Dutch Disease Effects

The term "Dutch disease" describes a phenomenon by which the abundance of natural resources in a country becomes in a disadvantage instead of being something from which the country could benefit through the commerce. The mechanism by which Dutch disease is manifested is through international trade. It begins with the abundant natural resources extraction, then is continued in the export of those resources and ends in the inflow of foreign exchange as result of the sale of those natural resources. The term arises from what happened to the economy in the Netherlands after large amounts of natural gas was produced in that country in the late 1960s and early 1970s.

According to World Bank authors, Dutch disease results where, "In places where natural resources are abundantthat is, where they can be produced at low cost, relative to the marginal cost of production elsewherethey generate large profits (economic rents) for the owners. This has two major effects on the relative incentive structure in the economy. First, to the extent the resources are exported, the inflow of foreign exchange appreciates the real exchange rate: that is, it raises the price of non-tradable goods relative to that of tradable goods. Second, it increases the returns to production of the resource relative to other tradable goods. Both of these effects reduce the incentive to invest in production of other tradable goods, resulting in a production and export structure concentrated in the resource. (Sinnott, Nash, & De la Torre, 2010)

For an example, assume that a country finds it has a lot of mineral wealth - say silver. The silver is mined, and then sold for dollars in the international market. The dollars come into the country and are then converted into the local currency. This raises the value of the local currency with respect to world markets, making wages and local raw material increase in price conducting higher costs for local producers. This drives people out of potentially useful areas, often in the agricultural sector.

In the 1960s, natural gas was found off the coast of the Netherlands. This led to rise in the value of the Dutch currency, making Dutch manufacturing less competitive and harming the Dutch manufacturing sector. A solution could be for a country to give up its domestic currency, like Panama switching to dollars as its currency. However, the drawbacks from such a move could be serious, as what happened in Greece in 2013 after it switched to using the Euro as its currency.