Dutch disease and the resource curse: Paradoxes of plenty

Open full sized image

Don’t crowd us out.

© cherryandbees/stock.adobe.com, © MaxSafaniuk/stock.adobe.com; Photo illustration Encyclopædia Britannica, Inc

In the late 1950s, petroleum geologists who were searching for oil ended up discovering a huge natural gas field in the north part of the Netherlands. At the time, the bonanza was the largest find of the fuel in the world, and it was so influential that heating and cooking appliances in the Netherlands, West Germany, Belgium, and northern France were adapted to deal with the relatively high nitrogen content of gas from the field.

But all wasn’t well.

In addition to contributing to earthquakes that damaged thousands of buildings, another long-term negative effect of the discovery was a seismic (upward) shift in the Dutch guilder that became a huge drag on the economy, creating what is now known as Dutch disease.

First coined by The Economist magazine in the 1970s, “Dutch disease” refers to an economic phenomenon where a country’s currency rises dramatically in response to a windfall in one area of its economy and, as a result, exports falter in others. Although the country appears quite healthy from an international perspective, it’s actually falling behind.

Because this situation often arises as a result of a windfall petroleum discovery, the term falls under a broader category known as the “oil curse” or the “resource curse,” where a country’s economy falters despite having ample valuable natural resources.

Both offer lessons in why countries want to diversify their economies and why investors in emerging and (especially) frontier markets need to pay attention to those diversification efforts, as well as the ebbs and flows of prices for commodities those countries export.

When a country suddenly discovers a big natural resources asset—whether it be fossil fuels, minerals, or something else—there can be an influx of highly paid international workers from multinational oil and gas or mining companies. That boosts local economies temporarily, but it can also cause the local currency to rise in a way that disadvantages locals working in other sectors.

This pattern often unfolds in predictable ways.

1. Wage disparities. Even if a country has domestic companies that can develop a resource themselves—in the case of the Dutch oilfield, it was a joint venture between homegrown Royal Dutch Shell and United States–based Exxon (now part of ExxonMobil)—wages in that extractive sector can still rise faster than those in other parts of the economy.

2. Currency appreciation. Once a petroleum project or mine becomes operational, strong export revenues can drive up the local currency further, even though those exports are only from one narrow part of the economy.

3. Import/export imbalance. A strong local currency ends up hurting exports of industries that don’t rely on extracting natural resources by making their goods more expensive abroad. And a currency that is stronger locally than internationally also encourages imports, which can come at the expense of local manufacturing jobs.

In the original 1977 article that named Dutch disease, The Economist expressed concern that the United Kingdom might face a similar fate. Although rising oil prices in the 1970s ushered in a windfall from North Sea oil, the U.K. did end up with a severe, protracted recession.

Dutch disease is one aspect of the broader resource curse, where countries with abundant natural resources often struggle with economic stagnation and instability.

The broader affliction can be exacerbated by a strong currency, as with Dutch disease, but that isn’t the only factor. Corruption, armed conflict, boom-and-bust commodity cycles, and the legacy of extractive colonialism can also contribute to poorer economic growth and development in resource-rich countries whose economies aren’t well diversified.

The term resource curse was first coined by economist Richard Auty in a 1993 book, Sustaining Development in Mineral Economies: The Resource Curse Thesis. It’s also sometimes referred to as a “resource trap” or “paradox of plenty.”

When a country has a significantly valuable natural resource, it can be tempting for its leaders to go whole hog into developing that commodity at the expense of other industries.

This approach can lead to a situation similar to Dutch disease, where a wealth gap develops between workers in industries that extract natural resources and those in other segments of the economy. Corruption can exacerbate the problem if national leaders siphon off wealth for themselves, fostering authoritarianism and eroding trust from international investors.

Such myopic economic development also leads to economies being tied to the price of commodities, which are set in international markets that individual countries often don’t have much control over. Commodities are notoriously volatile because they are tied to economic cycles, and downturns can severely affect countries that are dependent on natural resources.

Petroleum, in particular, has been linked to several harmful effects. A 2015 study in the Annual Review of Political Science found “robust evidence” that oil wealth tends to strengthen authoritarian regimes, increase certain types of corruption, and contribute to violent conflict in low- and middle-income countries.

There are also examples of other natural resources playing roles in conflicts, which sap economies of sources of legitimate income and workers to exploit them, whether they be casualties of fighting or refugees.

One example is in the eastern Democratic Republic of the Congo, where much of the tantalum used in the world’s smartphones comes from. So-called blood diamonds fueled civil wars in Congo, Angola, and Sierra Leone in the 1990s and prompted reforms in the international diamond trade.

History has shown that a resource curse doesn’t have to be permanent. But overcoming it requires a coordinated effort among policymakers to diversify the home economy, frequently by diverting a portion of the profits from the resource-rich area of the economy to others it wishes to promote. Examples include:

Dutch disease and the broader resource curse can be detrimental to a country’s economy, affecting local jobs, domestic politics, national security, and the fortunes of international investors.

A key remedy is a properly diversified economy that relies on more pillars than a single natural resource. Countries that have successfully avoided the resource curse have typically diverted some of the windfall revenue from their top commodities to support other areas of the economy.