Custom «Saudi Arabia and the Dutch Disease» Essay Paper Sample

1. Definition of the Dutch Disease.

Corden, & Neary (2006) define the Dutch disease as a state of inflow of capital, caused for example by an oil boom, causes the real exchange rate to appreciate. The reason for this appreciation is that domestic prices in the tradable and non-tradable sector will be affected asymmetrically with the prices of the non-tradable sector rising at a faster rate. This further implies that the competitiveness of the tradable goods deteriorates in international markets as the opportunity cost of producing tradable goods has increased.

2. Examples of some countries which have experienced the Dutch Disease.

Netherlands experienced the Dutch Disease in the 1960s following a gas export boom after the discovery in petroleum gas within its boundaries.  This was followed by an appreciation of its currency due to the exportation of the gas and as stipulate by the Dutch Disease Theory, which is yet to be discussed in this paper, the manufacturing industries suffered a setback. Consequently the total export really reduced relative to the to the Gross Domestic Product (GDP). However the problem was short-lived as the Dutch nation managed to take appropriate measures to increase its total export and it managed to improve. The Netherlands recovered quickly from the Dutch disease, and have seen a persistent upward trend in their total exports relative to GDP since the mid-1960s. Currently according to world records, the export of Netherland is above 60%. It is also worth noting that it because of the Netherland’s case that this economic situation was called the ‘Dutch Disease’.

Another country that experienced the Dutch Disease is Colombia which experienced the ‘disease’ in the 1970s too. This was due to the doubling of coffee production in 1967 which saw its currency appreciate a great deal. The country’s export was greatly affected as other exports really declined but the Colombian Government manage to curb the situation in around 1986.

Kazakhstan is also among the list of countries which have suffered the Dutch Disease. Its case is almost similar to Netherlands case because the Dutch Disease emerged after the discovery of oil. Due to the boom the GDP of Kazakh’s Economy was lowered. This was due to the influx of money in to the economy. The graph below  shows how Kazakh’s GDP was affected with the boom in oil export

Columbia is yet another country which has experienced the Dutch Disease. This occurred after coffee production almost doubling in the 1970s. “Production and export of coffee reacted to market incentives in the late 1970s, nearly doubling output and sales from 1967 levels. The export boom generated a large increase in foreign exchange, which had the effect of increasing the value of the peso and the price of domestic goods” (U.S. Library of Congress)

2. The Dutch Disease Theory.

Postulate 1. Exchange rate

National data rarely specifies which products are tradable (goods) and which are non-tradable (services). Dutch Disease theory it is very helpful as it clarifies the shifts of the resources between the three sectors hence making it justifiable to use in theory. An appreciation of the real exchange rate, as a consequence of capital inflow in the case of Dutch Disease, implies that the opportunity cost of producing tradable goods has increased.

Postulate 2. The spending effect

The spending effect explains the consequences from an increase in disposable income following a boom in the energy sector and from inflow of foreign exchange. Assuming positive income elasticity, the increase in disposable income leads to increased spending and demand for both tradable and non-tradable goods. The increased demand for non-tradable gives rise to an increase in prices since the country’s resources limit the supply of these goods and the boom has not increased these specific resources. The price of non-tradable goods on the other hand is determined on the world market

Postulate 3. Resource Movement effect

This is split into two sub-effects, the direct and indirect resource movement effect. The direct resource movement effect implies increasing marginal productivity of labour and hence increasing wages in the booming sector. As was the case in the spending effect, increased wages in one sector tends to attract labour from other sectors. In this case however, labour is attracted from the non-tradable and the lagging sector into the booming energy sector. The shift of labour will continue until wages are equalized in all sectors. The result of the direct resource movement effect is called direct de-industrialization. (Corden, and Neary, 1982) 

The indirect resource movement effect is similar to the spending effect and results from the reduced production in the non-tradable sector. With unchanged demand for non-tradable the reduced supply results in excess demand. With excess demand follows increased prices which in turn will increase the wage in this sector compared to other sectors. This will lead to further labour reallocation from the lagging sector to the non-tradable sector.

The Dutch Disease and Saudi Arabia

Saudi Arabia’s economy can be describes to over dependent on oil exports. This has been so since the discovery of oil within its borders. In the early 1970s, as oil exports increased sharply, royalty payments and taxes on foreign oil companies increased considerably and as the Kingdom began setting and increasing oil prices, the economic situation changed dramatically. Saudi Arabia’s revenues per barrel of oil quadrupled from US$0.22 in 1948 to US$0.89 in 1970. By 1982 the average export price had reached well above US$30 per barrel of oil. Today, Saudi Arabia is by far the largest oil producer in the world and relies heavily on oil revenues (Diboo%u011Flu, and Alesia, 2004)  .The oil sector is the key domestic production sector as oil revenues constituted 84 % of total government revenues and 46 % of GDP in 2004. Oil export revenues, of which a large portion is allocated to the budget, accounted for 88 % of total exports in 2004.

The table below shows the GDP growth rate of Saudi Arabia 1960- 2002

As can be seen from the above table, non-oil sector was greatly affected by the oil sector. The overall rate is 7.4 percent (Between 1960 – 2002). However the expansion since 1980 of 2.3 percent has not been sustainable to the growing population. It is also  worth noting that there was an average 0.9 drop in the GDP between 1960 and 2002. The figure below (Fig. 3) shows the Saudi Arabia’s Record of Crude oil export and number of discovered oil fields.

 Number of oil fields has been on the rise since 1981 and by 200 it there were 86 already discovered oil fields. The crude oil export has also been on the rise and in 2000 in was standing at 2962.60 (Kingdom of Saudi Arabia Ministry of Petroleum and Mineral Resources)