Dutch Disease and Resource Curse

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Introduction

Hypothesis of the “natural resource curse” is based on the evidence that countries with rich stocks on average have economies that are growing at the slower rates compared to the countries that have poor stocks of resources. For instance, this hypothesis is applicable to Venezuela, Ecuador, Angola and Nigeria; all these countries have large stocks of natural resources and have failed to boost their economic growth during the last several decades. On contrary, countries in Asia, for example, over the course of the past few decades have experienced a rapid economic growth irrespective of the low resource level. Evidence of the negative relationship between the ration of resource exports to GDP and real GDP growth per capita has been widely documented in the literature (Sachs and Warner 2). Considering the sample of 97 developing countries for the period of twenty years (1970–1989), Sachs and Warner found that this negative relationship is robust for a range of different measures of resource abundance and numerous growth determinants, including trade policy, investment rates, initial per capita income, and government efficiency (Sachs and Warner 21).

There are several approaches that attempt to explain the nature of the “resource curse”. One potential explanation is that the accumulation of large amounts of resources often leads to the rise of a fight over them, which is consequently associated with deprived quality of the institutional system and also lowers economic growth. In other words, having rich stocks of natural resources that are associated with large rents is motivating government, as well as private sector, to involve themselves into “rent seeking behavior”, corruption, “voracity” and conflicts, thus, deteriorating economic growth (Lane and Tornell 213; Mauro 681; Collier and Hoeffler 563). Another common explanation of the “natural resource curse” is volatility of the natural resources’ rent. Volatility of the natural resources’ rents originates from the low price elasticities of their supply. As a result, volatility of the natural resources’ rents is negatively affecting economic growth in the country (Ramey and Ramey 1138). This paper is concentrated on the discussion of the third approach towards an explanation of the “natural resource curse”, which is based on the concept of the “Dutch Disease”. Latter has been theoretically and empirically studied (Corden and Neary 825). In general, concept of the “Dutch Disease” implies that an exogenously increased resource output or resource prices leads to the decline of production in the manufacturing sector of the country and appreciation of the real exchange rate.

“Natural resource curse” or “Dutch Disease” as its economic explanation is a negative phenomenon to be experienced by economy. As a result of the appreciated real and nominal exchange rates that are caused by the commodity prices, the manufacturing sector of the economy that is not associated with rich stocks of natural resources loses its competitiveness in terms of reduced production and employment in this sector. In particular, vanishing of the manufacturing sector, which is not oil related, is associated with the booming phase of the economic cycles. This is explained by the fact that during the decline period of the commodity price cycle, there is no other manufacturing that is able to balance decline in the commodity manufacturing sector. Therefore, fluctuations in the commodity prices are robustly associated with fluctuations of the national economy. Hence, economic growth of the country is hurt in the long run as a result of the non-commodity manufacturing hollowing out. 

Considering short run negative consequences of the “Dutch Disease” for the national economy, it should be noted that a country may limit the use of its stocks of natural resources as a result of the stabilization policy.

Theoretical Analysis of Dutch Disease

The concept of “Dutch Disease” has been explained from the theoretical point of view by Corden and Neary in 1982. In the framework of the model that they have developed, goods that are produced in the economy have been grouped into three categories, including the group of natural resources (“oil”), group of non-resource tradable goods (“manufacturing goods”), and a group of non-tradable goods (“services”). It is well established that tradable goods both resource and non-resource related (“oil” and “manufacturing goods”) are subject to the international competition. Therefore, prices of these tradable goods are determined by the world supply and demand. Moreover, authors also set up assumption that the country is not able to affect the world price on tradable goods, their supply and demand. However, on the other hand, services are not subject to the international competition. As a result, prices of services are determined by the domestic supply and demand (Corden and Neary 829).

Theoretical model of Corden and Neary of the “Dutch Disease” predicts that if the “Dutch Disease” is present in the economy, then it can be “diagnosed” with the help of the spending effect and resource movement effect. Based on the assumption that the supply of the resource related tradable goods (“oil”) is not perfectly inelastic, then an increase in their prices will cause a rise of the demand for capital and labor in the sector of the resource related tradable goods (“oil”). In turn, this leads to increased wages in this sector, as well as higher returns on capital. In case factors of production are mobile in the economy, then this situation will encourage capital and labor to move from the manufacturing sector of the remaining tradable goods (“manufacturing goods”) and sector of the non-tradable goods (“services”) to the resource relate tradable (“oil”) sector (Corden and Neary 831). Furthermore, model predicts that employment and output of the “oil” sector will consequently increase, while employment and output in the “manufacturing” and “services” sectors will decrease. Corden and Neary consider this decline in the production of the non-resource related tradable goods (“manufacturing goods”) as “direct de-industrialization”. At the same time as the price of “manufacturing goods” does not change in the economy, since it is determined abroad, decrease of the output of “services” is associated with excess demand for them, thus, increased prices of “services”. Hence, prices of non-tradable goods largely exceed prices of the tradable goods, along with the appreciation of the real exchange rate in the country (Corden and Neary 835).

Even though, the resource movement effect can be detected in the country only when factors of production are sufficiently mobile between the “oil” sector and sector of “manufactured goods”, the spending effect can be observed regardless of the amount and mobility of labor in the “oil” sector. The spending effect takes place when higher prices on the resource related tradable goods (“oil”) create higher wages and profits in this sector, therefore, increasing aggregate demand in the economy. Partially increased aggregate demand is associated with the domestically produced non-tradable goods (“services”), causing the increase of their prices, while the prices of tradable goods (both “oil” and “manufacturing goods”) remain unaffected. Similarly, this induces the appreciation of the real exchange rate in the country (Corden and Neary 835). In case labor is entirely immobile in the economy, then the supply of non-tradable goods (“services”) remains unaffected, and the only impact of a demand’s shift is a rise of the “services’” relative price. On the other hand, if the labor is mobile between the “services” and “manufacturing goods” sectors, then an increased demand for “services” will cause a rise in the supply of “services”, as well as increase of demand for labor in the “service” sector. Thus, wages in the “service” sector will be pushed upwards. This will serve as motivation for workers to switch from the “manufacturing” and “oil” sectors to the “service” sector. Moreover, even though that companies in the “manufacturing” and “oil” sectors will make attempts to increase wages, they will not be able to compensate the difference by raising prices for their goods and, hence, will incur profit loses. The resulting decline in employment and production of the non-resource related tradable goods (“manufacturing goods”) is considered to be “indirect de-industrialization” (Corden and Neary 837). 

Considering both effects jointly, the following predictions of the “Dutch Disease” can be established. First, given increase of the relative price of non-tradable goods (“services”), the real exchange rate in the economy will be consequently appreciated. Moreover, an explicit drop in employment and output of the non-resource related sector (“manufacturing”) serves as a sign of both direct and indirect “de-industrialization”. Next, the joint effects of employment and output in the “oil” sector and the “service” sector are unclear, since the resource movement effect and spending effect work in opposite directions. Nevertheless, if the “oil” sector has smaller labor or if it is rather immobile, then it can be expected that the resource movement effect will be dominated by the spending effect, brining an increase of employment and output of the “service” sector. Finally, in case labor is mobile in the economy, then presence of the “Dutch Disease” will be associated with the increase of wages (Corden and Neary 837). 

Dutch Disease in the Framework of the Post Soviet Countries

There is extensive evidence in the literature of the “Dutch Disease” presence in numerous developing countries, including the post-Soviet ones (Egert 5). “Dutch Disease” is empirically tested using four principal “symptoms”, such as a slowdown in the growth of the manufacturing sector, appreciation of the real exchange rate, increase in the growth rate of wages, and increase in the growth of the service sector.

Considering Russia as a post-Soviet country in the framework of the “Dutch Disease”, it should be noted that the real exchange rate of Russian ruble has been strengthened by oil prices (Oomes and Kalcheva 25). In particular, it has been found that a one percent increase in the oil price in Urals on average is associated with the appreciation of the real exchange rate by 0.5%. Nevertheless, there is no proof that the real exchange rate has exceeded the estimated equilibrium level. Moreover, remaining “symptoms” of the “Dutch Disease” have been also detected in Russia. For instance, findings of Oomes and Kalcheva show that since 2001 the manufacturing sector in Russia has been growing at slower rates, along with the decline of employment in the manufacturing sector unlike other sectors of the economy. In addition, during the similar period, share of the service sector has substantially increased, implying that the resource movement effect in Russia is dominated by the spending effect. Finally, real wage has been growing at high rates during the same period in Russia. Therefore, it can be concluded that Russia exhibits all the peculiar characteristics of the “Dutch Disease” (Oomes and Kalcheva  26).

Conclusion

“Resource curse” is a phenomenon predicting that countries with rich stocks of natural resources are developing at considerably slower rates, unlike the countries with fewer natural resources. The notion of “Dutch Disease” has been introduced as an attempt to provide economic reasoning of the “resource curse”. It implies that an exogenously increased prices or output of resources is associated with the decline of production in the manufacturing sector of the country and appreciation of the real exchange rate. These patterns negatively affect development of the country. “Dutch Disease” has been “diagnosed” in numerous developing countries, including Russia and other post-Soviet countries.

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