Dutch Disease

Today we present our paper on a phenomenon called “Dutch Disease,” that tries to explain changes in growth of an economy in the presence of a favorable shock. While it most often refers to natural resource discovery, it can also be extended to include "any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment."[1] The term was coined in 1977 by The Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959.

The theory asserts that an increase in revenues from natural sources will de-industrialize a nation's economy by appreciating the real exchange rate, which makes the tradable sector less competitive. Corden and Neary (1982) modeled this idea and explained Dutch Disease as "adverse effect on non-booming sector due to booming sector."

In their model, there are non-traded (services sector - transport, financial services, etc) and two traded goods sectors (booming and non-booming). The non-booming sector is agriculture and manufacturing sectors.[3] There has been research into the Dutch Disease effect and this has shown one perplexing result: Why do some countries experience the negative effects of Dutch Disease while others seem to avoid the Resource Curse; for eg: Norway’s success and UK’s failure despite conditional similarities of their oil discoveries.

The classic model depicting Dutch Disease was created by two economists (W. Max Corden and J. Peter Neary) in 1982. In this model there in one non-traded goods sector (services etc.) and two traded goods sectors, one is booming and the other is lagging. The booming sector usually arises from the exploitation of natural gas and oil but has also been referred to other natural resources such as minerals (cooper, gold etc.). The lagging sector is almost always the manufacturing sector.

This in fact would hit closer home albeit in a different manner. We shall also see the “Dutch Disease” effect in the Indian economy due to growth in the software/technology services sector at the cost of our manufacturing sector.

While IT did bring in extensive foreign currency revenues (which is contradictory to the actual Dutch Disease model which actually states that exploitation in the exporting of natural resources leads to an appreciation in the value of the currency of a country thus making its exports less competitive internationally, in our case, revenues from our IT sector brought in foreign currency that played not a small role in triggering an uncontrollable inflation. Runaway inflation directly impacted our trade balance as exports seemed comparatively more expensive and thus less competitive. Out of all the sectors, this has had  the greatest impact on our manufacturing sector which was just emerging out of license raj.

1. EBRAHIM-ZADEH, CHRISTINE (MARCH 2003). "BACK TO BASICS – DUTCH DISEASE: TOO MUCH WEALTH MANAGED UNWISELY". FINANCE AND DEVELOPMENT, A QUARTERLY MAGAZINE OF THE IMF 40 (1). IMF. ARCHIVED FROMTHE ORIGINAL ON 2008-06-17. RETRIEVED 2008-06-17.

"THIS SYNDROME HAS COME TO BE KNOWN AS "DUTCH DISEASE". ALTHOUGH THE DISEASE IS GENERALLY ASSOCIATED WITH A NATURAL RESOURCE DISCOVERY, IT CAN OCCUR FROM ANY DEVELOPMENT THAT RESULTS IN A LARGE INFLOW OF FOREIGN CURRENCY, INCLUDING A SHARP SURGE IN NATURAL RESOURCE PRICES, FOREIGN ASSISTANCE, AND FOREIGN DIRECT INVESTMENT.

ECONOMISTS HAVE USED THE DUTCH DISEASE MODEL TO EXAMINE SUCH EPISODES, INCLUDING THE IMPACT OF THE FLOW OF AMERICAN TREASURESINTO SIXTEENTH-CENTURY SPAIN AND GOLD DISCOVERIES IN AUSTRALIA IN THE 1850S."

2. "THE DUTCH DISEASE" (NOVEMBER 26, 1977). THE ECONOMIST, PP. 82-83.

3. CORDEN, W. M., AND P. J. NEARY. 1982. “BOOMING SECTOR AND DEINDUSTRIALIZATION IN A SMALL OPEN ECONOMY.” ECONOMIC JOURNAL 92: 825–48.