The Dutch Disease

Abstract

The main reason why medium-income countries tend to have overvalued exchange rates is the Dutch disease; the main reason why some nevertheless grow fast, while others fall behind, is that the former are able to neutralize this disease. The Dutch disease is a market failure or market syndrome resulting from the existence of cheap and abundant natural resources used to produce commodities whose exports are compatible with a more appreciated exchange rate than would be needed to make the other tradable industries competitive. By using cheap resources, the respective commodities cause the appreciation of the exchange rate because they can be profitable at a rate incompatible with the rate that other goods, using the best technology available worldwide, require. Resources are cheap because they generate Ricardian rents for the country; in other words, they are cheap because their costs and corresponding prices are less than those prevailing on the international market, which are determined by the less efficient marginal producers admitted to this market. The Dutch disease is a market failure that affects almost all developing countries and may permanently obstruct their industrialization because the market converges on a long-term equilibrium exchange rate that is caused by this disease. It is consistent, in the long run, with the equilibrium of a country's foreign accounts, that is, with a balanced current account – something that does not occur with the policy of growth with foreign savings, which usually ends with a balance-of-payment crisis.