The Dutch Disease

In the 1960s, the discovery and development of Europe’s largest natural gas field in the Netherlands triggered an unexpected structural shift in the Dutch economy. The surge in export revenues brought in large inflows of foreign currency, leading to an appreciation of the Dutch guilder. A stronger currency made Dutch manufactured goods more expensive in international markets, reducing their competitiveness and contributing to a decline in manufacturing. (In economics, when a currency depreciates, say the USD moves from ₹80 to ₹90, exporters receive more rupees for every dollar earned abroad. This makes it easier to cover domestic costs such as wages and inputs like electricity and freight charges. Conversely, when a currency appreciates, exporters receive fewer units of domestic currency per dollar, squeezing margins and weakening export competitiveness.)

Countries reliant on natural resources like oil or precious stones often run into this problem. The intoxication of easy money, often through concessions given to international institutions, results in little attention paid to manufacturing and agriculture. The influx of hard currency leads to a consumption boom which results in more money chasing fewer goods. This soon leads to a rice in prices of local goods and services. And the moment the commodity prices fall globally, the whole economy collapses.

Joe Studwell, in ‘How Africa Works: Success and Failure on the World’s Last Developmental Frontier’ explains this with the case of Angola and its oil industry:

Resource-rich states feature what have been called ‘consumption cities’ – urban centres that spend revenues from mineral and hydrocarbon output on imported, and local non-tradable, goods and services, while manufacturing and farming for export almost nothing. The ultimate example is Angola’s capital, Luanda, which features a booming real estate sector, shopping malls and luxury boutiques, and a wild night-life. In some years it tops the global expatriate cost of living index, beating cities like Geneva, Tokyo and Singapore. Luanda produces almost no tradable goods beyond oil.

Dutch Disease in Africa also took on a new unpleasant dimension. Periods of strong resource prices enabled governments to borrow offshore. Regimes in countries like Angola did so aggressively. When commodity prices crashed – as happened at the end of the last supercycle in 2014 –states had to allocate increasing budget shares to foreign debt interest and faced the recall of loans. Hard currency flowed out of resource-rich states and exchange rates that had previously appreciated went into freefall, providing a fresh shock to economies. Public debt in Angola, the second least diversified economy in the world after Iraq, rocketed to 120 per cent of GDP in 2020 as the national currency, the kwanza, fell by half against the dollar. The Angolan government, which long refused IMF intervention, belatedly accepted the largest Structural Adjustment Programme (SAP) in Sub-Saharan Africa.

Closer to home, many economists argue that the diagnosis of Dutch Disease partially apply to Kerala and Karnataka. In Kerala, the dependence on foreign remittances resulted in a construction boom (Mallus and their mansions) and a consumption frenzy. When you travel across Kerala, the natural beauty and the rustic charm hides an unpleasant truth – the almost complete absence of any form of an industrial base. Similarly, the IT boom for which Bangalore became synonymous with was also at the cost of completely bypassing the manufacturing phase of transition. 78 years after independence, we’re now scrambling and frantically attempting to attract chip and mobile phone manufactures to India.

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