What Is a Dutch Disease?

A "Dutch disease" is an economic term referring to the negative consequences that may arise from spikes in the value of a nation’s currency. While Dutch disease is primarily associated with a natural resource discovery, it can likewise result from any large influx of foreign currency into a country, including foreign direct investment, foreign aid, or substantial increases in natural resource prices.

The Basics of Dutch Disease

Dutch disease exhibits the following two chief economic effects:

  1. It decreases the price competitiveness of exports of the affected country's manufactured goods.
  2. It increases the quantity of imports.

Both phenomena result from a higher local currency. In the long run, these factors can contribute to higher unemployment, due to manufacturing jobs moving to lower-cost countries. Meanwhile, non-resource based industries suffer, because of the increased wealth generated by the resource-based industries.

Origin of the Term Dutch Disease

The term "Dutch disease" was coined by The Economist magazine in 1977, when the publication analyzed a crisis that occurred in the Netherlands, following discoveries of vast natural gas deposits in the North Sea in 1959. The newfound wealth and massive exports of oil caused the value of the Dutch guilder to rise sharply, subsequently making exports of all non-oil products less competitive on the world market. Unemployment rose from 1.1% to 5.1%, and capital investment in the country dropped.

Dutch disease later became widely used in economic circles, as a shorthand way of describing the paradoxical situation where seemingly good news, such as the discovery of large oil reserves, negatively impacts a country's broader economy.

Real World Examples of Dutch Disease

In the 1970s, the same economic condition occurred in Great Britain, when the price of oil quadrupled, and it thus became economically viable to drill for North Sea Oil off the coast of Scotland. By the late 1970s, Britain had become a net exporter of oil, when it had previously been a net importer. Although the value of the pound skyrocketed, the country fell into recession, when British workers demanded higher wages, and exports became uncompetitive.

In 2014, economists in Canada reported that the increased influx of foreign capital related to the exploitation of the country's oil sands may have led to an overvalued currency and a decreased competitiveness in the manufacturing sector. Simultaneously, the Russian ruble greatly appreciated for similar reasons. In 2016, the price of oil dropped significantly, and both the Canadian dollar and the ruble returned to lower levels, consequently easing the concerns of Dutch disease in these countries.