QUESTION
There is a controversial debate in Australia regarding whether the national economy is facing a phenomenon known as the Dutch Disease- where a rapidly expanding resource-based export sector crowds out or displaces other sectors of the economy – and whether such a situation should become a focus of policy.
Your task is to write a paper evaluating whether the concept of the Dutch Disease has relevance in the Australian context and whether the Federal government ought to adopt a particular policy stance in relation to this. Specifically, your paper must address the following issues.
- Theory-Model. Find theories or models that are relevant to understanding the nature of the Dutch Disease concept. Describe the salient characteristics of this theory or model and what the model concludes.
- Empirical. Using Australian economic data, find some evidence that supports or refutes the claim as to whether the Dutch Disease is of particular relevance in the Australian context.
- Policy Implications. Based on your analysis in above sections briefly discuss what role, if any, is there for the Australian government in adopting a particular policy stance for dealing with a booming resource sector.
Each section above is equally weighted for grading. This is a research project. We expect it to take the appearance of an academic paper and be structured as follows:
– Introduction
– Theory/Model – explaining the Dutch Disease
– Empirical evidence – using Australian data
– Policy implications – Australian context
– Conclusion
– References
The assignment must be clearly written; any diagrams, charts etc must be clearly labelled and explained in your text. There is no specific right or wrong answer here; rather you will be assessed on the quality of your arguments, the clarity with which you explain and illustrate the relevant concepts and the way in which you relate theory to evidence and consequent policy implications.
SOLUTION
It affected the Netherlands in the 1970s and stayed through 80s. During that decade, theboom in the North Sea Oil in the country resulted in plunging of manufacturing sector by leaps and bounds to have a shaking impact on its economy.The phenomenon was known as he “Dutch Disease”. After Netherlands suffered economic imbalance in the 70s due to a shift from manufacturing sector exports to massive natural gas exploitation, the term Dutch Disease came to be coined by The Economist.
In Australia, a similar trend seems to be surfacing with the development in the mining sector. The boom in mining sector is shifting capital and labor away from the rest of the sectors in Australia. There has been a rise in the exchange rate and a drop in the trade-exposed sectors. As the economists have acknowledged, the resources boom in Australia has led its manufacturing sector to struggle. The symptoms are quite indicative of the Dutch Disease being set in the Australian economy. The decline in the manufacturing sector has taken place over a decade, yet no federal address seems to have addressed the phenomenon with any major seriousness. It is still debatable if the “Dutch Disease” is the reason behind outflow of profits to foreign shareholders anddraining-off of Australian businesses to countries with weaker currencies despite the mining boom.
Corden, W.M., 1984 has tried to explain the impact of sectoral boom on the equilibrium of any economy. Referring to Forsyth & Nicholas, 1983, Corden draws back the concept of Dutch Disease to the sixteenth century citing the effect of inflow of American Treasure on the Spanish Industry during that time. He even states that the effect of Dutch Disease in Australia can traced back to the eighteen fifties when gold discoveries in Australia had affected the Australian industries.
Corden &Neary Core Model Explaining Dutch Disease
The term “Dutch Disease” is an economic paradox which leads a booming sector of an economy to have a detrimental effect on the non-booming trading sec tor. In other words, when this phenomenon takes place the rise in a natural resource-based sector causes a sharp decline in the competiveness of manufacturing sector. In the long run, the impact of Dutch Disease is responsible for shifting manufacturing businesses to countries having weaker currencies. It ends in non-resource industries being hurt by the rise in wealth generated by the resource-based industry.
The Dutch Disease is a process of de-industrialization of the tradable base due to switching of capital towards discovery of natural resources and the pressure it exerts on the currency and wage rate.The Corden & Neary Core Model explains Dutch Disease showing how boom in one sector had devastating effect on the non-booming sector in Ireland.
O’ Toole, R., 1998 gives an overview of the Salter Non-Tradable Model and the Corden & Neary Model to explain Dutch Disease. However, the Corden & Neary model gives more explicit explanation of the phenomenon. It is in fact a major improvement on the Salter’s Non-Tradable Model, which explains the concept through non-tradable influences.
The Corden & Neary model on the other side by laying importance on the supply factor in determining equilibrium of an economy. The model was devised at the time Dutch Disease impact in Netherlands in 1983.
The model assumes that there are three industries in an economy – non-traded sector (N), lagging sector (L) and booming sector (B). It further assumes that labor is perfectly flexible among all three sectors, but capital is sector specific.
It has been explained with the help of two diagrams. The first has been constructed taking the output of the lagging sectors (L) of the economy as numeraire. The second diagram represents the labor demand schedules of N, L and T, where T is total traded sector. The diagrams lead the author to identify two effects namely the resource effect and the spending effect which determine the de-industrialization of the manufacturing sector.
- Resource Movement Effect: Here when the productivity of the booming sector increases, the equilibrium wage rate rises up, leading the ouster of the labor factor from the production of lagging sector. In both the diagram we can see that the boom raises equilibrium (e) to a point higher (ep). Plus, in the second diagram the Booming Sector curve (B) shifts upwards raising the equilibrium wage rate from W0 to W1. The result of shift in the equilibrium leads to reduction in the output of L, which is called de-industrialization.
Moreover, while the equilibrium in the first diagram shifts from (e) to (ep), the consumption od non-tradable remains unchanged at (b).
In order to correct the equilibrium the currency rate must appreciate, which means the opportunity cost of N in terms of L must rise.
- Spending Effect: This effect shows that increased income through booming sector spent on non-tradable sector pushes the wages up in the lagging sector. It bids out labor from the production of both L and B.
In order to isolate the spending effect it is assumed that energy sector works without labor, and so the boom only pushes the PPF outwards.
Conclusion of the theory
Any increase in real wage due to shift of production from lagging sector to booming sector will raise the equilibrium of economy to raise exchange rate. In order to correct Dutch disease, the dependence on the third world for non-tradable goods should be curtailed.
Relevance of Dutch Disease in Australia
Gottliebsen, R., 2011 in his report published in the Business Spectator, cites Joseph Healy National Australia Bank group executive business banking. Healy stated that the cut on bank lending to small and medium business could have repercussion for Australia, and which he links to Dutch Disease.
The reason why Australia’s GDP declined by 1.2 percent the previous quarter of year 2011 making it the worst fall in 20 years, might just be indicating the Dutch Disease in Australia, (Dobbie, P. 2011. BNET). As the phenomenon implies, Australia’s economy has become inflated by revenues resource industry causing a significant drop in the manufacturing sector.
AAP, 2011 states that employment in manufacturing sector has plunges by an average of 9,000 per year over the past decade. On the other side, employment in the mining sector has grown by 15, 000 per year.
There has been rise in exchange rate at USD 90c and its rapid acceleration against other major currencies is yet another factor leading to crushing manufacturing sector in Australia (Cleary, P. 2007).
Overstatement
Having abundance of natural mineral and energy resource wealth as reported by the Treasury, Australia cannot be inflicted by Dutch Disease. After all, Dutch Disease implies exploitation of natural resources, which is yet not the case with Australia.Further more a Statement 4 in the year’s Budget paper asserts that Dutch disease does not result in decline of overall economic growth. (Treasury Secretary, 2011). He asserts, once the currency rate falls and the boom is over the manufacturing sector will bounce back.
He further goes asserting that occurrence of Dutch Disease in Australia is difficult to substantiate seeing the unemployment trend. He says that unemployment rate has instead declined during the mine boom. However, it does not give the government an excuse to overlook the private debt load and structural current account deficit statistics.
Worse implication
However, it is somewhat overlooked by the Treasury perhaps is that Australia’s manufacturing production is merely showing 8% production during resource boom as against 20%, which was the percent manufacturing production of the Dutch during Dutch disease. It could be even more serious repercussion waiting toaffect Australian economy than the Dutch disease.
David Murray from Future Fund has also indicated at the ABC’s Inside Business program yesterday, “In Australia, we have about a 20-year uninterrupted growth period; we have nearly record terms of trade, and we’re not prospering. So the settings here are not right”.
Failure of Fiscal Policy in Australia
Despite all defenses made by the federal leaders for mine boom, it cannot be denied that Australia’s economy is at risk of suffering Dutch Disease. The federal and state governments must design effective policies to reduce their reliance on foreign capital and lessen their international debt.
Economists suggests that when only companies benefitting the natural resources are flourishing while others are showing sluggish or no growth, the government must be failing devising corrective fiscal solutions.
The policies need to be made to curb further international debt on the already highly indebted Australian economy. It is now almost imperative for the state and federal governments to turn the resource boom into a trade boom to lift the burden of foreign liabilities on the economy (Bingemann, M., 2011).
Conclusion
In order to attain resource boom for economic prosperity over the course of past 20 years, the Australian economy has become highly indebted with foreign liabilities. Despite great boom in the resource sector, there has been slow growth in tourism and trade in the country. It clearly implies that Australia is at risk of crisis to be caused by Dutch Disease. There has been unambiguous failure of government to stiffen its monetary policy, which could have avoided foreign debt. The government asserts in its defense that the Netherland’s Dutch disease and Australia’s situation are not alike and once the boom ends its manufacturing production will bounce back. Moreover, they also maintain that employment rate has only grown with the boost in the resource sector. However, the prosperity may not last long if it continues to cause rise in the exchange rate and capital outflow to foreign economy to fund the exploitation of its natural resources.
References
AAP, 2011. Dutch Disease Symptoms in Australia. Published: Oct 7, 2011
Bingemann, M., 2011. The Australian. Dutch disease a threat for Aussie economy. Published: September 25, 2011
Corden, W.M., 1984. Booming Sector And Dutch Diseases Economics: Survey and Consolidation: Oxford Economics Paper 36
Cleary, P. 2007. The Age. Mining boom could bust us. Business Day. Published: November11, 2007.
Dobbie, P., 2011. BNET. Has Australia Caught Dutch Disease. Online. Url: http://www.bnetau.com.au/blog/aussierules/has-australia-caught-dutch-disease-btalk/7721
Gottliebsen, R., 2011. The Business Spectator. Australia’s Dutch Disease diagnosis.
O’ Toole, R., 1998. Student Economic Review. The Dutch Disease. Trinity College Dublin.
Treasury Secretary., 2011. Australian Industry Group National Forum. THE IMPLICATIONS OF GLOBAL ECONOMICTRANSFORMATIONS FOR AUSTRALIA
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