Dutch Disease

Definition

Dutch disease refers to the negative consequences that can arise from a large increase in a country's income, typically due to the discovery of a natural resource or a rapid increase in the price of one of the country's exports. This can lead to the appreciation of the country's currency, making other exports less competitive and causing a decline in the manufacturing sector.

5 Must Know Facts For Your Next Test

1. Dutch disease can lead to a decline in the manufacturing sector, as the appreciation of the currency makes the country's exports less competitive in the global market.
2. The resource curse is closely related to Dutch disease, as countries with an abundance of natural resources often experience a decline in other sectors of the economy.
3. The appreciation of the currency can also lead to a decline in investment in the manufacturing sector, as it becomes less profitable to produce goods for export.
4. Dutch disease can also lead to a decline in government revenue, as the country becomes more dependent on the revenue from the natural resource sector.
5. Diversifying the economy and investing in other sectors, such as education and infrastructure, can help to mitigate the negative effects of Dutch disease.

Review Questions

• Explain how Dutch disease can lead to a decline in the manufacturing sector of a country.
  • Dutch disease can lead to a decline in the manufacturing sector of a country due to the appreciation of the country's currency. When a country experiences a large increase in income, typically due to the discovery of a natural resource or a rapid increase in the price of one of its exports, the value of the country's currency tends to appreciate. This makes the country's exports more expensive and less competitive in the global market, leading to a decline in the manufacturing sector as it becomes less profitable to produce goods for export. The appreciation of the currency can also lead to a decline in investment in the manufacturing sector, further exacerbating the problem.
• Describe the relationship between Dutch disease and the resource curse.
  • Dutch disease and the resource curse are closely related phenomena. The resource curse refers to the paradox that countries with an abundance of natural resources often tend to have less economic growth and worse development outcomes than countries with fewer natural resources. Dutch disease is one of the mechanisms by which the resource curse can manifest. When a country experiences a large increase in income from a natural resource, the appreciation of the country's currency can lead to a decline in the manufacturing sector and other tradable sectors, making the country more dependent on the natural resource sector. This can lead to a decline in economic diversification and long-term economic growth, as the country becomes vulnerable to fluctuations in the price of the natural resource.
• Evaluate the potential policy responses a government could implement to mitigate the negative effects of Dutch disease.
  • Governments facing the challenges of Dutch disease have several policy options to mitigate its negative effects. One key strategy is to diversify the economy and invest in other sectors, such as education and infrastructure, to reduce the country's dependence on the natural resource sector. This can involve measures like promoting the development of other export industries, encouraging investment in research and development, and improving the overall business environment. Additionally, the government could implement policies to manage the influx of foreign currency, such as sterilizing the impact of natural resource revenues, or using sovereign wealth funds to save and invest the proceeds rather than allowing them to directly impact the exchange rate. Fiscal policies, such as tax reforms and targeted subsidies, can also be used to support the manufacturing and other tradable sectors. Ultimately, a comprehensive and well-coordinated policy approach is necessary to address the complex challenges posed by Dutch disease and promote sustainable economic development.

Related terms

Resource Curse: The resource curse refers to the paradox that countries with an abundance of natural resources, often tend to have less economic growth and worse development outcomes than countries with fewer natural resources.

Appreciation of Currency: The appreciation of a country's currency refers to an increase in the value of the currency relative to other currencies, making the country's exports more expensive and less competitive in the global market.

Deindustrialization: Deindustrialization is the process of social and economic change caused by the removal or reduction of industrial capacity or activity in a country or region, especially heavy industry or manufacturing.