Dutch Disease and Déjà Vu: Policy Advice for the T&T Economy in the Wake of a Second Oil Boom

• Author: Bhoendradatt Tewari/Roger Hosein
• Pages: 147-180

Chapter 6

Dutch Disease and Déjà Vu: Policy Advice

for the T&T Economy in the Wake of a

Second Oil Boom1

During the 1970s the Trinidad and Tobago (T&T) economy was blessed

by an oil boom occasioned by increases in both its production of crude

oil and the prices each barrel of crude oil fetched on the international

market. In the context of the Dutch Disease and the Resource Curse

thesis, a number of policies enacted by the government, at the time, were

erroneous. The T&T economy is once again faced with the prospects of

another boom in its hydrocarbon sector. This paper reviews the elements

of the Dutch Disease and Resource Curse thesis, which emerged in T&T

during the first oil boom and focuses on providing some policy advice to

the government of T&T the second time around.

This chapter was first published in the West Indian Journal of

Engineering, Vol. 26, No. 2, Jan 2004, pp. 1–21.

1 The authors acknowledge the invaluable comments of D. Mahabir, lecturer in the

Department of Economics, UWI

Trade, Investment & Development

148

6.1 INTRODUCTION

Since the 1970s the international trade literature has recognized the

structural effects and policy implications of a boom in a tradable

resource good. A boom in a primary export commodity can especially, in

terms of the empirical experience be either a boom or a curse. A resource

boom will benefit both national income and the balance of payments

whilst other sectors especially those in the non-booming tradable sector

can contract as their output levels and factor incomes fall.

Many researchers in the economics literature have emphasized natural

resource rents and their developmental potential. Natural resource

booms, however, although playing an important role in helping to

alleviate some of the traditional obstacles to development, including;

bridging fiscal deficits, savings and investment gaps and providing a

rapid inflow of foreign exchange, have also brought with it adverse side

effects.2 This paper reviews the impact of the first oil boom in T&T of

the 1970s and provides some policy advice for the government in the

context of a second oil boom which the country is expecting to engage

within a few years.

6.2 THE DUTCH DISEASE CONCEPT

The term ‘Dutch Disease’ which basically refers to the negative effects a

booming tradable resource has on other traditional export sectors, was

first used to refer to the experience of the Netherlands’ manufacturing

sector on account of the natural gas discoveries of the 1960s. In the

Dutch economy, the discovery of a massive pool of gas resources in the

Schlochteren area motivated a higher real exchange rate, triggered

principally by appreciating nominal wages in the Dutch economy,

especially in relation to Germany. The export boom caused an

appreciation of the Dutch currency (the guilder) significantly above

levels that attained prior to the discovery of natural gas, and in so doing

decreased the level of competitiveness of the Dutch industrial sector as

its real exchange rate appreciated. The exposition of the Dutch Disease in

what follows is based upon the works of Corden (1982) and Kamas

(1986).3

2 As early as 1776, Adam Smith argued that mining should not be high on the list of

choices of policy makers because it did not replace the capital, which was deployed in its

extraction (Smith, 1776, pg 562).

3 It should be noted that the Dutch Disease model has been deployed in the literature to

consistently deal with countries that have experienced energy sector booms. This model,

Dutch Disease 149

The Basic Model

Let us assume that we have two sectors, a traded sector (T) and a non-

traded sector (NT), Y is national income. The T sector has two main

components, booming (B) and non-booming (NB). Thus,

Y = T + NT

T = B + NB

If we assume that the non-traded goods sector has a positive income

elasticity of demand and the increase in income in the booming tradable

sector is of magnitude 'Y, of which D'Y is spent on the non-traded

sector (0<D<1), then a resource boom, by sprouting an increase in

demand for goods in the non-traded sector would also lead to an increase

in the price of goods in this same sector and hence, an increase in the

overall price level. The rise in the price level of goods in the non-traded

sector increases the profitability of this sector. This change occurs on

account of the spending effect (Se) of the boom (Corden, 1982).

The boom stimulates an expansion in the marginal product of factors of

production, which are employed in the booming sector, and this

encourages a flow of resources into this sector, this is the resource

movement effect (Re) of the resource boom. If we consider the Se and the

Re then the output of the non-booming traded goods sector will be lower

than it was initially, i.e. for the non-booming tradable sector, Re and Se

complement each other. Se expands the size of the non-traded sector

whilst Re contracts it, so that the eventual impact on the output of the

non-traded sector will depend on their relative magnitudes. However,

because the majority of commodities in the non-tradable sector are

services and given that in most developing economies services have an

income elasticity of demand which is positive, then one would expect

that with a resource boom the overall size of the non tradable sector

would expand.

The mechanics of the Se and Re movements can be explained in greater

detail as follows. With a resource boom (for example, a new oil

discovery) an increase in the country’s oil exports stimulates domestic

income. If all of the foreign currency earnings are spent on imports, then

there will be no impact on the domestic money supply, nor on the

however, is equally well applicable to any country which is experiencing a boom but in a

tradable goods sector for which domestic absorption is limited.