What is Dutch Disease in Economics?

You would think that the discovery and exploitation of natural resources would only lead to prosperity, but it can be a curse that brings a lot of negative results. Dutch Disease is the paradox whereby the discovery of natural resources negatively impacts a county’s economy.
When a country exports natural resources, the money that are paid is called export revenue. The more exports a country has, the more revenue it makes, and the more that country’s currency is likely to appreciate. This currency appreciation is driven by several factors including more demand for the currency which strengthens the value versus other currencies. The country may began to export more than it imports leading to more foreign currency being exchanged for the local currency. Foreign investors will be attracted to the country to invest their foreign currency after first exchanging it for the domestic currency. You also have speculators engaging in currency trading in the hope of making a quick profit. All of these factors result in currency appreciation.
While currency appreciation makes imported goods and services cheaper, it makes domestic goods and services more expensive for foreign consumers. A strong currency is bad for exports because it makes the exports more expensive for other countries to purchase and import. Domestic manufacturing and agriculture becomes less competitive because it is more costly for other countries to purchase. These sectors will begin to shrink and support less employees. The workers from these shrinking sectors may be drawn to the resource sectors in a phenomenon called “sectoral reallocation.” The resource sector will begin to hinder the development of other sectors as the economy becomes overly reliant on the natural resources. A country’s industries and sectors will become less diversified and more economically vulnerable. We see how when the price of oil drops, many oil exporting countries are left scrambling.
Another issue is the growth of the service sector. Increases in wealth leads to increased spending on the service sector. The real wages of workers in the economy will rise which increases the cost for manufacturing firms to employ workers. Increase labor costs for the manufacturing sector further decreases their competitiveness versus other countries when it comes to exports. Consider how the United States is largely a service based economy. The high wages that manufacturing workers demand versus their peers in other countries means American manufacturing is uncompetitive when compared to the relatively low wages in Asian countries like China and Vietnam.
Natural resource exploitation leads to income inequality as the enormous wealth and benefits are concentrated in the hands of the few. While it is true that were will be higher wages, and the service sector will grow, this pales in comparison to the enormous wealth that is concentrated in the hands of just a few of billionaires. Often, natural resources are exploited by foreign multinationals whereby the wealth is taken out of the country.
The output of natural resources leads to substantial tax revenues for the government. The government then tends to spend more on public services and entitlement programs. Over time, the government will likely cut other taxes and become overly reliant on oil tax revenues. What happens when oil prices crash, or the supply dries up, and the country can no longer afford its generous benefit programs? Government spending will have to be curtailed whereby taxes are raised and / or expenditures are reduced. This will lead to political and civil turmoil and unrest.
There are ways to mitigate Dutch disease. A stabilization fund can be established that saves excess resource revenue for future use. Revenues from exploiting natural resources can be invested into infrastructure and education which promotes economic diversification. Governments should implement prudent fiscal and monetary policy to manage the appreciation of their currency. However, what usually happens is that countries with abundant natural resources end up with corrupt and inept government that squander the wealth, instead of investing it for the day when the natural resources are no longer available.
When the natural resources, like oil, dry up, and no longer provide reliable income, the country is left with a small and weak manufacturing export sector that has likely fallen far behind its peers in the rest of the world. It will take many years to catch up with the manufacturing sector in the rest of the world, if ever.
In 1959 vast natural gas deposits were discovered in the North Sea which led to the rapid creation of wealth from oil exports. As the Netherlands exported oil, what followed was an influx of foreign currency increasing demand for the guilder, strengthening it. The value of the Dutch currency rapidly rose which made all non-oil products uncompetitive in the world market. Another issue is that gas and oil extraction and processing is a capital-intensive business that generates few jobs. Unemployment spiked from 1.1% in 1970 to 5.1% in 1977. Capital investment decreased.
Works Cited:
https://www.economist.com/the-economist-explains/2014/11/05/what-dutch-disease-is-and-why-its-bad
https://www.economicshelp.org/blog/11977/oil/dutch-disease/
https://corporatefinanceinstitute.com/resources/economics/dutch-disease/
https://www.brookings.edu/blog/future-development/2017/10/31/dutch-disease-an-economic-illness-easy-to-catch-difficult-to-cure/
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