sE searched 

Royal Dutch Disease

Logic says that petroleum-rich countries should be rich. The oil-producing, less-developed nations that reaped a bonanza during the past few years of sky-high oil prices ought to be sitting pretty even as crude prices experience free-fall today. However, things aren't that simple.

Venezuela, for instance, thanks to mismanagement of its oil windfall, is suffering high inflation, a drop in petroleum production, and is talking of possible austerity measures, even though it is the Western hemisphere's largest oil exporter.

In fact, history shows that oil and natural gas reserves frequently can be a bane, not a blessing, for poor countries, leading to corruption, wasteful spending, military adventurism, and instability. Too often, oil money intended for a nation's poor lines the pockets of the rich, or is squandered on showcase projects instead of productive investments.

A classic case is Nigeria, the eighth-largest oil exporter. Despite half a trillion dollars in revenues since the 1960s, poverty has increased, corruption is rife, and violence roils the oil-rich Niger Delta.

The term "Dutch Disease" was coined after the Netherlands' economy weakened following the 1960s discovery of natural gas, thanks to a rising exchange rate and a fall-off in manufacturing. Even OPEC countries are not immune. As a group, their per capita gross national product actually dropped from 1965 to 1998, one study found.

This "resource curse," as economists call it, curses America, too. It worsens global poverty, which can be a seedbed for terrorism, it empowers autocrats and dictators such as Saddam Hussein, and it can crimp world petroleum supplies by breeding instability.

What can we do to reverse the resource curse? A new report I commissioned from the Senate Foreign Relations Committee staff, "The Petroleum and Poverty Paradox", offers some answers. There is no simple cure, of course. But where leaders are ready to face the problem, outsiders can offer important incentives and advice.

One key prescription is to promote stronger anticorruption measures and more openness, or transparency.

The World Bank and the International Monetary Fund have launched efforts to improve accounting and transparency of extractive industry revenues, to make it harder for officials to hide corruption – and easier for citizens to demand that the money be spent wisely.

An especially promising development is the Extractive Industries Transparency Initiative (EITI), a voluntary program which certifies that participating countries, and the oil companies operating there, are honestly accounting for funds flowing into their coffers. The G-8 and UN have praised the EITI and its work.

Yet action falls short. In Vietnam, where 30 percent of the budget comes from oil, the World Bank and major bilateral donors have done little to address extractive industry transparency. Peru and Equatorial Guinea have signed up for EITI, but major-country donors are not stepping forward to strengthen those nations' capacity to manage massive oil wealth. Skeptical Indonesians asked why America has not joined EITI. In Angola, which has the world's highest infant mortality rate, the US is terminating a program to help the country administer its oil billions, which are largely unaccounted for.

There is an urgent need for concerted diplomacy and assistance targeted at budget management and expenditure accountability. Donor coordination in these areas is rare. And China, whose state-backed oil companies have a large footprint in many developing countries, has not yet engaged on these issues.

As we are now seeing, oil prices can come down just as far, and just as fast, as they go up. That's why it's so critical that developing countries act urgently to ensure that their funds are managed wisely, so that they are not left in poverty after earning billions. We can do more to help:

•America should lead by example and sign up for EITI, submitting its oil and gas royalties to outside audit. This low-cost move would encourage more developing countries to follow.

•The G-8 countries should back their transparency words with deeds. They could, for instance, require that their oil and mining companies publish country-by-country data on royalty, tax, and other payments as part of routine financial reporting.

•International assistance to resource-rich countries should focus on improving revenue management and fighting corruption. Relatively small amounts of aid money could thus help channel large amounts of countries' own funds toward poverty reduction.

•Oil and mining companies can be part of the solution by voluntarily disclosing their payments to countries where they operate.

Most important, the United States, whose attention to transparency often appears sporadic, should vigorously back these efforts. Reversing the curse is in everyone's interest.

Dick Lugar is a Republican senator from Indiana and the ranking member on the Senate Foreign Relations Committee.

The Misery of the "Dutch Disease and Deindustrialization" Argument


Otaviano Canuto | Jul 22, 2007

High commodity prices, abundance of liquidity, and sustained growth in Asia: all factors of good luck in the current foreign environment of Latin America, right? Not quite, according to frequent references to “deindustrialization” and “resource curse” afflicting the region as features of the international labor division that has been consolidating along the current world economic cycle.

This pessimistic view has two components. One relates to the structural downward move of the price of labor-intensive goods and services relative to natural resource-based ones and the associated geographical dislocation of manufacturing activities toward Asia (either in relative or absolute terms), combined with increased natural resource-linked activities in Latin America. On the same direction, a second strand of “bad luck” arguments alludes to a kind of “Dutch disease” contracted by Latin American economies in the current cycle. The substantial increase of value of exports of natural resources, in conjunction with the liquidity glut abroad and huge capital inflows would be generating insurmountable pressures toward overvalued local currencies, and a corresponding second round of deleterious effects upon domestic labor-intensive production.

Those who characterize this double trend as intrinsically negative express a view that the specialization in natural resource-based production is necessarily harmful to development in the long run. In our view, both lines of arguments often convey an ungrounded prejudice in terms of sector analysis, potentially leading to a mistaken policy agenda if taken for face value in the usually superficial manner with which they are formulated.

Let us recall the concept of “Dutch Disease”. The term appeared for the first time in an article in the November 26, 1977 issue of the The Economist magazine. It referred to Holland’s discovery of natural gas in the North Sea in the 1960s, and how the real appreciation of the Royal Dutch as a consequence of increased exports contributed to a decline in the local manufacturing production. Since then, the expression has been used whenever one sees harmful consequences of discoveries – or sudden upward revaluations – of exported natural resources in developed and developing countries alike.

The theoretical argument about the ultimate effects of such discoveries or permanent revaluations of domestic natural resources on the local GDP composition and labor allocation - after full adjustment in both goods and labor markets - is clear-cut. Independently of whether nominal exchange rates are fixed or flexible, as well as of whether or not domestic aggregate demand is continuously fine-tuned to keep the local price index stable, any substantial and prolonged surge in export revenues of a limited set of goods tends to rob labor and capital from other tradable sectors. See Deindustrialization and the Dutch Disease regarding the different channels by which the Dutch Disease may inflict the competitiveness of other existing activities in the economy.

In order for such a blessing by nature to be ironically treated as a “disease” in Latin America, amplified by the huge extension of low-cost labor-intensive production in Asia, one has of course to state why it entails negative effects for the region’s income growth, levels or quality of employment, etc. despite improved terms of trade. And at this juncture of History and knowledge one has to go much beyond the outdated generic contraposition of “primary products” versus “manufacturing”, as it was the case at the time of the old-fashioned Prebish-flavored controversies. Furthermore, let me take as reasonably evident that in the long run the system of prices and the corresponding adjustments prevail upon “structural rigidities” in factor and product markets. It does not suffice simply to proclaim that natural resource-based patterns of specialization are intrinsically inferior to manufacturing-based ones!

This falls far short from saying that “patterns of specialization do not matter”, as traditional trade theory has predominantly led us to think. We suggest here two recent papers that take stock of theoretical arguments and empirical evidence favorable to two key propositions that contrast with what most conventional trade models convey: firstly, different patterns of specialization do affect future growth of individual economies (Hausmann, Hwang and Rodrik), and secondly, such patterns are “sticky” and tend to exhibit path-dependence and differing degrees of scope for evolution, diversification, and technological change (Hausmann and Klinger).

Nevertheless, one should not incur in a mistaken full-of-prejudice association between natural resource-based products and low requirements in terms of technology and skilled labor. Take for instance the case of agro-energy (biofuels) or soybeans in Brazil, where the bioengineering of seeds and the diffusion of computer-aided weather and soil analysis have been at the core of astounding high rates of productivity increases. Besides those backward linkages and in-house technological requirements, that progress generated favorable inducements forward (as e.g. new flexible sugar-ethanol mills close to crop sites and new flex-fuel ethanol-user vehicles). 

Think also of Brazilian savannahs (“cerrados”), which have become fertile areas as a result of agricultural research, whereas they were considered as desert-like zones not long ago. The fact is that the “discovery” and incorporation of “cerrados” as natural resources has been made feasible by both the dynamism of agricultural markets abroad and technological change, and it has crowded-in capital accumulation, rather than stolen factors of production from more prosperous activities. One should also keep in mind the indirect positive effects that such a “discovery” brought to other activities, by e.g. helping decrease levels of the country risk premium.

Nor it is appropriate to identify the mere presence of manufacturing activities with automatic progress, even when these activities include unskilled labor-intensive segments of production chains in industries classified as “high-tech”. If human and physical capital accumulation, as well as local mastery of technology, does not evolve accordingly, a country may get stuck in producing low technology, low skilled-labor manufacturing activities.       

The bottom-line is straightforward: instead of playing with protectionist measures to halt what is taken as “Dutch disease” and mischievous deindustrialization forces, Latin American economies might better focus on mitigating the real diseases, i.e. low levels and quality of education, insufficient capillarity of science and technology in the production system, dead-weight inefficiencies and lower private willingness to invest derived from institutional failures in the business environment, lack of fiscal space for public investments in infrastructure and other structural malaises.   


Otaviano, a very interesting piece that refutes ongoing concerns about Dutch Disease and excessively overvalued currencies. 
But here two questions, the first of which i already asked Mark Turner in his recent blog on Peru: 
1. It looks like - as you also suggest - that the new comparative advantage of Latin American economies is in resources: they can grow fast if they invest in such resources as commodity prices are now so high and expected to remain high. But such resorce intensive sectors are often capital intensive (mines, energy, etc.). Thus high growth from resources may not trickle down to the masses; thus inequality of income and wealth may persist in spite of high growth and lead to social unrest unless fiscal policy has some redistributive role. Is this argument correct or not? 
2. If we take your argument literally Brazil, Colombia and other Latam economies should not prevent the nominal and real appreciation that is accompanying the recent high commodity prices, increases in terms of trade and capital inflows. So any forex intervention to slow down such appreciation should be avoided as there is no Dutch Disease to worry about. Do you agree? Should they all stop intervening and allowing the resulting exchange rate appreciation? At which point - if any - that would hurt manufacturing exports? Or there is not issue at all with that?

Reply to this comment By Nouriel on 2007-07-23 16:33:36

As you say, "Latin American economies might better focus on mitigating the real diseases," which you enumerate. 
Why not also fully exploit a nation's comparative advantage by encouraging the advantaged industry to vertically and horizontally integrate into related activities? One of the reasons Norway is regarded as a model petro state is that it insisted that multinationals transfer technology to it. And then Norway went beyond being a supplier of oil to having a world class company, Statoil, that competes in exploration and development and in many other areas. One of the problems with Latin America's resource industries, starting with the Spanish and Portuguese colonization, is that much of the value added from resource industries was realized outside Latin America. Keeping it at home creates businesses, generates high value employment, and establishes a solid tax base. But it probably won't win friends in Washington.

Reply to this comment By JohnH on 2007-07-23 19:51:34

Correct me if I'm wrong fellowbloggerOtaviano, but the best way to avoid dutch disease is to move to a second phase of growth via capital investment in value-added products (eg Argentina builds itself a shoe factory or two and stops selling leather to Brazil who then sells shoes to Argentina....a hundred other examples available). In this way GDP growth is maintained when the growth spurt in the (dare i say the word) primary industry reaches maturity. 
Thus your argument at the bottom of the note (paragraph beginning "the bottom line..") is a slight self-contradiction, is it not? Your proposals are the same things that avoid dutch disease from spreading in the first place! 
I expect (and probably deserve) a thwack on the head due for my insolence.

Reply to this comment By Mark Turner on 2007-07-24 18:30:32

1. I think your argument about the likely income-distribution implications of a capital-intensive pattern of growth in poor countries is correct. But notice that this is more the case with mineral resources than with agro-industry: modern and competitive agriculture is nowadays one component of a cluster of activities that range from manufacturing to high-tech services. It all depends on whether the exploitation of resources occurs as part of a whole value chain (including backward and forward linkages) or as a stand-alone activity (without the vertical and horizontal integration - referred by JohnH in his comments - that was a key element of the Nordic countries’ successful natural resource-led industrialization). As far as income and wealth inequality is concerned, and the associated risks of social unrest: the redistributive role of fiscal policy will have to stay with us in Latin America for at least a generation, with or without higher growth, until hopefully a generational change in the level of education of the masses takes place. The social legacy of the region’s past will remain a burden for many years…  
2. The best thing to do while the current long upward phase of the commodity-price cycle does not turn down is to pile up reserves (up to a threshold, at least) and, if possible, reduce domestic real interest rates. In the meantime (before there occurs the expected reversal of hot money inflows), cold blood… and speed up reforms that can mitigate the Asian impact on manufacturing! Ad hoc economic measures have a long sad history in the region and we should avoid them as much as possible. 
You are right wihen you argue that what makes a difference in the case of natural resources is the extent of local vertical and horizontal integration. But rather than emphasizing the nationality of ownership of resources, I would highlight local investments in education, physical and social infrastructure, applied research, institutional improvement enhancing local financial markets and investment funding etc. Local private owners or even state-owned companies are no guarantee of a trickle-down… 
Fellow blogger Mark 
I have to acknowledge "Touche'" when you say that if the reforms mentioned in the last paragraph were in place, there wouldn't be a Dutch disease to start with. Maybe I should rephrase my argument in the following: the Asian challenge is just making the absence of those reforms an even more lethal feature...

Reply to this comment By Otaviano Canuto on 2007-07-24 21:17:40

"....the redistributive role of fiscal policy will have to stay with us in Latin America for at least a generation, with or without higher growth, until hopefully a generational change in the level of education of the masses takes place. The social legacy of the region’s past will remain a burden for many years...." 
A standing ovation. Beautifully put. I doff my cap.

Reply to this comment By Mark Turner on 2007-07-24 21:44:41

"I would highlight local investments in education." I agree. And the best education is technology transfer, so that local people perform the high value tasks often outsourced to places like Houston and New York. Once people have leading edge skills and technology, they are in a position to start creating businesses in areas related to the country's comparative advantage.  
Simply having an educated workforce in no way means that foreign resource companies will choose to perform the highest value added functions locally or that they will chose locals to fill those jobs. Nor does it mean that locals will ever be able to develop the highly specialized skills needed to create businesses in related areas that fully exploit a nation's competitive advantage.

Reply to this comment By JohnH on 2007-07-25 10:28:14

Overview: A Perspective on Dutch Disease

Walter Molano | Jul 15, 2008

Many analysts worry that a heavy emphasis on natural resource development can trigger the formation of Dutch Disease. The economic ailment supposes that increased revenues from commodity development can lead to deindustrialization and slower rates of development. Strong capital inflows can trigger an appreciation of the currency and reduce the competitiveness of the industrial sector. The theory was developed after the events that occurred in the Netherlands during the late 1960s and early 1970s, when it developed its natural gas fields. The guilder appreciated; there was a loss of competitiveness and manufacturing declined. Economists applied the Dutch experience to explain the lack of development in other commodity-rich countries—particularly Venezuela, Nigeria and Indonesia. The recent discovery of large oil deposits in Brazil recently produced warnings about the perils of Dutch Disease. However, economists have not been able to find statistical data to support the argument that commodity production can have an adverse effect on development. Nevertheless, many commentators cite the examples of Venezuela, Nigeria and Indonesia to argue against too much emphasis on commodities. However, the histories of these three countries shows that their oil sectors were purposely developed to ensure a low level of industrialization.

The internationalization of the oil sector at the start of the 20 th century was fraught with risks. Early on, the large multinationals, particularly Standard Oil and Royal Dutch Shell, realized that the development of an oil industry in a foreign country was a dangerous proposition—especially if it was located in a developing country. The opportunities for political risk and nationalization were extremely high. The forced appropriation of the Russian oil sector in 1918 and the subsequent expropriation of the Mexican oil industry convinced the multinationals to separate their upstream and downstream operations in high-risk countries. Venezuela, Nigeria and Indonesia were very good examples of countries where the multinationals purposely moved all (or most) of the refining capacity offshore. Given the fact that the Netherlands held several colonies in the Caribbean, Royal Dutch Shell concentrated its Venezuelan refining operations in islands such as Aruba and St. Maarten; thus giving a new perspective to the so-called Dutch Disease. It was not so much that the countries contracted symptoms similar to what occurred in the Netherlands during the 1960s and 1970s; it was that the Dutch left them with a deindustrailized legacy that was difficult to overcome. The same pattern occurred in Asia, where most of the refining was centered in European colonial strongholds, such as Singapore—although the oil fields were in “high risk” regions such as Indonesia and Malaysia. Ironically, Indonesia was another Dutch colony. Likewise, Nigeria only utilizes a small fraction of its refining capacity. Coincidently, Royal Dutch Shell was the dominant player in the development of the Nigerian oil sector. Hence, the inability of these three countries to refine their oil removed an important source of industrialization and development. There is a long chain of downstream products, such as petrochemicals, plastics and manufacturing, that add enormous value to the petroleum that is extracted from the ground. Many countries, such as the U.S. and Russia, were able to accelerate their economic development thanks to their oil sectors. The petroleum sector at the end of the 19 th century helped the U.S. and Russia leapfrog over some of the European superpowers that had industrialized 100 years earlier, thus moving into the vanguard of the global economy and emerging as the victors of the Second World War.

Fortunately, Brazil is in a different situation. The development of the Brazilian oil sector is under the domain and control of Petrobras—a national oil company. It is taking the lead in the exploitation of upstream opportunities and downstream products. Not surprisingly, Brazil is recouping all of the benefits. Although foreign oil companies are being invited to develop some of the new offshore oil fields, Petrobras is taking the lead. New oil rigs are being built near Rio de Janeiro, creating thousands of jobs and advancing the country’s manufacturing base. Brazil will also be able to take advantage of more downstream opportunities, leading to further industrialization and development. Therefore, the concerns about Dutch Disease may be uncalled for, as long as Brazil does not allow a certain European company to shape the evolution of its oil sector.


Good paper, but I must miss something, if the solution is Brazil, i.e. to develop a national oil company which is taking the lead in the exploitation of upstream opportunities and downstream products, who prevents the corrupt Nigeria, Indonesia and the populist Venezuela to do the same? Is it not corruption, ineficiency and populism?

Reply to this comment By JP Dumas on 2008-07-16 05:05:53

Your facts are partially incorrect: St Marten does not have a refinery (Curacao does, Indonesia had at least one big refinery (Shell) before WWII (i.e. in colonial times) and still refines oil. Refining oil close to markets is economically sound, since it is cheaper to ship crude (product tankers are much more expensive than crude carriers).
Second Holland's de-indutrialzation as you call it happened primarily as a result of a weak strategic position of certain industries (textiles, shipbuilding etc) exposed to emerging Asian competition. This coincided with the inflow (both gvt budget and BOP) of natural gas revenues. Of course the inflationary effects of "effortless" exports benefiting a social democratic government in a country just recovered from WW II devastation could not be contained politically (democracy, era of keynesian policymaking, strong redistributive tendencies among part political establishment, etc) .

It would have ben better to have saved (Nowegian style) those proceeds (or leave the gas in the ground) but that would not have saved those industries. And giving using these funds to prop up obsolete, underinvested industries with weak products and poor management would have been as wasteful as letting people enjoy a higher standard of living for a while...

Reply to this comment By Rien Huizer on 2008-07-18 04:35:21

You are assuming that the only contributing factor to a "dutch disease" is the oil industry, but in Brazil, there are many other commodities that are in effect driving up the value of the currency, and effectively making industrial exports less competitive in the world markets. While I agree with you that the mere presence of oil in Brazil is not enough to start fretting about the dangers of "de-industrialization", I think you framed this discussion too narrowly when only discussing the impact of oil, and not of the other commodities (soy, sugar, oranges, etc, etc)

Reply to this comment By BRIAN BUTLER on 2008-07-18 10:28:55

Page mailing to a friend temporary disabled