If a country discovers substantial amounts of oil, gas or another natural commodity, it will begin to export these goods causing a substantial increase in GDP; this will improve tax revenues, improve the current account and create employment opportunities. But, often countries who discovered oil have gained much less than you might expect. The diversification of the economy is a strategy that can almost eliminate the negative impact of Dutch disease on the economy. Economic diversification can be achieved by subsidizing lagging sectors of the economy or establishing tariffs to support domestic producers.
Understanding Dutch Disease
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.
Decline in Non-Resource Industries
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.
B: Description of Explanatory Variables and List of Countries
The coefficient on the resource-dependence proxy enters with a positive sign and is significant at the 1% level. The estimate indicates that a 1% increase in the resource-dependence index appreciates the real effective exchange rate by approximately 0.023%. However, previous studies utilize remittance flows (Lartey et al. 2012), commodity prices (Ricci et al. 2013), or resource discovery (Harding et al. 2020), instead of total natural resource rent (% of GDP), which aligns with my proposed theoretical model. On the contrary, a group of the existing literature focuses solely on the resource movement effect.
Dutch Disease and Resource Curse
This issue could also be attributed to heterogeneity across country groups in terms of their dependence on resource rents.Footnote 30 The results for a sample of resource-rich and resource-poor countries are reported in Columns (4) and (5), respectively. The coefficient of the resource dependence index is negative for resource-rich countries and positive for resource-poor countries. Additionally, the results suggest a relatively larger economic significance in the country groups’ samples compared to the full sample. These results indicate that a one-percentage-point increase in the resource dependence index raises the relative sectoral output by approximately 3.3% in the resource-poor country group and decreases it by approximately 1.1% in the resource-rich country group. This latter finding aligns with the outcomes of a recent empirical study conducted by Amiri et al. (2019). Equation (8) verifies that the steady-state growth rate is driven by the LBD effects and the spillover effects from the resource process activity.
A specification with only one lag is incapable of adequately capturing the dynamics in the output level (Acemoglu et al. 2019). The results presented in Table 12 suggest no further evidence of serial correlation in the residuals when additional lags in output per capita are included. Furthermore, the estimates for the explanatory variable of interest show qualitative similarity to my baseline results, but not quantitative similarity. In recent decades, these questions have attracted increasing attention from researchers.
This latter effect explains why DD is often defined as a cause of the “de-industrialization” process. However, Corden (1984) underlines that the tradable sector is not restricted to manufacturing industries and can include agricultural products. He argues that DD could result in “de-agriculturalization” rather than “de-industrialization.” This is of crucial importance for several developing countries that, while weakly industrialized, are specialized in export crops. On the other hand, some agricultural (subsistence agriculture) and industrial activities (construction) are mainly non-tradable and can benefit from DD effects.
To address this, I introduce a two-sector growth model and assume the presence of learning by doing (LBD) in both sectors, along with spillovers between them. Additionally, I postulate that technological improvements are unevenly transferred from the resource sector to both domestic sectors. This novel aspect of the theory distinguishes the LBD mechanism from the one proposed in Torvik (2001), while retaining its core essence. The modified model demonstrates that a resource boom results in an appreciation of the real exchange rate (in the steady state) and stimulates the growth rate (in the steady state) at both the national and sectoral levels-outcomes not anticipated by previous models. Within this framework, the spending effect is usually considered to be the main channel through which Dutch disease operates, while the resource-movement effect is usually seen as secondary.
- Up to this point, I have analyzed the impact of a proxy for the natural resource boom and the appreciation of the real exchange rate on relative sectoral output.
- These luxury goods tend to be imported meaning that domestic firms gain little benefit.
- A statistically significant negative coefficient on the real exchange rate confirms the previous interpretation and underscores the independence of the results from various real exchange rate databases.
- Devaluing a currency may not suffice to rekindle exporting sectors if income inequality and political instability are the true underlying problems.
- 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.
- Equation (8) verifies that the steady-state growth rate is driven by the LBD effects and the spillover effects from the resource process activity.
- Because this situation often arises as a result of a windfall petroleum discovery, the term falls under a broader category known as the “oil curse” or the “resource curse,” where a country’s economy falters despite having ample valuable natural resources.
- Subsequently, for a more comprehensive examination of the resource movement channel, I analyze the effects of a resource proxy on growth rates within the manufacturing sector, the service sector, and the overall national economy, along with relative sectoral output.
- Initially, I investigate the impact of a resource proxy on the real exchange rate to explore the spending channel.
Based on OLS regressions, he observes a clear negative impact of oil revenues on agricultural output in all countries except Venezuela (where the impact is not significant), but a positive effect on the manufacturing and the non-traded sectors in all 5 countries. These results seem to support the idea that the agricultural sector is likely to be the main tradable sector in developing countries. On the contrary, manufacture appears here to be a relatively protected sector (imperfectly tradable).
However, the coefficient value within the sample of developing countries is slightly lower compared to the full sample. Aligning with Lane and Milesi-Ferretti (2004)’s findings, I can conclude that the transfer effect is less pronounced in developing economies. Could he have recognized, in his own country, symptoms of what later became known as “Dutch disease,” a term that broadly refers to the harmful consequences of large increases in a country’s income? A survey of the best investment strategies would be off-topic here since it is highly country-specific. However, we can briefly underline the balance between investment in physical capital (such as public infrastructure) and in human capital (education or health). Mexico has drawn most of the attention in the empirical literature on DD in Latin America.
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Consequently, productivity growth in the manufacturing sector slows down more than in the service sector, resulting in a decrease in the economic growth rate. The declining relative productivity ratio along the transition path triggers a compensatory labor movement from the service to the manufacturing sector. This movement, in turn, mitigates the real exchange rate appreciation along the transition path. However, since the change in the service sector’s labor share in the steady state due to the resource boom surpasses the given critical threshold, the real exchange rate eventually settles at a higher level than the initial level. As one of the most influential studies, Torvik (2001) proposed a general model in which both sectors can contribute to the learning process, and there are imperfect learning spillovers between these sectors.
Both oil price increases and oil discoveries affect long-term non-oil tradable prices. It appears that the relative sectoral output remains a reliable and plausible proxy for the relative productivity level. Consequently, I consider the relative output of the manufacturing sector to the service sector (at constant prices) as the dependent variable. The explanatory variables of interest consist of the real effective exchange dutch disease rate and the resource-dependence index.
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