Diversification, Dutch Disease, and Economic Growth: Options for Uganda

Abstract

Natural resource discoveries, even when fairly modest in terms of the revenues they are expected to generate, can have significant macroeconomic effects and implications for the conduct of fiscal and monetary policy. In this respect, Uganda is no different from other oil-rich countries. In five main ways, all of which suggest the need for economic diversification as an efficient risk management strategy, the Dutch disease manifests itself through (i) An appreciation of the local currency in real terms, undermining the profitability of other export industries, and of local industries competing with imports by encouraging imports. (ii) The increased volatility of the real exchange rate induced by oscillating oil prices in world markets, which reduces investment and economic growth over time. (iii) Wage increases in the resource-intensive sector that spill over to the non-resource-based sector, further hampering employment and investment in the non-resource-based sector. (iv) Socially counterproductive rent seeking (and even plundering) in the absence of effective legal and institutional mechanisms that would ensure resource rents accrue to the rightful owners with minimal leakages, and are managed for the benefit of all. (v) Crowding out, by which natural capital (if not well managed) tends to undermine other types of capital essential to economic development, including human and social capital. The need for diversification can be viewed in terms of channeling the revenues generated by resource rents into the generation of human capital through education and training, and social capital through institution building conducive to good governance and transparency, aiming, inter alia, to keep rent seeking at bay. Economic diversification for the purpose of containing the preponderance of the resource-intensive industry at the expense of other industries, and political diversification through democracy aimed at encouraging pluralism and high-quality leadership both convey parallel principal benefits to the economy and society in terms of efficiency and fairness.