dutch disease

DUTCH DISEASE (RESOURCE CURSE)

Impact on international competitiveness

Team:Artem Chepurnoy

Vera Lazarenko

Dmitriy Kovalenko

Dmitriy Asinovskiy

Evgenia Belova

What is the Natural Resource Curse?

Many developing countries with abundant natural resources experience lower rates of economic growth and development than countries with few natural resources

“Dutch Disease”

The Economist (1977)

1960s – Discovery of large natural gas deposits in the North Sea

Subsequent shift in resources and decline in the manufacturing sector

Dutch Disease1970s: Netherlands

Influx of revenue from natural gas led to increased spending on social programs

Dutch Disease1970s: Netherlands

“Crowding out” of manufacturing led to lost jobs Creation of “safety net” social programs resulted

in high levels of unemployment and disabilities

Netherlands: Export Performance

Researches concerned about the reasons of worsened export performance

How does it work?

Cordon and Neary model, 1982

The Specific Factor Model

TRADABLE

NON-TRADABLE WO

RLD

ECO

NO

MYManufacturing

Energy/Mineral

COU

NT

RY E

CON

OM

Y

The Specific Factor Model

– relative international prices for tradable goods are fixed

– price for non-tradable goods is determined by demand and supply

The Specific Factor Model

TRADABLE

NON-TRADABLE

Manufacturing

Energy/Mineral

Labo

r

Manufacturing-type capital

Natural resources

Non-tradable-type capital

The Specific Factor Model

Each sector uses two factors of production:

- specific factor of production for sector - labor, which is perfectly mobile among sectors The real wage is perfectly flexible

Spending effect

There is a boom in mineral sector, which increases country GDP and thus demand in the country .

Let’s suppose, the demand increases equally on manufacturing and on non-tradable products.

Manufacturing goods market

𝑃

𝑄𝑄1

𝑃

𝑄2

Non-tradable goods market

𝑃

𝑄𝑄1

𝑃1

𝑄2

𝑃2

Spending effect

So, the price for non-tradable goods rises in terms of tradable goods

This makes production of non-booming tradable goods less attractive for domestic producers

Finally, tradable goods (manufacturing) sector narrows

Factor reallocation effect

𝑂𝑥 𝑂 𝑦

𝑤 𝑤

𝐿1

𝑤1𝑤1

Man

ufac

turi

ng in

dust

ry (

Y)

Min

eral

indu

stry

(X)

Labor distribution

𝑉𝑀 𝑃𝐿𝑋 𝑉𝑀 𝑃𝐿𝑌

𝑤2𝑤2

𝐿2

Factor reallocation effect

Labor force moves from the manufacturing industry, so the industry lacks for labor

Cost of labor increases for manufacturing industry So, this effect squeezes profitability and output of

the manufacturing industry Decreased global competitiveness of manufacturing

sector due to high domestic input prices In some cases, foreign producers may enter the

market and drive down prices to level where domestic producers cannot compete

Effects of resource curse: practical implications

Market effect Exchange rate appreciation Price volatility, discouraged

FDI Demand for labor, capital,

goods Deflected entrepreneurial

activityGovernment spending Social programs

Political Rent-seeking and

corruption

Social Capital Formation Savings False sense of security High inequality Change in economic

incentives of individuals

Effect on wealth creation: Change in economic incentives of individuals

industry's growth is usually limited by the availability of the resource

(size, rate of usage)

cannot be expanded by having resources being put into it

Gain a share of the wealth of booming sector: Engage in entrepreneurial

activity in other sectors

Competing for a larger share of a pie of fixed size

Symptoms and diagnosis

Mineral wealth’s correlation with: Appreciation of the real exchange rate Civil wars Low economic diversification/growth Authoritarianism/poor governance & weak

institutions High inequality

Dutch Disease: Impact on International trade and competitiveness

International Competitiveness

Analyzing of macroeconomic performanceExplaining of international trade trends

Main factors: technological innovation degree of product specialization the quality of the products involved, or the value of after-sales service high rates of productivity growth

Measures of international competitiveness

Difficult to measureNo unique approach

Criteria:1. Cover all sectors2. Encompass all the markets3. Fully comparable internationally data

Measures of international competitiveness

1. Import Competitiveness (IC)

2. Export Competitiveness (EC)

3. Overall CompetitivenessEC* + IC*

4. INTERLINK Model explains changes in countries’ changing in exports

Diseased countries

Nigeria Azerbaijan Russia

NorwayBotswanaVS

Nigeria

First oil found in 1956 by The Shell D’Arcy

Nigeria: 1960-1970

GDP

Employment

Agriculture

72%

54%

Total Export Earnings 51%

Nigeria: since 1970

GDP

Employment

Oil

70%

54%

Total Export Earnings 91%

10%

Agriculture

Nigeria: problems

Huge external debt High unemployment Overdependence on oil

Huge public expenditures Corruption Money wasted

Russia

Ratio of Hydrocarbon Exports to Gross Domestic Product, 1992–2005

  1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

GDP, billions of rubles 1196 1092 953 914 881 893 846 900 990 1041 1090 1169 1253 1334Total Export, , billions of rubles, including: 745 417 265 268 230 221 264 389 436 384 384 411 433 469

Hydrocarbons 305 151 88 88 85 84 85 142 201 177 179 199 213 260

- Crude oil 130 65 37 38 35 32 31 65 96 85 92 107 126 146

- Refined oil products 63 26 14 14 17 16 13 25 42 32 36 38 41 59

- Natural gas 111 60 37 35 33 36 41 52 63 60 50 54 46 55 Other products and services 440 266 177 180 145 137 179 247 235 207 205 212 220 209Share of hydrocarbons in export, % 40.9 36.2 33.2 32.8 37.0 38.0 32.2 36.5 46.1 46.1 46.6 48.4 49.2 55.4Ratio of hydrocarbons export to GDP, % 25.5 13.8 9.2 9.6 9.6 9.4 10.0 15.8 20.3 17.0 16.4 17.0 17.0 19.5Yearly average prices of UK Brent grade oil, dollars per barrel                            

actual 19.4 17 15.8 17.1 20.5 19.1 12.7 17.7 28.3 24.4 25 28.9 38.3 54.4comparable (in 2005 prices) 27 23 20.9 21.9 25.5 23.3 15.2 20.8 32.1 26.9 27.1 30.6 39.6 54.4

1991-1998 Russian manufacturing industry: -56% Machine building and metalworking: -64% Timber, woodworking, paper industry: -66% Building materials: -70% Light industry: -89% Food processing: -47% Crude oil output: -32% Gas output: -15%

Russia

As a result, additional hydrocarbon resources were freed up for export. Thus, Russia experienced the onset of the “Dutch disease” in 1992–1998.

Russia

Fig. 2 Investment level and oil price. Source: Yudaeva et al. (2004)

0

5

10

15

20

25

30

35

40

01.9

6

04.9

6

07.9

6

10.9

6

01.9

7

04.9

7

07.9

7

10.9

7

01.9

8

04.9

8

07.9

8

10.9

8

01.9

9

04.9

9

07.9

9

10.9

9

01.0

0

04.0

0

07.0

0

10.0

0

01.0

1

04.0

1

70

80

90

100

110

120

130

Oil price, $/bar (left scale) Gross f ixed investment index, SA (right scale)

Symptoms of Dutch Disease since 2005

Growth of oil sector GDP with declining growth of non-oil tradable sector

Growth of oil sector share in economy Sharp government expenditure growth and especially

growth of investments in non-tradable sector

time

oil

Azerbaijan

GDP dynamics and structure

Azerbaijan

Labor force No significant movement of labour force to the oil sector

As a result no “resource movement effect” – characterized as a symptom of Dutch Disease

Azerbaijan

Government investments

Dramatic investments in non-tradable sector since 2005

Money come from the oil sector

“Spending effect” – symptom of the Dutch Disease

Azerbaijan

Norway

First oil found in 1969 Before oil:

The poorest Scandinavian country Slow growth

Norway

Norway and oil discovery

No harm to non-oil sectors Economical development Used government policies to avoid DD

Norway’s policies to avoid DD

Pay back foreign debts when possible Invest abroad Encourage domestic accumulation of instead of using foreign

specialists Channel resources into education, research and development Put emphasis on knowledge, technological progress, and

human capital Stimulate female participation in the labor market

BOTSWANAEVIDENCE & EXPLANATION OF EXCEPTIONALISM

Sustained economic growth and socio-economic development since 1966

Mineral wealth Good macro-economic

management Good governance and

institutions

Evidence 1: Sustained economic growth since 1967

1966, independence

• Among the poorest states

• GDP per capita – US $ 283

1966 -1999

• Highest economic growth rate in the world

2007

• GDP per capita – US $13,600

• Status of upper middle economy

Evidence 2: Sustained socio-economic development

1966, independence

• 12 km of paved roads

• Life expectancy at birth – 50 years

• Adult literacy rate: 34%

1966 -1999

• HDI : 0.509

• Peace & stability

2007

• Developed road network, 6000 km paved

• Life expectancy – 68 years

• Adult literacy rate: 81%

• HDI : 0, 694

Explanation 1: Mineral wealth - diamonds

1966, independence

• GDP:

• Agriculture – 40 %

• Mining – 1,6 %

• Export earnings:

• Mining – 1 %

1966 -1999

• GDP:• Mining – 51 %

• Export earnings:

• Mining – 75 % (1989)

2007

• GDP:

• Mining – 35 %• Export

earnings:• Mining – 89 %

Explanation 2: Good macro-economic management

Successful in utilizing the financial capital from mining to drive and sustain economic growth and development.

Popular explanation: country’s sound macro-economic objectives and policies

Explanation 2

Two objectives adopted very early:

Avoidance of external debt and stabilization of government expenditure

Management of the exchange rate in order to promote economic diversification

Explanation 3: Good governance and institutions

A functioning constitutional multi-party democracy since 1966.

Enduring social and political stability

Free media

Quality and respected governance and watchdog institutions

ARE THERE STILL ANY RESOURCE CURSE SYMPTOMS?

Weak diversification despite efforts High unemployment (16-40%): low job creation capacity of diamond mining weak development of the non-mining private sector High inequality(Gini coefficient - 0.56, 1980-1998) Increasing expenditure on public consumption

(from 0.84 in 1995 to 1.08 in 2007).

Trends in economic sector shares, 1966-2005 (Based stats from Siphambe, 2007, p.3)

0

10

20

30

40

50

60

Year

%sh

are

of G

DP

Agric

Mining

Manufacturing

Trade, hotels & restaurants

Banks, insurance & busserv

General government

Anyway, Botswana has so far largely succeededin fighting resource curse

Geographic isolation – landlocked deep into the interior of Southern Africa

Drought proneness, soil infertility agricultural development challenging

Small domestic market SACU free trade area membership HIV/AIDS

COMPOUNDING FACTORS

Any treatments for “Dutch Disease”?

Primary concern of financial institutions (World Bank/IMF): “Democratic, consensual and transparent

processes” (Stiglitz) Anti-corruption programs Assistance of Western governments Stabilization funds

I. Slowing the appreciation of the real exchange rate

1. Sterilize the boom revenues:• save some of the revenues abroad in special funds• create a stable revenue stream• save some of the revenues for future generations (hard in

developing countries)

2. Increase saving in the economy in order to reduce large capital inflows • Encourage individuals and firms to save more (reducing income

and profit taxes)• Increase Saving - reduce need for loans to finance government

deficits and FDI

Any treatments for “Dutch Disease”?

Sovereign wealth funds

The Government Pension Fund in Norway The Stabilization Fund of the Russian

Federation State Oil Fund of Azerbaijan Future Generations Fund of the State of Kuwait

II. Boosting the competitiveness of the manufacturing sector Investing in education and infrastructure

BUT NOT PROTECTIONISM!

selling rights to natural resources, subsidizing other industries imposing tariffs on imported goods

Any treatments for “Dutch Disease”?

Natural resources: curse or blessing?

Conclusion

References1. Booming sector and Dutch Disease Economics: Survey and Consolidation, W.M. Cordon, Oxford Economic Papers, 1984 2. Boom and gloom. Azerbaijan's economy, drunk on oil, is suffering rapid - inflation, The Economist, 2007 3. “Diagnosing Dutch disease: Does Russia have the symptoms?”, Oomes N., Kalcheva K. (2007) International Monetary Fund4. “Dutch disease and Azerbaijan economy”, Hasanov F., Econimics Education and Resource Consortium , Baku, 20105. DOUBLE DIAMONDS, REAL DIAMONDS: BOTSWANA’S NATIONAL COMPETITIVENESS6. Jay van Wyk, Pittsburg State University, Academy of Marketing Studies Journal, Volume 14, Number 2, 20107. Escaping the Natural Resource Curse and the Dutch Disease’, Larsen, E., 200, Statistics Norway, Research Department,

Discussion Papers No. 3778. Impact of Government Expenditure on Growth: The Case of Azerbaijan,  Koeda J., Kramarenko V. , IMF Middle East and Central

Asia Department, 20089. Indicators of international competitiveness: conceptual aspects and evaluation,” Durand M., Giorno C. (2008) , Organisation

for Economic Co-operation and Development (OECD)10. Lessons from the Dutch Disease: Causes, Treatment, and Cures’, Gylfason, T., 2001, Institute of Economic Studies11. Nigeria: Petroleum Revenue Management, PREM Sector Unit, Sub-Saharan Africa region’, Washington DC, World Bank, 2004,12. The Primary Sectors of the Economy and the Dutch Disease in Nigeria’, Olusi, J., Olagunju, M., 2005, The Pakistan Development

Review, Vol. 44 : 2,pp. 159–17513. The Dutch disease in Russia: Macroeconomic and structural aspects,Problems of Economic Transition, Fetisov G. (2007) Vol.

50, Iss. 1, 2007, 53–73.14. THE DETERIORATION OF THE NETHERLANDS' EXPORT. PERFORMANCE DURING THE LATE 1970's: A MATTER. OF

COMPETITIVENESS OR EXPORT STRUCTURE?, S. Brakman, C. J. Jepma and S. K. Kuipers, DE ECONOMIST, Volume 130, Number 3, 360-380

15. Trade in Minerals, Graham A. Davis, Division of Economics and Business,Colorado School of Mines, December 15, 2009