Dutch Disease – Definition, Negative Aspect, and Example

What is Dutch Disease?

On a typical day, countries would often want ownership and easy access to natural resources as it is the backbone to the efficient functioning of the economy. But sometimes, having ownership of excess resources can harm a country and ultimately impact its growth. One such concept to describe such a situation is ‘Dutch Disease’. The term was initially coined in the year 1977 by the Economist Magazine. When a crisis occurred in the Netherlands after the discovery of natural gas deposits in the North Sea in 1959.

Dutch Disease: Definition

According to the concept, ‘Dutch Disease’ is a situation when a country suffers negative consequences from having excessive valuable natural resources. Because of this, there is a huge influx of foreign money into the country. Following the appreciation of domestic currency compared to foreign currency, the domestic currency appreciates to such an extent that exports become very costly in the global markets.

In another way, when there is a rapid development of one sector in the economy, all resources are diverted to that very sector. And some other sector bears the brunt of this ignorance or low focus. And thus that other sector starts lagging. So simply put one sector of the economy (usually the natural resources extraction) starts booming and because of that, the other sector starts deteriorating.

Impact

This appreciation in the value of domestic currency leads to a huge fall in foreign currency value. Thus the influx of foreign currency and fall in the value of foreign currency leads to an increase in imports. Because the import becomes cheaper and thus spends increases.

Ultimately, the impact is seen not only on the Balance of Payments (BoP) of the country. But also on the growth and sustainability of the manufacturing sector. Due to too much focus on the export of natural resources, the overall development of the country is stagnated. This leads to problems like unemployment and price instability. Countries like Kuwait, Oman, and other African countries have been great examples of ‘Dutch Disease’. As the economies of these countries are majorly dependent on the export of products like oil, gas, commodities, etc. And all these are natural resources available with them.

For example, petroleum accounts for 43% of the total GDP of Kuwait and 70% of its export earnings. Due to the high and continuous demand for resources like oil and gas, the currency of Kuwait and Oman have consistently been in the top 5. These two countries hold the strongest currencies in the world. Some countries like India, China, UAE, and even the mighty USA depend on Kuwait and Oman to meet their Oil and gas demands. However, the moment there is a supply bottleneck or reduced requirements, these countries do face issues.

Negative Aspects

When we look at the negative side, these countries have not been able to excel on other fronts except for setting up industries to exports petroleum products. Crude petroleum, petroleum gas, and refined petroleum make up almost 70% of Oman’s exports. This has led resource-rich countries like Oman to depend on other countries for technological know-how and other basic necessities. Although these countries have been able to grow economically year-on-year, Venezuela and Nigeria have suffered from sluggish economies. Even though they were having rich natural resources. There are two possibilities as to why this has happened:

  • First, countries rich in resources have failed to focus and develop manufacturing and other services segment as well as economic institutions necessary for growth.
  • Second, the country has heavily suffered from Dutch disease. Where domestic currency appreciation driven by strong exports for resources has to make other segments of the economy globally uncompetitive.

Even though countries like Kuwait and Oman have seen growth in recent years in the long term, the growth is not sustainable. The primary reason would be that resources like oil and gas will deplete. And also, developed countries are gradually shifting to a green economy by resorting to electric vehicles. This will, in some way or other impact the dominance that Middle-East countries currently hold. And gradually their purchasing power will reduce and dependence on exports will create issues.

Impact of Dutch Disease on Venezuela

Venezuela is rich in crude oil supplies. In the 1920s, the country discovered an abundance of crude oil which bought many lessons for a resource-rich country. Oil prices in the Venezuelan economy dropped from $100 in 2014 to $21.5 per barrel in January 2016. One of the prime reasons is the country’s heavy dependence on export crude oil sales. Oil sales constitute 99% of the export earnings and one-fourth of the country’s GDP. Due to the falling prices, their production has hit a new low. Venezuelan GDP shrunk by two-thirds from 2014-to 2020 as the demand for oil was affected due to the pandemic. The Venezuelan economy is a fine example of the impact of Dutch disease.

Examples

To say, it is not a negative or bad omen for countries to have ownership of important natural resources. But looking at other developed countries like USA and UK, it is evident that for countries to grow, access to resources is more important than ownership. Kuwait, till now, has successfully been able to thrive and has dominated the oil markets globally. It has become one of the richest countries in the world, with its ranking 5th in the world by Gross national income per capita. Its economy is the 20th largest by GDP per capita, with the majority of the credit going to its abundant reserves of petroleum and gas.

However, African countries like Nigeria and Rwanda have not been able to capitalize on the natural resources they possess. Poverty and illiteracy are some of the reasons for their continuous backwardness. The government in these countries have not invested in developing other important economic institutions, with their focus being on exploiting their resources. There have also been instances wherein even the developed countries had to suffer the wrath of ‘Dutch Disease’. In 2014, Canada’s currency became highly overvalued due to the influx of foreign capital in relation to the exploitation of the country’s oil sands. But sooner or later, these countries have been able to subside the impact.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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