Public Affairs - A dangerous case of Dutch disease

Claude Clarke, Contributor

THE NETHERLANDS entered the 1960s on an economic high. Newly discovered North Sea oil and gas was injecting vast amounts of foreign revenues into the economy. Public expenditure and incomes soared and the Dutch currency strengthened.

But the good times would end when the weight of these high incomes and government expenditure undermined the competitiveness of the guilder and the viability of Dutch production on the international market. Exports fell, imports rose, and the once highly productive and stable economy of The Netherlands became a model of economic dysfunction later to become known as 'Dutch disease'.

Dutch disease describes the economic condition that arises when a vast amount of wealth, resulting from external factors, flows into a country. The windfall revenues create high inflation and sustain a currency priced beyond its competitive value. It drives up production costs and leaves the output of the economy uncompetitive. Capital invested in the economy becomes unproductive and the productivity of labour declines.

For the Dutch government of the 1960s, North Sea oil and gas was the lowest of low-hanging economic fruit; as irresistible as the forbidden fruit was to Adam in the Garden. Certainly, it was a great financial boon. But without the steadying hand of government, using policy measures to maintain the competitive viability of the overall economy, the boon soon became a monumental bust.

Fix with policies

Holland's experience demonstrated that Dutch disease is a condition that has to be met with policies to maintain the competitiveness of the whole economy if the good fortune of a sudden increase in externally generated revenues is not to become a costly liability to an economy.

In spite of Holland's example, though, several other countries contracted the disease, with even more disastrous consequences, particularly in the developing world. Lured by easily realised gains from real or imagined low-hanging economic fruit, they ignored the critical structural economic arrangements that bring productivity and competitiveness to an economy, in favour of easily garnered revenue. In the end, they reaped the bitter fruit of economic profligacy: an economy unable to achieve sustainable growth and provide economic opportunity for its people.

Africa's most populous nation, Nigeria, was one of the earliest victims of that economic malady. Before the flow of oil revenues reached its peak, Nigeria's economy was a world leader in the production of several major agricultural commodities, like cocoa. Between 1975 and 1985, after the revenues from oil took effect, it fell from being the second-largest cocoa producer to eighth place. Its agricultural base had provided reliable export earnings and employment to Nigerians across the board. But after its oil revenue windfall began, the country experienced a collapse of its agricultural sector to the point where its food production could no longer keep pace with population growth, resulting in rising food imports and the loss of the food self-sufficiency the country had achieved.

Before oil, this leading West African economy might have transitioned from its strong agricultural base towards industrialisation. But the discovery of oil changed all that. The easy flow of oil's externally generated revenues created a sector with very high incomes that brought with it a generalised demand for high wages that could not be supported by its traditional industries or any industrialisation that might have been envisaged.

The country lost its position as a top agricultural commodity exporter to countries like Malaysia and Indonesia because of its reliance on the flow of oil revenues. Malaysia went on to build a significant manufacturing capability from its strong agricultural base; not from oil. And though Nigeria has been doing better in recent years, it is yet to make that turn to industrialisation.

The proof of the pudding is in the output of the people. In 1970, the economic output of the average Nigerian was two and a half times that of an Indonesian; but by 2000 the average Indonesian was producing twice as much as the average Nigerian.

The experience of countries with heavy endowments of foreign revenue from commodity exports, even one as valuable as oil, has demonstrated that for development, nothing rivals the hard grind of the sound management that makes an economy productive and competitive.

This is amply exemplified by the experience of Trinidad, which was also afflicted by Dutch disease when oil prices surged in the 1970s and was famously called 'Trinidad's oil revolution' by its revered Prime Minister Eric Williams. However, when oil prices fell in the 1980s, the inflated incomes, prices and costs that had been created by the 'oil revolution' could no longer be sustained and the government took action, including exchange rate adjustments, income cutbacks and a partial embargo of CARICOM imports to protect the country's economic competitiveness.

Jamaica and Dutch disease

Jamaica, too, has had its experiences with Dutch disease. The heavy investments in and development of the bauxite alumina industry in the 1960s brought with it some of the negative symptoms of rising production costs. But the experience was positive overall because the increased revenues were based on a substantial local productive content and had the added benefit of spinning off technical skills that lifted the country's industrial competence. This contributed in no small way to the surge in manufacturing activity that occurred in Jamaica during that period.

However, today Jamaica is in the grip of a far more virulent and dangerous form of Dutch disease. We have rapidly lost the ability to feed ourselves. Inflation is rampant. In 2010, our inflation was almost 10 times that of our main trading partner, the United States, although our import-dominated economy benefited from low imported inflation and a four per cent currency revaluation. Our currency is persistently overvalued. Our imports are soaring and our exports are stagnating. Capital invested in production is unproductive and labour productivity has been in constant decline. All: the unmistakable symptoms of Dutch disease.

Ironically, the principal cause is a phenomenon that is regarded by many as the best thing the country now has going for it: remittances from abroad. This heavy flow of foreign funds coming from loved ones and money launderers alike has represented as much as 15 per cent of our gross domestic product. No Jamaican goods or services have been produced to earn it. But as it flows into the economy and fuels demand for imports, it undercuts demand for domestic production while it inflates the cost of locally produced goods and services.

The amount of remittances flowing into Jamaica each year is greater than all we earn from our exports, as well as from tourism; and more than the value of mining and manufacturing combined.

There can be no disputing the short-term value of the over US$2 billion infusion into our cash-starved economy each year. But if not properly taken into account in shaping our economic policies, its lasting effect will be to drive a stake in the heart of our productive sector and ultimately our country's ability to support itself and develop.

The economic malaise of Nigeria's economy that followed its discovery of oil resulted from windfall revenues representing about 15 per cent of its GDP. Jamaica's remittances revenues also represent around 15 per cent of GDP; and it bears all the potential for economic damage as Nigeria's oil revenue did. It is, therefore, of the utmost importance that the Government develop policies to ensure that the flow of remittances, despite its benefit to consumption, does not retard the ability of the economy to recover and grow sustainably.

Unearned inflows

The Government, rather than simply taking comfort in the aid that remittances give to consumption, must institute the policies necessary to mitigate the negative effect of these unearned inflows on prices, incomes and the cost of production in our factories and our farms.

I am not here prescribing the strategies needed to reconcile the blessing and the curse of remittances. But Government needs to recognise the economy's desperate need for capital and increased labour productivity. It must discharge its responsibility to organise the economy to attract capital to production, raise the productivity of our people, and create an economic environment within which costs are low and the goods and services we produce competitive. These are the things that will increase our export earnings, reduce our dependence on imports, and put our economy on the pathway to sustainable growth.

Dutch disease is not fatal but it carries all the pain of slow death. Trinidad has proven it is a condition that can be reversed by government. And even if it lacks the will to resist the temptation to ignore easy money, our Government must take actions now that will allow us to avoid the pain of a slow economic death.

Claude Clarke is a former minister of industry and commerce. Send feedback to columns@gleanerjm.com