciation is an easier and more viable strategy to prevent the adverse effects of Dutch disease. It can sometimes be achieved by smoothing the spending of revenues earned from the export of natural resources. The results for the coefficient of the resource dependence index indicate that when the regression is performed on 98% of the sample, the estimated coefficient remains close to the coefficient of the full sample.
I find that the real exchange rate appreciation resulting from a resource boom (i.e., the spending channel) is more pronounced in resource-poor countries than in resource-rich countries. Additionally, the resource movement channel exhibits differences between resource-rich and resource-poor countries. In resource-rich countries, a resource boom reduces the growth rate in the manufacturing sector more than in the service sector, leading to a decrease in relative sectoral output and a slowdown in economic growth. On the other hand, in resource-poor countries, a resource boom accelerates the growth of the manufacturing sector and decelerates the growth of the service sector, resulting in an increase in relative sectoral output and economic growth. First, it appears that the distinction between agriculture and manufacturing as the main exportable sector is important when investigating the presence of DD, especially in developing countries. Many empirical studies find evidence of an appreciation effect without evidence of a decline in non-resource tradable sectors, which supports the idea that DD might not be a disease for the real economy.
Otherwise, subsidies can be subject to lobbies and rent-seeking behavior in sectors that would have declined even without DD. Finally, if the level of subsidy is directly linked to the level of resource revenues, a high volatility in international commodity prices will generate a high volatility in subsidies. Bahar and Santos (2018) investigate the impact of resource revenues on export diversification through a modified model of DD. They consider that some firms are more labor-intensive than others, and so include transport costs for exporting firms in their DD model.
Exchange Rate Policies
The reliance on resource exports can make the economy susceptible to commodity price fluctuations. This can lead to volatile economic growth with periods of boom and bust, which can hinder long-term development planning and stability. Higher revenue from the exports of natural resources (like oil exports or gas exports) will benefit a small percentage of the population, leading to income inequality.
B: Description of Explanatory Variables and List of Countries
Nevertheless, other indexes can be used, such as the internal exchange rate (defined as the ratio of non-tradable to tradable prices as in Corden and Neary’s model), the terms of trade, or domestic inflation. Accordingly, they use an external RER, defined as the ratio of import (foreign) prices to domestic non-resource tradable prices. Their model stresses the role of exchange rate movements on foreign exchange markets in the presence of sticky domestic prices, which was not considered in Corden and Neary’s model. First, oil production does not require labor, implying that starting oil production does not directly affect the other sectors’ production through workers’ movement (contrary to Corden–Neary’s resource-movement effect). Second, consumption follows the permanent income hypothesis, meaning that oil revenues are not fully consumed during the exploitation period but partly saved to smooth consumption over time, affecting the long-term steady state of the economy.
This is because, in the short run, labour is treated as the only mobile factor of production, and since the extractive sector is assumed to be capital-intensive, it employs relatively few workers. As a result, direct shifts of labour from manufacturing or agriculture into resource extraction are thought to be limited, and deindustrialisation is instead explained mainly by real exchange rate appreciation following a spending boom. It makes heavy use of intermediate inputs such as fuel, electricity, water, and transportation, many of which cannot easily be imported and whose supply depends on other factors that are not perfectly mobile, including natural resources and capital. When resource extraction expands, it can therefore draw these inputs away from other tradable sectors, generating cost-push pressures when prices rise to clear the market. Moreover, because the production of these intermediate goods requires labour, the extractive sector also affects employment indirectly.
Decline in Non-Resource Industries
- Column (1) in Table 10 presents the fixed effect estimates.Footnote 43 Additionally, I investigate the robustness of the results with respect to country-group heterogeneity, considering development level, institutional quality, and currency union effects.
- They find that oil discoveries have a significant positive impact on the RER, but that the higher the share of oil-intensive industries, the less prone to DD the country is.
- Due to high fixed costs, a SWF should be preferred only when expected future resource revenues are large enough (AfDB/BMGF, 2015).
- They may also want to continue to diversify exports to reduce dependency on the booming sector and make them less vulnerable to external shocks, such as a sudden drop in commodity prices.
As the resource sector becomes dominant, non-resource industries may struggle to compete. This will result in a decline in job opportunities, investment, and innovation of new products in these sectors. A 2015 study in the Annual Review of Political Science found “robust evidence” that oil wealth tends to strengthen authoritarian regimes, increase certain types of corruption, and contribute to violent conflict in low- and middle-income countries. When a country has a significantly valuable natural resource, it can be tempting for its leaders to go whole hog into developing that commodity at the expense of other industries. Once a petroleum project or mine becomes operational, strong export revenues can drive up the local currency further, even though those exports are only from one narrow part of the economy.
Since resource revenues tend to appreciate the exchange rate (reducing non-resource exports and encouraging imports), they generate a deterioration in the non-resource trade balance (even if the total trade balance improves due to resource exports). This makes trade balance equilibrium dependent on resource exports, implying that a fall in prices can lead to a large external deficit. This was observed in Zambia in the 1980s and 1990s, when the sudden drop in copper prices (the country’s biggest export) created a large current account deficit that was solved only after the copper price increased in the mid-2000s. More recently, the COVID-19 crisis has made the utility of stable public revenues even more crucial. The conjunction of DD and commodity price volatility can also generate exchange rate volatility, reducing exports and discouraging foreign investments (Gylfason, 2008).
- Dutch disease, as a term, originated in the 1970s to describe the paradoxical situation in which seemingly good news, such as the discovery of large oil reserves, negatively impacts a country’s broader economy.
- Due to the discovery of oil and an increase in oil exports, the country will see an appreciation in the exchange rate.
- Additionally, I compute the baseline regression model using a sample from the IMF database to investigate the influence of the real exchange rate measurement approach on the results.
- What happens next depends on whether the country’s (nominal) exchange rate—that is, the price of the domestic currency in terms of a key foreign currency—is fixed by the central bank or is flexible.
- Both offer lessons in why countries want to diversify their economies and why investors in emerging and (especially) frontier markets need to pay attention to those diversification efforts, as well as the ebbs and flows of prices for commodities those countries export.
What are some examples of countries that successfully managed a resource curse?
The purpose of this section is to examine dutch disease the response of the real exchange rate to a resource boom (i.e., the spending effect). The dependent variable in the dynamic regression model is the real effective exchange rate, and the explanatory variable of interest is the resource-dependence index. Additionally, GDP per capita, inflation, government spending, terms of trade, openness index, and foreign direct investment are included to control the regression model.
Dutch Disease Definition
Often the discovery of raw materials, such as oil benefits a relatively small percentage of the population. Those who own the oil fields can see huge wealth, but the benefits of oil and gas are often not equally distributed within society. Workers may benefit from rising real wages in the service sector, but the discovery of raw materials often creates a few billionaires, so the increase in GDP is often concentrated in the hands of a small number. In several developing economies, oil fields are developed by foreign multinationals, causing some of the wealth to be taken away from the country. With manufacturing becoming uncompetitive due to higher exchange rate and higher wages, output will fall, and there will be a decline in investment, leading to lower growth.
They may want to take steps to boost productivity in the nontraded goods sector (possibly through privatization and restructuring) and invest in worker retraining. They may also want to continue to diversify exports to reduce dependence on the booming sector and make them less vulnerable to external shocks, such as a sudden drop in commodity prices. A case in point is the Netherlands, where policymakers assumed that the country’s income from natural gas would last a long time and used part of the windfall to finance a very generous welfare system. But when natural gas prices plummeted in the 1970s, the country’s income dropped dramatically, and the government was not able—for political and social reasons—to turn back the clock on its welfare policy. In a general state, if a resource boom alters the steady-state labor share in the service sector to the point where it exceeds a critical threshold, the resulting real exchange rate appreciation from the resource boom becomes permanent.
Using a quasi-natural experiment, they show that a discovery worth 10% of a country’s GDP results in a real exchange rate appreciation of 1.5% within ten years after the discovery. Moreover, a median discovery reduces the employment share in the manufacturing sector by 0.45%, while also increasing labor productivity in the traded sector by 1.8% and decreasing labor productivity in the non-traded sector by 0.3%. Some early works examined the impact of DD on the sector composition of GDP without the specific focus on manufacture found in more recent studies. For instance, Looney (1990) and Looney (1991) estimate the impact of oil resources on the value-added of several tradable and non-tradable subsectors in Saudi Arabia and Kuwait, respectively.
Related terms
When a country experiences a surge in revenue from resource exports, it can lead to currency appreciation. This makes non-resource sectors less competitive in the international market as their goods and services become more expensive. The term ‘Dutch disease’ was first coined by the Economist in 1977 to describe the decline in Netherlands manufacturing after the discovery of gas fields in the early 1960s.
