The Dutch Disease

September 25, 2009

Riches get their value from the mind of the possessor; they are blessings to those who know how to use them, and curses to those who do not.

I am going to analise two important phenomenas that affect a country development: The Dutch Disease and The Democracy Effect in Economy. I will start with the former and analyse the later in my next post.

Dutch disease is named after the effect that the discovery of natural gas had in Holland in the 1960s. It is also called the Resource Trap but it can originate not only in natural resources discovery, but in any development in that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment.

Imagine first a country like Japan in the 1950s, with not natural resources. Japanese people want to buy imports, but they can only do so with hard currency, so they need to produce exports to get it. Exports (tradable goods) would sell in hard currency and sell it to importers who will use it to buy imports and sell them in Japan. Exports in such cases are manufactured products and some services (and some natural resources in a limited fashion), so the country start producing in order to import goods that lacks, making the national industry important and competitive. The local non-tradable good and services (like restaurants) get some of the money since people increase their standard of living, elevating the price of these non-tradable goods and services, and attracting some labour

Imagine then a country that discovers oil or gas or diamonds. This natural resource is sold in the international markets, creating a surge in the inflow of hard currency to the country. Since the price of tradeable goods is set internationally, the laws of supply and demand make rise the exchange rate of the country in question, hence making the rest of the exports in the country less competitive. Additionally, the extra revenue make non-tradeable goods and service more expensive in the country since there is more money to be spent and demand for new items.

Example, in the 1970s, Nigeria exported peanuts and cacao, then the oil revenues started to build up, and the Nigerian currency gain value, making their peanuts and cacao too expensive. Both industries collapsed. When prices eventually went down, the growth and standard of living of Nigerians was halved.

So the ill effect comes when the resource runs out or when the price goes down. The manufacturing industry has been badly damaged and cannot compete in international markets. All the foreign investment went towards the natural resource, and nothing to the traditional manufacturing sector. The country then stops development and spiral down.

Foreign Aid has the same effect that a natural resource discovery: It brings unearned hard currency to a country, making his own currency more expensive and killing its exports.

Hence, a sudden surge in the foreign currency inflows to a country make this country uncompetitive in the global markets, killing his tradable sector, making his non-tradable sector more expensive, and slowing the growth in the long run.

Now with pictures: In a normal economy without lots of natural resources, the manufacture sector is big (blue), some people and employ in services (green), and very few are in the natural resources sector (red) and, with hope, very few are unemployed (grey)

Country without resources

Country without resources

Then oil is discovered and a boom starts. The booming sector attracts all the labour force and foreign investment, while the traditional sector lags behind and gets reduced. The non-tradeable sector grows a little since there is a new demand for its goods and products, and draws some of the capital and labour, making these goods and services more expensive and in further detriment of the traditional sector. The excesive exports of the natural resource make the currency so expensive that further damages the traditional tradeable industry.

The economy in a natural resource boom

The economy in a natural resource boom

After some years or decades, the natural resources either ran out or the international prices plumbed. The former boom sectors shrinks, laying out people, the demand for non-tradable good and services shrinks too, laying out people, and the traditional manufactures are now too small to accommmodate the excess of labour. No further investment is done, and unemployment rises.

Dutch Disease effects

Dutch Disease effects

Ending Extreme Poverty

March 9, 2007

It is easy when we are in prosperity to give advice to the afflicted.

Engineers Without Borders launched an initiative this week to end poverty in 2020. They edited a newspaper with the main headline “Worldwide celebrations: End of extreme poverty declared”. They outlined three steps to end extreme poverty: Fair Trade, Aid, and Corporate Responsibility.

If only that would be so easy!

Fair Trade is one of the most important movements to help end extreme poverty. If I finally can start my PhD, Fair Trade will be a very important component in my research, and my final thesis on my MBA was about Fair Trade, as you can read in many of my post (check out the fair trade category!). In reality though, fair trade is not an end by itself. I found out that, while we want people to receive fair prices for their products, as long as they continue producing the same goods in the same way, they will continue to be poor. Fair Trade only accounts for 5% of coffee and chocolate market now, and even less for other products. Even the newspaper states that fair trade are “most notably coffee, but also chocolate, sugar, cotton and more”. Can we really end poverty focusing in such a reduced products spectrum?

International Aid. The paper made a very good observation about the quality of international aid offered by Canada and other developed countries: “Today, roughly 40% of our international aid comes with strings attached – it’s “tied” to purchases of Canadian goods and services, rather than being used to buy the most appropriate or inexpensive items available. It’s estimated that fully 50% of Canadian food aid is tied”. But several scholars, included Jacques B Gelinas have questioned the efficacy of international aid for solving poverty.

Corporate Social Responsibility is the strongest point. With the rise of active shareholders and social and sustainable index, companies are forced to do a better job to create and share wealth among society, but only a small part of the world is employed by these corporations. An ethical code of conduct shall be adopted by all the companies, even those small and medium, to behave in the business world. I can still recall how the worst cases of workers abuse in my country are not inflicted by international corporations but by small business that still discriminate by age, gender and physical appearance.

I hope that we can follow Karl Marx’s directive of nobody having in excess while others lack the essential.