In 1959, natural gas was discovered in Groningen, Netherlands. Over a period of time as the gas field bloomed, labour shifted from manufacturing sector to gas though not in large numbers. The discovery led to a boom in the natural gas sector that earned increasing foreign exchange leading to appreciation of currency, thus making other exports dearer. The economy consists of tradable goods and non-tradable goods. The increasing incomes will result in the demand for non-tradable goods thus creating an employment boom in those sectors. Given the constant labour pool, this increase must necessarily come at the expense of the non-commodity tradable sector thus causing a decline in manufacturing. This was witnessed in Netherlands post gas discovery thus leading to a new term being coined. The term was Dutch disease.
Most Gulf countries perhaps experience a Dutch disease of varying degrees. As the oil prices reduce, the absence of robust non-oil economy might result in unintended consequences for the Middle East. It is likely to more pronounced in Iran even aside of the Wuhan pandemic ravaging the country. Evidence from Dutch disease has emerged from Azerbaijan through oil, Chile through an increase in mineral prices among others. Another interesting example from the 19th century would be the gold rush in Australia.
There was a detailed discussion in the post “Oil Games” on the likely directions in the oil prices. As the battle of chicken assumes greater proportions, increase the stakes, the after-effects of the Dutch disease are likely to rear head in both the sides. The Middle East has suffered from appreciated exchange rate apart from very narrow export base. Moreover, production capacity is skewed in favour of non-tradable goods. This is evident in the rise of services sector in UAE, Qatar among others. A prolonged period of low oil prices is akin to a long winter making people sick.
Traditionally, the disease arises out of a series of steps. The discovery of scarce natural resource creates a boom in the sector increasing employment accompanied by higher exports. As exports increase, one observes an increased inflow of foreign exchange through sales, foreign investment etc. this leads to accumulation of foreign exchange reserves generating domestic currency appreciation relative to external currencies. This makes the exports dearer while imports cheaper in other tradable sectors like manufacturing. A direct impact is a slow decline in the manufacturing sector and jobs slowly shifting away from the sector.
The above resource movement effect leading to direct deindustrialization leads to increased demand for non-tradable goods like services which see increased employment levels. As more people move into the non-tradable sectors, the spending effect assumes greater proportions causing a cascading shifts in increasing demand for services sector. The spill-over would be sharp decline in manufacturing sector causing decline in the production basket diversity. Exchange rate movements followed by large scale foreign exchange inflow is primarily believed to be the transmission mechanism.
One of the first authoritative signs of the disease is the rising inequality in distribution of natural resource rents. To reiterate the above, the shift in spending making it heavily skewed towards non-tradable sectors like luxury goods, services etc. create rising wages and economic profits in these sectors. An outcome of the same is the shift in labour these sectors thus raising the marginal wages in the manufacturing sector. The rising wages makes the cost of the production higher in the non-commodity manufacturing sector thus making goods costlier affecting the exports. In a way, the non-commodity manufacturing sector is no longer a priority even for the authorities given the short term horizon and the seemingly endless rents accreting from the booming commodity and non-tradable services sectors.
Analysts have found evidence of the Dutch disease linked to political instability. To some, there exists a significantly inverse association between political instability and investment in tradable manufacturing sectors. Higher the political instability, the lower would be the investment in the tradable manufacturing and services sectors (One report quoted here). Political instability do not seem to have any impact on the Greenfield investment in natural resources and non-tradable services sectors. To most business, access to production and the markets is a prized asset. There is enough of rent seeking in non-democracies. Many overseas business entities are not averse and in fact cherish regulatory capture. The evidence is visible from Latin America to Africa to Eastern Europe. They thrive on arbitrage opportunities apart from monopoly access in the politically unstable countries without any worry about governance structures and challenges. Moreover, the political instability also rules out the possibility of exchange rate appreciation.
The inner strength of the resource rich economies are slowly destroyed from within through a combination of overvalued currency, political instability and unequal distribution of resource rents. The inequalities in distribution of resource rents are often a product of political instability itself. Rulers might not be averse to allocate uneven rents in exchange for support, a sort of quid pro quo. A suggested solution is essentially creating a sort of universal basic income, a distribution of revenues directly to citizens. Most of the politically stable Dutch disease affected countries essentially thrive on the same. There exists a social peace in exchange for money. As the commodity prices remain high, there is increase inflow of foreign exchange. Low population enables higher distribution of these incomes to the population. The trade-off entails social peace and allowing the ruler to rule by command and control. Any violation or opposition or refusal to be purchased by money is punished severely. Thus low rate of deviation from the normal. Each and every activity is linked to the probability of political survival and thus a trade-off of allowing certain clout in exchange for political power.
This arises an element of interest to observe how the consequences of Dutch disease will play out as Saudi Arabia and Russia play out the oil games with the other oil producers like Iran among others being silent spectators. However, they might not remain so for a long period. In the context of Middle East, there might be political changes thus an uncertain future at least in the immediate run.
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