Dutch Disease gets its name from an economic phenomenon seen in Holland. The discovery of natural gas reserves in Holland in the 1960s led to an economic slump in other sectors like manufacturing. It is the recession that hits other sectors when one industry dominates, or increases its exports.
Causes
The major cause of this phenomenon was the discovery of natural gas in Holland. Dutch Disease normally leads to a country’s currency appreciating in value. Since the value of the currency rises, manufacturing sectors no longer remain competitive, leading to a slump in the manufacturing sector. This results in manufacturing jobs moving to other countries.
Results
It causes a rise in imports and decrease in exports, since the high value of currency makes manufacturing and other sectors unviable. The high cost of production makes the goods less competitive than the goods manufactured in other countries.
The Economic Model
The economic model to explain this phenomenon was developed by W Max Corden and Peter Neary in the 1980s. According to them, the parties involved include the non-traded goods sector and the traded goods sector. Of the traded goods sector, one sector is a booming sector, while the other is under-performing. The booming traded goods sector may be natural gas, while the under-performing may include manufacturing or agriculture.
The booming sector will attract more labor, leaving the non-booming sector stranded. This may not be a cause for concern, because the natural gas sector is not labor intensive, so it will not employ too much of the country’s workforce.
However, the increasing currency value means that the non-booming trade sector is no longer attractive to the workforce. Instead, people turn to non-trade sectors, like services. Through an increase in the demand for non-traded goods, the price of the non-trade sector increases. This leads to a steep boost in the real exchange rate.
Examples from History
Before Holland in the 1960s, this phenomenon had struck many economies around the world, though it was not recognized with such a name at the time. In the 16th century, the gold brought by Spanish conquistadors from South America to Spain led to the earliest known case. The gold rush in Australia in the mid nineteenth century is another example. Great Britain too caught it in the 1970s due to the discovery of gas fields in the North Sea.
Though some critics think that the effects of Dutch Disease on the economy have been exaggerated, it is still a good option to be prepared for all eventualities. This is especially so if you run a small business, since your livelihood depends on the non-traded goods sector. A boom in one sector could lead to a slump in another, so it is best to be prepared.
David Gass is President of Business Credit Services, Inc. His company publishes a free weekly e-newsletter on Small Business Consulting at their web site smallbusinessconsultingdotcom