Dutch disease and the resource curse: Paradoxes of plenty

But all wasn’t well.

In addition to contributing to earthquakes that damaged thousands of buildings, another long-term negative effect of the discovery was a seismic (upward) shift in the Dutch guilder that became a huge drag on the economy, creating what is now known as Dutch disease.

First coined by The Economist magazine in the 1970s, “Dutch disease” refers to an economic phenomenon where a country’s currency rises dramatically in response to a windfall in one area of its economy and, as a result, exports falter in others. Although the country appears quite healthy from an international perspective, it’s actually falling behind.

Because this situation often arises as a result of a windfall petroleum discovery, the term falls under a broader category known as the “oil curse” or the “resource curse,” where a country’s economy falters despite having ample valuable natural resources.

Both offer lessons in why countries want to diversify their economies and why investors in emerging and (especially) frontier markets need to pay attention to those diversification efforts, as well as the ebbs and flows of prices for commodities those countries export.

1. Wage disparities. Even if a country has domestic companies that can develop a resource themselves—in the case of the Dutch oilfield, it was a joint venture between homegrown Royal Dutch Shell and United States–based Exxon (now part of ExxonMobil)—wages in that extractive sector can still rise faster than those in other parts of the economy.

2. Currency appreciation. Once a petroleum project or mine becomes operational, strong export revenues can drive up the local currency further, even though those exports are only from one narrow part of the economy.

3. Import/export imbalance. A strong local currency ends up hurting exports of industries that don’t rely on extracting natural resources by making their goods more expensive abroad. And a currency that is stronger locally than internationally also encourages imports, which can come at the expense of local manufacturing jobs.

In the original 1977 article that named Dutch disease, The Economist expressed concern that the United Kingdom might face a similar fate. Although rising oil prices in the 1970s ushered in a windfall from North Sea oil, the U.K. did end up with a severe, protracted recession.

The term resource curse was first coined by economist Richard Auty in a 1993 book, Sustaining Development in Mineral Economies: The Resource Curse Thesis. It’s also sometimes referred to as a “resource trap” or “paradox of plenty.”

When a country has a significantly valuable natural resource, it can be tempting for its leaders to go whole hog into developing that commodity at the expense of other industries.

This approach can lead to a situation similar to Dutch disease, where a wealth gap develops between workers in industries that extract natural resources and those in other segments of the economy. Corruption can exacerbate the problem if national leaders siphon off wealth for themselves, fostering authoritarianism and eroding trust from international investors.

Such myopic economic development also leads to economies being tied to the price of commodities, which are set in international markets that individual countries often don’t have much control over. Commodities are notoriously volatile because they are tied to economic cycles, and downturns can severely affect countries that are dependent on natural resources.

Petroleum, in particular, has been linked to several harmful effects. A 2015 study in the Annual Review of Political Science found “robust evidence” that oil wealth tends to strengthen authoritarian regimes, increase certain types of corruption, and contribute to violent conflict in low- and middle-income countries.

There are also examples of other natural resources playing roles in conflicts, which sap economies of sources of legitimate income and workers to exploit them, whether they be casualties of fighting or refugees.

One example is in the eastern Democratic Republic of the Congo, where much of the tantalum used in the world’s smartphones comes from. So-called blood diamonds fueled civil wars in Congo, Angola, and Sierra Leone in the 1990s and prompted reforms in the international diamond trade.