Dutch Disease Definition and Theory

The existence of natural resources or excessive foreign exchange flows and an export boom in any industry constitute the Dutch disease. Dutch Disease is a phenomenon that negatively affects all macro variables in the long run.

1.1.1 Dutch Disease Definition

With the discovery of natural resources in the Netherlands in the 1950s, the increase in natural gas and fuel exports led to inflation and unemployment. For this reason, it has meant the fact that within the framework of the growth theory of states that dominate important resource reserves, other things are equal, have more production capacity compared to other countries, and that the per capita GDP of countries rich in this resource is higher. It has been possible to take advantage of opportunities due to accelerating economic growth. However, it shows the lower economic growth rates of states that actually have natural resources. Most of these, compared to developed countries that have a lower GDP per capita, and these studies have shown the country's natural security and resources create a number of problems, one of the consequences of slowing economic growth.¹ In the Netherlands, which is the origin country of the Dutch Disease concept, with the discovery of natural gas reserves and the rapid increase in exports in the 1950–1960 period, the domestic currency has greatly appreciated and export-oriented sectors have been negatively affected by this situation. In order to benefit from natural gas reserves and develop the natural gas industry, investment and employment resources have started to be directed to this industry intensively.

The labor force has started to be employed in the natural gas industry rather than in the agriculture or manufacturing sector. The reason for this is the increase in wages and profitability in the natural gas industry with the acceleration of capital flow to the natural gas industry and related industries. On the other hand, the Dutch government's use of some of its foreign currency revenues to increase the welfare of the society is considered as another reason. Even the unemployment benefit amount was higher than the wages earned in agriculture in the relevant

1 Sachs, J. D., and Warner, A. M. (2001). The curse of natural resources. European Economic Review, 45(4-6), pp. 827-838

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period. With the effect of all these factors, the development of other sectors in the country has weakened or stopped completely. As a result, the country's economy started to develop unilaterally. General symptoms of Dutch Disease can be listed as follows:²

 With the entry of foreign exchange revenues obtained as a result of the increase in oil production and exports into the foreign exchange market of the country, the appreciation of the domestic currency;

 As a result of the appreciation of the domestic currency, the decrease in the competitiveness of traditional export products and the gradual decrease in exports;

 Labor and financial opportunities shifting to other sectors (such as the service sector and the petroleum sector) due to the loss of competitive power of the exporter sectors in both domestic and foreign markets;

 With the rapid increase in the amount of crude oil production, the production structure of both the economy and the industry changes and the unilateral development in the economy emerges;

 The increase in the dependence of the economy on imports as a result of the appreciation of the domestic currency and structural changes in the economy (the decline of non-oil industries and the development of the oil industry);

 With the increasing dependence of public revenues on the oil industry, the degree to which public revenues are affected by fluctuations in oil prices in the world market.

It is not easy to think that it can automatically ensure economic development, although there are examples showing that having rich natural resources will affect the economy positively.

Even the opposite results have been observed. In many studies examining the economic performance of countries rich in natural resources, remarkable determinations are made in this respect and it is stated that being rich in natural resources can have negative effects. The term Dutch disease is used in economics to explain these negative effects on the economy.³

The cause of Dutch Disease is that oil and other natural resources often do not create jobs for them and often exclude other economic areas. The large amount of foreign currency obtained from oil and natural gas exports is used by the currency of the country and increases the country's

2 Arezki, R. (2012). The Natural Resource Curse: A Survey of Diagnoses and Some Prescriptions in Commodity Price Volatility and İnclusive Growth in Low-İncome Countries.

3 Lederman, D. (2008). In Search of the Missing Resource Curse. Economia Fall, pp. 1-58.

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production, causing the country to lose its competitiveness in foreign markets. At the same time, currency valuation has a negative impact on imports of goods and the state of the domestic market.

Exports of important resources such as oil and natural gas have a negative impact on the manufacturing industry and in many domestic sectors, especially in industry and agriculture. As a result of the currency valuation, the country is getting richer and dependent on natural resources.

Dutch Disease can occur in different ways. The factors that trigger the foreign exchange flow, such as the revival in the natural resources sector, sudden changes in capital inflows and outflows, and foreign aid, lead to the rise of the national currency, the distribution of production factors from the beginning, and a decrease in the output of the manufacturing industry.

1.1.2 Discussions on the Natural Resource Curse and Dutch Disease

In 1975, former Venezuelan oil minister and founding member of OPEC (Organization of Petroleum Exporting Countries) Juan Pablo Perez Alfonso said: “Ten years from now, twenty years from now, you will see that oil will bring destruction to us.” Oil contributed greatly to the Venezuelan economy at that time and oil revenues were very high. Although this statement was regarded as strange at that time, Juan Pablo Perez Alfonso's predictions proved correct and after a short-term economic prosperity, per capita income in Venezuela returned to the level of the 1960s.

Although this situation may appear as an anomaly, it is actually not an exception. In many countries rich in oil, minerals and other natural resources, economic growth tends to slow in the long run compared to economic growth in other countries that are not as rich in natural resources. This phenomenon is called the Curse of Resources in the economic literature.⁴

There are also studies showing that basing the natural resource curse hypothesis solely on natural resource richness and dependency may be erroneous or incomplete. Since the publication of Sachs and Warner's (1995) work, the development of scientific and analytical approaches to natural resources has gone through several stages. In the 1990s, most economists shared a common view: The raw curse was really circulated by an economist who was interested in solutions to the impact of natural resources on economic development. However, beneficial minerals were thought

4 Sergeeva, Z. Kh. (2011). Hydrocarbons: a development factor or a resource curse? Bulletin of Kazan Technological University, (8).

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to have a negative effect on the growth effect. Hence, various ideas have emerged that highlight the different phenomena in which resource dependence inhibits growth.⁵

In their studies, Sachs and Warner argued that natural resource richness is not a real condition for low growth, and that this should be considered together with climate and geography factors. In the post-World War II period, the curse of natural resources, which came to the fore especially in Latin American countries, is the role of decreasing global demand and prices.⁶ It is argued that the wealth of natural resources creates compression effects at the general level of prices through demand expansion in non-tradable sectors and thus price increases. The basic principle of Dutch Disease is that the country exporting natural resources allows significant foreign currency to flow into the national economy. According to the Dutch Disease theory, capital movements cause an overvaluation of the real exchange rate and have a negative effect on economic growth.

This means the appreciation of the national currency, so tradeable sectors other than the natural resource sector (manufacturing sector) cannot compete in international markets. As a result, this sector shrinks by causing structural changes in the economy and unemployment.⁷

On the other hand, K. Fremer thought that the main goal of innovative development on the role of economic growth and economic structure based on natural resources is to get rid of resources. An unexpected decline in relation to the production of resources and changes in marketing conditions (eg the discovery of new natural resources or the use of production technologies) lead to instability of private sector investment and public revenue. The so-called Dutch disease is associated with the idea that unexpected resource income is negative. It affects other sectors of the economy due to the increase in real exchange rates.⁸ The classical economic model of his disease was developed in 1982 by W. Max Corden and J. Peter Neary. This model is

5 Buyanov, V. (2011). BP: 2011 statistical review of world energy. Economic Policy, 4, pp. 38-55

6 Sachs, J. D., and Warner, A. M. (2001). The curse of natural resources. European Economic Review, 45(4-6), pp. 827-838

7 Bulte, E. H., Damania, R., and Deacon, R. T. (2005). Resource intensity, institutions, and development.

World Development, 33(7), pp. 1029-1044.

8 Gylfason, T. (2001). Natural resources, education, and economic development. European Economic Review, 45(4-6), pp. 847-859.

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still considered a large model. According to the model, there are three conditions for Dutch Disease:⁹

1. To increase the share of the export sector 2. Excessive appreciation of the national currency

3. Loss of competitiveness through transition to other developing sectors

According to the model, the economy of the Dutch Disease is different from three sectors:

 Natural resource or explosive sector

 Remaining export products sector

 Non-export products sector

The Dutch disease is caused by the economy being more open and the relatively high natural resources. Natural resources from Australia and the Netherlands to Guyana and Zambia have exceeded the pace of the economic development of the country with rich natural resources.

With this, the resource curse has emerged with the problem of sharing funds generated by resources, so that you can create new technologies.

1.2 The Macroeconomic Effects of the Dutch Disease