Dutch disease

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Dutch disease is an economic phenomenon that refers to the harmful effects of a sudden increase in a country's income.

Dutch disease is often associated with the discovery of new sources of natural resources.

However, it can occur with the development of any activity that generates a significant increase in foreign exchange earnings. For example, an increase in the price of commodities or the flow of foreign investment.

Origin of Dutch disease

In the 1960s, the Netherlands found large reserves of natural gas in the North Sea. Consequently, a significant increase in their wealth was generated and, therefore, a greater income in foreign currency from the exploitation of gas.

Contrary to what one might think about the consequences of increased wealth, some effects were not positive for the country. Having strong repercussions in important economic segments. Dutch disease reflects this income paradox.

Characteristics of Dutch disease

Some of the effects that this phenomenon contemplates are the following:

  • Currency appreciation: The main effect is that the local currency becomes more expensive relative to the currencies. In other words, the demand for local currency increases. Consequently, the price of exports unrelated to the activity that generated the income boom increases.
  • Loss of competitiveness: The local industry becomes less competitive compared to the rest of the world. Due to the increase, in real terms, of its production costs. For example, increase in real wages. Likewise, this could lead to indirect deindustrialization by lagging economic sectors. Furthermore, with deindustrialization the country becomes more vulnerable to price fluctuations in the booming sector.
  • Increase in imports: In addition, the local industry must deal with cheaper imports that compete with the domestic product. That is, while local production costs rise, external production costs remain. Therefore, residents could buy the same cheaper product made abroad.
  • Unemployment: In the long term, this phenomenon can lead to higher levels of unemployment. This, because local production could move to other countries where manufacturing costs are lower.

Ordinary or extraordinary income?

An important element to know to combat these harmful effects is whether the new wealth is temporary or permanent:

  • In the case of temporary income, the monetary authority can mitigate the effects by slowing the appreciation of the currency. In this way, you could sell local currency to maintain value. In practice, this is accumulation of reserves.
  • On the other hand, if the income is permanent, structural economic changes are required. For example, boost the productivity of lagging sectors to maintain or increase diversification.

Criticism of the concept

Like many things in economics, this concept does not have the approval of the entire union. Some wonder if it really is a problem and if the term disease is appropriate. This, considering that the income is permanent.

These detractors argue that these changes only represent the adjustment of the economy to its new dynamics. That is, changes in tradable and non-tradable goods are a self-correcting mechanism.

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