Dutch Disease
What is Dutch Disease?
Dutch disease is the decline of a country's manufacturing and farming after a resource boom raises the real exchange rate and prices their exports out.
Two forces do the work. A resource boom brings a flood of foreign currency into the country, which bids up the exchange rate or, under a fixed rate, raises domestic prices and wages, and either route makes the real exchange rate appreciate, so factory and farm exports become expensive for foreign buyers. At the same time the booming sector bids workers, engineers and capital away from those industries by paying more, which economists call the resource movement effect. Manufacturing shrinks, and because manufacturing is where a lot of learning and productivity growth happens, the damage can outlast the boom. The name comes from the Netherlands, whose manufacturers struggled after large natural gas discoveries in the nineteen-sixties.
Dutch Disease: a worked example
A country discovers offshore gas and export earnings jump. Foreign buyers need the local currency to pay for the gas, so demand for it rises and it appreciates from $1.00 to $1.25 per unit. A shirt factory that has always priced its shirts at 20 units now costs a foreign wholesaler $25 instead of $20, a 25 percent rise, with nothing about the factory having changed. Orders move to a competitor abroad, the factory lays off workers, and the gas field hires some of them at higher wages. When gas prices later fall, the factory and its accumulated know-how are gone.
The mistake students make with dutch disease
Dutch disease and the resource curse get used as synonyms, and they are not. Dutch disease names one specific mechanism: a real appreciation plus a pull of resources into the boom sector, which together shrink other tradable industries. The resource curse is the broader and much-argued finding that resource-rich countries tend to grow slowly and govern badly, with Dutch disease as only one channel among several. Note too that aid or remittance surges can trigger the same appreciation, with no resource involved.
Dutch Disease questions
Why is it called Dutch disease?
The name comes from the Netherlands, where manufacturing struggled after large natural gas fields were developed in the nineteen-sixties. Gas exports strengthened the currency and Dutch factories found their goods harder to sell abroad. A British magazine coined the phrase, and it stuck as shorthand for the pattern.
Can a country avoid Dutch disease?
Countries limit Dutch disease mainly by keeping resource revenue out of the domestic economy. A sovereign wealth fund that invests earnings abroad and a fiscal rule allowing only a small, steady withdrawal each year keep the currency and government spending from swinging with the resource price. Spending on skills and infrastructure that raises productivity in other tradable sectors also helps offset the appreciation.
Does Dutch disease only happen with oil and gas?
No, any large and sustained inflow of foreign currency can produce the same effect. Big aid programs, surging remittances, a mining boom or a rush of foreign investment can all appreciate the real exchange rate and squeeze exporters. The mechanism depends on the size and persistence of the inflow, not on what generates it.
Formula / Example
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