Dutch Disease

Definition

Dutch Disease refers to the economic phenomenon where an increase in revenues from natural resources leads to a decline in other sectors of the economy, particularly manufacturing and agriculture. It often results from capital inflows that appreciate the local currency, making exports more expensive and imports cheaper, which can harm the competitiveness of other industries. This concept is crucial for understanding the effects of capital flows on both host and home countries.

5 Must Know Facts For Your Next Test

1. Dutch Disease was named after the economic decline of the Netherlands following the discovery of large natural gas reserves in the 1960s.
2. As resource revenues increase, governments may prioritize spending on sectors related to the resource, neglecting manufacturing and agriculture.
3. The appreciation of local currency due to capital inflows can lead to a significant loss in export competitiveness for non-resource industries.
4. Countries experiencing Dutch Disease may face increased unemployment in sectors outside of the resource industry as those sectors shrink.
5. To mitigate Dutch Disease, some governments implement policies aimed at diversifying the economy and stabilizing currency fluctuations.

Review Questions

• How does Dutch Disease illustrate the relationship between natural resource wealth and economic sector performance?
  • Dutch Disease illustrates that while natural resource wealth can lead to significant revenue generation, it can simultaneously weaken other economic sectors. When a country experiences an influx of capital from natural resources, it often leads to currency appreciation, making exports from non-resource sectors less competitive. This results in a decline in industries like manufacturing and agriculture, which can create imbalances in economic performance and employment.
• Evaluate the impact of Dutch Disease on a country's long-term economic stability and growth potential.
  • Dutch Disease can severely hinder a country's long-term economic stability and growth potential by fostering dependency on resource revenues while neglecting other vital sectors. This imbalance may lead to volatility when resource prices fluctuate, causing economic instability. Moreover, if non-resource sectors decline significantly, it becomes challenging for the economy to recover and diversify, leading to potential long-term challenges in sustainable growth.
• Assess how government policies can address the challenges posed by Dutch Disease in an economy rich in natural resources.
  • To address the challenges posed by Dutch Disease, governments can implement various strategies aimed at economic diversification and stabilization. This may include investing in education and infrastructure to support non-resource industries, creating sovereign wealth funds to manage resource revenues prudently, and enacting policies that stabilize currency fluctuations. By fostering a more balanced economy that doesn't solely rely on natural resources, countries can mitigate the negative impacts associated with Dutch Disease and promote sustainable economic development.

Related terms

Resource Curse: A paradox where countries with abundant natural resources experience less economic growth and worse development outcomes than countries with fewer natural resources.

Capital Inflows: The movement of money into a country, typically through investments or loans, which can impact exchange rates and economic sectors.

Currency Appreciation: An increase in the value of a currency relative to others, often affecting a country’s export competitiveness.