What is 'Dutch Disease'?

Dutch disease is an economic term that refers to the negative consequences arising from large increases in the value of a country's currency. It is primarily associated with a natural resource discovery but can result from any large influx of foreign currency into a country, including foreign direct investment, foreign aid or a substantial increase in natural resource prices.

BREAKING DOWN 'Dutch Disease'

As an economic phenomenon, Dutch disease has two main effects: a decrease in the price competitiveness of exports of the affected country's manufactured goods and an increase in the quantity of imports. Both result from a higher local currency. In the long run, these factors can contribute to higher unemployment because manufacturing jobs are moved to lower-cost countries. The result is that nonresource 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. The magazine was analyzing 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 making exports of all nonoil products less competitive on the world market. Unemployment rose from 1.1% to 5.1%, and capital investment in the country dropped.

Dutch disease became widely used in economics to describe the paradoxical situation where seemingly good news, such as the discovery of large oil reserves, has a negative impact on a country's broader economy.

Examples of Dutch Disease

In the 1970s, the same economic condition occurred in Great Britain when the price of oil quadrupled, and it 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; it had previously been a net importer. The pound soared in value, but 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. At the same time, in Russia, the ruble greatly appreciated for similar reasons. In 2016, the price of oil dropped significantly, and both the Canadian dollar and the Russian ruble returned to lower levels easing the concerns of Dutch disease in these countries.

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