Dutch disease

Dutch disease, called the resource curse or the “curse of oil”, is the damaging effect on an economy as a result of the exploitation and export of natural resources. The term is also now used to refer to the the effects of other inflows such as a rise from remittances to their home country made by people working abroad.

The problem arises because inflows cause currency appreciation. This increases the cost (in foreign currency) of exports of the products of other industries, making them less competitive. The classic case is de-industrialisation as manufacturing industries are made less competitive by exports of oil and natural gas.

In addition, the increased demand for factors of production needed by the industry causing the problem, also raises prices and makes other industries less profitable: for example, if there are lots of well paid jobs in the oil industry, other industries will face higher labour cost.

This may appear to be beneficial, but there are a number of reasons it may be harmful, especially in the long term:

  • The exports (or remittances) may not be sustainable.
  • Especially in the case of commodities, prices may be volatile, making reliance on a exports of a single commodity dangerous.
  • The industry may have less growth potential than the industries it displaces.
  • The distribution of wealth may be uneven. Those within one industry can become dramatically better off, while many others become worse off.
  • Entrepreneurial activity is deflected from wealth creation.
  • There are political and consequences such as increased corruption.

Although “Dutch disease” and “resource curse” are often used interchangeable, the latter more clearly refers to the political and social consequences, whereas the former is often used to refer only to the effects of the resulting currency appreciation and changes in the cost of factors of production.

The effect on wealth creation comes about because the economic incentives individuals have changes. It often becomes more profitable to attempt to gain a share of the wealth being generated by that one industry, rather than engage in more entrepreneurial activity in others. As that industry's growth is usually limited by the availability of the resource being used (such as the size of reserves, and the rate at which they can be used), it cannot be expanded by having resources being put into it, as other industries would. The result is that people compete for a larger share of a pie of fixed size, rather than profiting from increasing the size of the economy

Some countries (such as Botswana and Norway) have managed to use their natural resources in ways that have ameliorated these problems to gain large net benefits from their natural resources. There are cures for Dutch disease, such as investing (especially abroad) rather than spending wealth, transparency and accountability in processes such as selling rights to natural resources, and subsidising other industries to keep them competitive for the future.

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