Introduction
Today’s discussion addresses the notion of Dutch Disease. This is put forward in the 2021 National Budget as the most dangerous pitfall the Authorities will have to navigate as the country pursues economic growth and development with macroeconomic balance. Simply put, the Dutch Disease pitfall refers to the substantial risk that, as the expected expansion of Guyana’s oil and gas sector proceeds, this could further impair the international competitiveness of Guyana’s exports and economy by leading to increases in the nominal and real foreign exchange rate.
By this is meant that a situation emerges in which less Guyana dollars are required to purchase a given unit of foreign currency, both in nominal terms, and real terms; that is, adjusted for price changes. The disease is labelled Dutch, because this phenomenon was first observed in the 1970s in the Dutch manufacturing sector, following on that country’s discovery of huge natural gas deposits two decades earlier.
Correlation
A correlation had been observed between the expansion of the natural gas sector and the decline of several sectors of the Dutch economy (manufacturing, agriculture, and services). This correlation underscores the prediction that, as Guyana’s petroleum revenues increase, the Guyana dollar will appreciate. That is, less Guyana dollars will be required to buy a given amount of foreign currency. For foreigners, the reverse occurs. That is, each unit of our currency becomes more expensive for them to purchase!
As this outcome prevails, the already uncompetitive sugar export industry and others; rice, bauxite, fishing, become increasingly uncompetitive! Export services (tourism) would also require foreign tourists to pay more, when visiting Guyana thereby making rival jurisdictions relatively more competitive. One can say therefore, more generally that, as the Guyana dollar appreciates, foreign products become more competitive relative to local ones.
Dual Trading Sectors
Two distinct types of trading sectors are therefore, likely to emerge. Namely, the oil sector, which rapidly expands and, the “other exports” that continue to either flag (sugar) or become less competitive; rice, bauxite, forest products and, fishing. In this way Guyana’s growing global un -competitiveness becomes manifest.
Further, the expanding petroleum sector increases income and spending within the domestic economy. In turn, this favourably impacts spending/ incomes in the non-traded sector, (mainly services and locally produced products). Wages and prices then rise domestically; and, strong inflationary pressures might even emerge. The petroleum sector’s prices are however, set internationally, so these do not respond significantly to rising domestic demand. The government is a big spender in the domestic non-tradable sector (construction, consumable goods, materials, services). Economists describe this outcome as the logical consequence of the sectoral re-allocation of Guyana’s resource base.
For Guyana, such “resource re-allocation” would adversely affect agriculture, which as readers know is a major source of employment and livelihoods. Recall also that it is heavily export oriented. Simultaneously, because petroleum production is heavily capital intensive, it does not offer great scope for employment, thereby alleviating this negative situation.
Strategy Response
Development theory indicates several basic strategies for combatting the Dutch Disease. It also indicates that, the spread of the Dutch Disease is an immediate threat, which emerges early in the expansion of the petroleum sector. Further, its effects are not only pernicious, but are likely to be long lasting. One well-tried response to the threat of Dutch Disease is to slow the pace at which the exchange rate is appreciating. A standard response to this also, is to sterilize increases in petroleum revenues! To achieve this requires Government to hold part of the petroleum revenues in the form of overseas investable financial assets. This is also a leading motivation behind calls to establish Sovereign Wealth Funds, SWFs, as Guyana is doing.
I have previously discussed SWFs extensively (January 1, 2017 to January 15, 2017) and I will not repeat here. Interested readers should visit those columns. The key point of note in this regard is that, SWFs can sterilize any substantial influx of foreign exchange. Such sterilization would reduce the negative distortionary effects of rapid, unplanned changes in Government spending. As we shall observe, SWFs affect other development challenges (for example, intergenerational equity).
Another response is to direct public spending towards re-engineering the traditional non-oil export sectors. The danger here though, is for Government to avoid subsidizing inefficient and uncompetitive businesses. Such subsidies could drain Guyana’s oil wealth to subsidize traditional exports for the benefit of foreign buyers!
A further strategy is to promote policies directed towards making input expenditures of the petroleum sector; promote linkages and spillovers to “local” businesses. It is this response, which lies behind calls for local content requirements, LCRs. Again, I have discussed this topic previously at some length before (March 26, 2017 to May 21, 2017). I shall return to this topic next week.
Conclusion
As indicated, at the economic core of the Dutch Disease phenomenon lies two economic traits; namely, 1) a tendency towards nominal and real exchange rate appreciation 2) a growing loss of global competitiveness. Experience suggests the implementation of three policies. These are 1) policies directed at slowing the rate of exchange rate appreciation 2) re-engineering the non-oil sectors (especially traditional exports) along with the domestic sectors producing goods and services for the domestic market and, 3) creating a Sovereign Wealth Fund, SWF, which invests in international assets markets. In effect, the creation of a SWF seeks to increase government savings. This modulates rapid inflows of foreign exchange and stems the consequential rise of national spending.
