Why do the people of so many natural resource rich countries live in poverty? Why does having great oil reserves damage the economy of the producer? Examples of this phenomenon abound: Venezuela, Nigeria, and most middle eastern countries including Saudi Arabia, Libya and Iraq.
The answer is that natural resource rich countries can easily be infected by “Dutch Disease” – a term coined by The Economist in 1977 to explain the harm caused to the economy of the Netherlands following the discovery of huge natural gas reserves in 1959.
Here’s what Dutch Disease is:
- When a natural resource such as oil or gas is discovered, the country experiences a great increase of exports of the natural resource.
- This causes foreign money to rush into the economy and drives up demand for the currency of the resource producer which results in the domestic currency rising in value. This is also inflationary.
- The strong local currency makes the country’s exports very expensive and imports very cheap. This dual effect kills local country manufacturing and industry as exports dry up and the country is flooded with cheap foreign goods.
- The local country central bank lowers interest rates to combat inflation and to lower the value of the currency. These low rates discourage investment in the local country and capital flees the country in search of higher returns.
- In addition, resource production is capital intensive and produces relatively few jobs, so unemployment rises as local business is harmed and jobs are not replaced by the natural resource discovery.
- Finally, having an economy closely tied to a single commodity leads to great volatility as price of the commodity rises and fall. A great example of this is the recent devastation of Venezuela’s economy and resulting political upheaval as the price of oil plummeted over the last few years.
There are beneficiaries of the natural resource production – the owners of the oil company – often the government of these countries – has a huge influx of wealth. This is how Saudi royalty can live in such great wealth while it’s people live in poverty. A redistribution of this wealth can combat poverty but does little to spur economic growth.
Countries other than third-world petrostates, such as Canada and the U.K., have suffered from the resource curse after major oil discoveries. The U.K. Economy was devastated in the 1980s with the discovery of its North Sea oil and Canada’s economy has been hampered in recent years by the great production from its oil sands.
Norway is a notable example of a resource rich country avoiding Dutch Disease. Their economy as boomed over the past 40-years following the discovery of massive oil fields off their coast. How did they do this? Amazing self-discipline based on learning from other resource rich countries. They follow the following rule they call the Managment Rule: All but 4 per cent of Norway’s oil earnings must be placed in the fund for savings; nothing can be withdrawn from the fund until the oil is gone, decades from now; and – most crucially – absolutely none of the money can be invested inside Norway. As a result, Norway has the largest Sovereign Wealth Fund in the world with almost $1 trillion. Pretty amazing for a country of 5.2 million people! This is a simplified explanation of what Norway has done – there are all sorts of papers on how Norway has avoided its oil resources from being a curse and there are many factors still being debated.
I’m in Norway right now. My current view from the M/S Zuiderdam:
Very interesting! We can all learn a lot from each other and history. Thanks for this IFOD. Looks like an amazing trip- enjoy!