The Dutch Disease: The Resource Curse And Other "Dirty" Economics Words

In the world of economics, the layman would assume that having a large amount of natural resources couldn't possibly be a bad thing. After all, how did the Persian Gulf States demonstrate such incredible growth since the discovery of oil? It can't be bad to strike gold...or can it?

Enter two seemingly paradoxical economics terms that confound and perplex those not versed in long-term economic surveying.

The Dutch disease

Economist magazine first coined the term "Dutch disease" in 1977, when analyzing the 1959 discovery of natural gas reserves and its ramifications on the Dutch economy. The value of the Dutch guilder rose sharply, and made all products other than Dutch natural gas less competitive in the international market. Unemployment rose fivefold and investment into the Netherlands plummeted. So let's dig into what happened there. Let's presume that country X's citizens discover a massive oil field off the country's coast. This is good news, right? More energy, more jobs, more exports and an overall better situation than the one we started with? We must not be so hasty to judge. What larger scope developments take place after the discovery of a natural resource? When the country begins exporting the resource (or resource-dependent product) the discovery is related to, it will have to do so in its own currency. This means that the importing trade partner will have to purchase country X's currency and then use it for purchasing the resources.

This means that there is an inflow of foreign currency into country X's market, which strengthens country X's currency. After all, what is being signaled is that country X's economy is solid, it's trading well and people want what it has - which increases confidence. So what happens when a country's currency increases in value? Surely that must be good for the local economy.

Again, no such luck. The higher value of the local currency results in two side effects - the price competitiveness of domestic goods in the international market suffers and the country affected by the Dutch disease imports more goods than previously. Worth noting is the fact that Dutch disease need not be contracted by finding natural resources - a sharp increase in foreign direct investment (FDI), an influx of foreign currency or even incoming foreign aid all result in the emergence of Dutch disease - because what fundamentally causes the ailment is the increased value of the local currency.

The price competitiveness of country X's products fall because in the short term (up to 5 years) domestic producers do not adjust their production cost to the new price environment - they keep their prices where they are. All other things being equal, when domestic producers keep their production costs and selling prices stable, they effectively make their prices higher on the international market and get outbid. They can't afford to reduce their prices because the local economy hasn't caught up to the currency value increase. It's an iterated prisoner's dilemma, which is why it becomes resolved eventually - but not before the long-term damage is done.

Not only is the trade situation of country X made worse, but the domestic work force will begin moving into the new field promising easy money (such as oil drilling), and manufacturing will become outsourced to less expensive foreign partners.

Dutch disease is, for lack of a better description, a paradoxical situation in which seemingly good news (like the aforementioned discovery of oil/natural gas) actually bring about a negative impact on the economic outlook of a country in the mid-to-long term.

The resource curse

The resource curse is a much less specific term than the Dutch disease. It usually explains why it merely possessing resources does not serve the long-term interests of an economy and can actually be damaging. It can usually be reduced to 5 points:

1. Resource prices are constantly falling, because the technology to extract said resources (especially non-renewable resource substitutes) is constantly improving, reducing the cost of extraction and thus the price the resource can reach in the market. This, naturally, dissuades new entrepreneurs from entering the market of resource extraction, because the payday is on a downward slope.

2. Certain resources can lead to a dead end: We take oil as an example. Technology is currently being developed to replace oil derivative products with cleaner-burning natural gas in combustion applications, whereas bioplastics and recycling is poised to undermine other oil refining sectors. Though it is still extremely lucrative to extract and especially refine oil, it will not be so for a long time - by the end of this century, oil extraction will be a single-digit percentage of what it is today. This is not because of "peak oil" scares, but because we will have discovered more practical and price-effective methods of production. This makes such resources inherently depreciating assets, and further limits investment.

3. Resources usually end up in the hands of elites - more often than not, natural resources become natural monopolies in a certain area and become inhabited by groups unresponsive to market conditions: Either modern governments or corporations privileged by them. This spells almost certain doom for an economy - such as the sale of logging rights in the Amazon to paper companies as opposed to the establishing of firm property rights.

4. Non-renewable resources encourage armed conflict - continuing from point 3, having resources also makes one a target. Espionage, threats, buy-outs, land grabs and similar tactics are too often employed in under-developed, resource-rich countries. It is often so that even within the countries militias or other violent groups make claim on the resources, and begin a bloody cycle of combat that some nations have yet to exit.

So, what is to be done?

Startup societies will essentially be competing for patronage from citizens worldwide. What will happen in the long term in the startup societies paradigm is that individual societies will specialize in their comparatively advantageous fields. So how can we avoid the occurrence of the above-listed economic diseases sustainably?

In examining Dutch disease, it is obvious that having one's own currency is a major factor. However, it is not the foreign currency coming into the economy that causes the problem, or the increased "value" of the domestic currency. It is the artificially increased economic confidence in a region that only achieved this through the actions of a few entrepreneurs. The confidence in a region rises over-proportionally compared to real growth.

This can be combated through powerful decentralization and freeing up trade. Nowadays when we see news headlines, they will usually say: "Panama strikes oil" or something similar. This is fundamentally wrong as it is more correct to say "XYZ Oil Corporation strikes oil in Panama". As soon as economic aggregates are scaled up to nation-size without there being much reason for such a development, nearby economic actors suffer. The increase of XYZ Oil Corporation's share price is the most that could be affected if XYZ were free to trade with whomever it desired, and the economic activity of XYZ weren't attributed to the policy of its home country. What causes Dutch disease is the binding of independent economic actors together with a term such as "nation" or "country".

The resource curse is a more ephemeral problem, but it would seem to reason that establishing property rights, free markets and trade would serve to reduce resource prices, but at the very least make them less volatile so that the entrepreneurs of resource extraction need not be scared off by potential ruin. The questions of elites can be handled by competitive pressures - as long as there is competition in a resource environment, prices will be kept low. Oligopolies and cartels can scantly survive the prying eye of the public in a truly free market.

In closing, these two economic maladies are rather universally present despite their cryptic names, much growth and wealth is being lost at this very moment to these economic failures that needn't occur. Perhaps the startup societies paradigm will administer a system in which it will be less likely that these afflictions affect as many people as they do currently in so profound a way.

Aleksa Burmazovic

Aleksa is an undergraduate student at the University of Belgrade in Serbia, working on a degree in finance and insurance.

He was involved with European Students for Liberty as a local coordinator in 2016, but has since retired from the organization of ESFL events.

Aleksa is fascinated with the idea of establishing new societies, competitive governance and new regulative structures.

An avid supporter of cryptocurrencies and free trade, he joined Startup Societies Foundation in the summer of 2017 while volunteering for the Startup Societies Conference in San Francisco.