dutch disease and the case in nigeria

The main reason is that abundant natural resources will make the real exchange rate of foreign currencies to VND increase foreign currency will be appreciated and thereby make the manufa

FOREIGN TRADE UNIVERSITY

HO CHI MINH CITY CAMPUS

-*** -MIDTERM REPORT

Major: Economic Development

TOPIC:

DUTCH DISEASE AND THE CASE IN NIGERIA

LECTURER: Ph D LÊ HẰNG MỸ HẠNH

Ho Chi Minh City, August 2023

TABLE OF CONTENT

LIST OF GRAPHS 2

1 Theoretical background 3

1.1 Definition of Dutch disease 3

1.2 History of Dutch disease 3

1.3 Causes, Symptoms and Effects 4

1.3.1 Causes 4

1.3.2 Symptoms and Effects 5

2 Dutch disease in Nigeria 7

2.1 Nigeria’s background 7

2.2 Outbreak of Dutch disease in Nigeria 8

2.3 Consequences of Dutch disease in Nigeria 11

2.4 Policy and recommendations 12

3 Lessons learned for Vietnam 12

3.1 Recommended policy to avoid Dutch disease 12

3.2 The situation of Vietnam 15

3.2.1 Vietnam and the Dutch disease – Revenue from resource exports 15

3.2.2 Vietnam and the Dutch disease – FDI perspective 16

3.2.3 Summary 17

REFERENCE 18

LIST OF GRAPHS

Graph 2.1: Economic growth and Natural Resources from 2012 to 2021 7

Graph 2.2: Nigeria’s oil and non-oil exports from 1981 to 2021 8

Graph 2.3: Real effective exchange rate index 9

Graph 2.4: Nigeria Wage and salaries workers, total (% of total employment) from 1991 to 2021 9

Graph 2.5: Service, value added (% of GDP) in Nigeria from 1981 to 2022 10

Graph 2.6: Manufacturing, value added (% of GDP) in Nigeria from 1981 to 2022 11

Graph 3.1: 10 largest export commodity groups in Vietnam 2020-2021 15

1 Theoretical background

1.1 Definition of Dutch disease

Dutch disease was first analyzed by two Australian economists, Max Corden and Peter Neary,

in 1982 It is a common phenomenon, usually in developing countries, where the exploitation of natural resources for export often undermines the development of the manufacturing sector It is also an economic term for the negative consequences that can arise from a spike in the value of a nation’s currency

The main reason is that abundant natural resources will make the real exchange rate of foreign currencies to VND increase (foreign currency will be appreciated) and thereby make the manufacturing sector less competitive Initially, the Dutch disease referred only to the exploitation

of resources, but later it referred to all the huge sources of foreign exchange, including rising prices of exports and foreign investment

1.2 History of Dutch disease

The term "Dutch disease" was coined by The Economist in 1977 to describe the decline of the Dutch manufacturing sector as the country ramped up natural gas exports During the period

of the post-World War II period and the 1960s, the Netherlands achieved remarkable success in many aspects, with low inflation, which was rarely exceeding 3% per year GNP growth is usually above 5% and unemployment hovers around 1% (Thuy Nguyen Thi, 2022) The secret to these successes is that the country's traditional export sector is now highly competitive against its competitors worldwide, such as agricultural products and electronics In the early 1970s, during exploration, geologists discovered a gas source with huge reserves in the North Sea The Dutch government decided to exploit this natural resource, according to the Office of Energy efficiency and renewable energy, from 1973 to 1975 the Netherlands exported a large amount of gas, increasing the total value of exports by 10% and increasing GNP by nearly 4%

Thanks to the exploitation of natural resources, the Netherlands has a very large amount of money that is called Windfall Its export turnovers jumped after the Netherlands decided to sell this natural resource A large amount of foreign currency had returned to the Netherlands after the first shipment However, this strengthened the Guilder (the local currency of the Netherlands), and to overcome such a phenomenon, the Netherlands was forced to keep interest rates low to

prevent the rapid appreciation of the local currency At the same time, the Dutch government also increased investment in many areas to revive the manufacturing industries The Dutch government has increased budget spending, invested in many inefficient sectors, produced uncompetitive non-foreign trade goods instead of continuing to focus on investing in agriculture and electronics, etc However, when gas resources are fully exploited, the money source is not enough to meet the spending needs of the country, domestic demand decreases, and the Dutch economy faces many difficulties such as rising inflation, exporting industries Traditional exports such as agricultural products and electronic goods decreased, domestic production costs increased, the dollar depreciated in the domestic market, income growth was low, unemployment rate increased, etc This caused the Dutch economy to stagnate and had severe consequences Fortunately, with reasonable policies, the Dutch government has revived and brought the economy up

Since there were too many cases of countries who had gotten the Dutch Disease, this had become the important topic of economists at that time Then, in 1982, two economists, W Max Corden and J Peter Neary, modeled the above phenomenon

1.3 Causes, Symptoms and Effects

1.3.1 Causes

As we all know Dutch disease is not only happening to this country, but it is also common

in many countries around the world, especially developing countries The main cause of this disease is the discovery of a large resource or the sudden increase in the price of some export items or the excessive investment capital being poured into the economy

However, because there is no effective use policy, those great resources have become a double-edged sword to hurt the economy The discovery of large reserves of natural resources (gas) by the Dutch, such as the one who picked up "the treasure that fell from the sky", caused the value of the gas export industry to skyrocket, the mining industry flourished, the proportion of exports has increased significantly, contributing to GDP greatly increased This is a good start for the export industry, but what about other industries? The increase in natural resource exports leads

to an increase in the price of exported goods and an increase in the domestic currency This raises the exchange rate and raises the general wage level, which in turn puts pressure on the competitiveness of other commercial sectors in the economy

When the general salary increases, people's income increases at the same time as the exchange rate increases, so the price of imported goods goes down With the psychology of consumers, choosing imported goods at that time was optimal Domestic consumption increases but not for domestic goods but for imported goods (cheaper than before) Manufacturers face the danger of having to compete with imported goods This requires them to reduce input costs, improve technology and improve labor productivity To do so requires appropriate investment, but their revenue not only does not increase, but also decreases, there is no money to invest anymore

An increase in the exchange rate brings high risks to capital-intensive technology industries, thereby creating a high risk of unemployment for society This problem can be solved by developing the service sector that can help offset the lost jobs of the industry However, many potential job opportunities in the service sector are relatively low productivity, which means low wages, leading to increased social tensions The increase in the resource export sector is causing more and more negative impacts on the economy When resources are exhausted and comparative advantage is no longer available, export prices and foreign currency revenue will drop suddenly, while other industries will be neglected and have not been able to adapt The economy went into crisis, slowly paralyzed like a body whose immune system was destroyed, no longer able to resist

1.3.2 Symptoms and Effects

From the case of the Netherlands, we can generalize the symptoms of the "Dutch disease"

as follows It can be said that when a country earns a large source of foreign currency, it can lead

to two big impacts: the impact on spending and the impact on attracting resources

In terms of the spending effect, when foreign currency flows into the country quickly and

massively, it will make the supply of foreign currency abundant while the demand remains constant, inevitably causing the exchange rate to change

As a result, the domestic currency appreciates, the foreign currency depreciates, and domestic goods appreciate relative to the world The export industry is less competitive in the world market; imported goods became cheaper than ever, appeared in the domestic market and people rushed to buy imported goods, domestic production failed because it could not compete in the market itself As a result, imports increased sharply; non-resource export products decreased markedly This is the first symptom of the "Dutch disease"

In terms of resource movement effect, due to the large income from foreign currency, the

economy concentrates on the resource extraction industry, not focusing on agriculture which is the main source of income Agriculture is less focused, leading to a decrease in quality and productivity The resource extraction industry develops and incomes from these industries increase, which attracts a large part of laborers from agricultural areas and other industries; and shifts large sources of income

Although the labor supply in some resource extraction industries has increased, these workers do not have high skills and working disciplines (because a large part of them are laborers from rural areas moving to modern ones) This causes the mining industry not yet to be efficient

As a result, there are too many labor supplies in some industries, and serious labor shortages in others The economy was destabilized, production stagnated This is the second symptom of the

"Dutch disease"

Thus, when a country suffers from the "Dutch disease", the economy will fall into a state of increased inflation; inevitably causing other goods to increase in price; decrease in national income (GDP); the proportion of exports decreased imports increased; increase of employment - pressure, the economy stagnates, cashew consumption, etc Once resources are exhausted, foreign currency revenue is no longer available To maintain the economy as before, this is indeed a disaster for those countries

Regards to resource movement Effect, the economy will adjust itself because P decreases Some export industries that are not eligible for higher export prices will have to reduce their production scale or go bankrupt as they become less competitive because of the falling real exchange rate Temporary unemployment from these industries will occur although they may shift

to manufacturing industries This is made worse as these lost export industries may be in the long-term investment phase and may affect export growth in the future When revenue streams are suddenly lost, restoring these export industries will take a long time

Regarding the Resource Effect, “over expected” revenues have caused consumer tastes to shift towards overconsumption When the funding for previously unexpected spending is no longer available, the short-term adjustment to consumption is also difficult And this will balance the foreign trade deficit

2 Dutch disease in Nigeria

2.1 Nigeria’s background

Located on the western coast of Africa, Nigeria is home to Africa’s biggest population and largest economy powered by a growing services industry with abundant natural resources, notably large deposits of petroleum and natural gas This country is also Africa’s top oil producer and oil

is the government’s biggest source of revenue, which accounts for 75% It has the second largest proven reserves on the African continent and is the 12th largest producer worldwide (GECF) However, its economy has been struggling and poverty levels are on the rise

Ever since the 1950s, when oil was first discovered in Nigeria, it has consistently remained the dominant driving force behind the economy, attributed to the exploration of oil and gas resources, coupled with the surge in global oil prices over the preceding years

Graph 2.1: Economic growth and Natural Resources from 2012 to 2021

(Source: World Bank) Oil and gas are the lifeblood of the nation’s revenues, economy, and national survival In

2020, oil accounted for 90% of Nigeria’s export earnings and consisted of 1/3 of the country’s annual revenue, however, it only contributed to 9% of GDP growth (Borgen Project)

Prior to 1970, agriculture played a fundamental role in the Nigerian economy The sector, on average, made up half of the country’s total export earnings (Olusi, J O., & Olagunju, M A., 2005), contributed roughly 50% of the GDP and 72% of the labor force between 1960 and 1970 (World Bank, 1975) In the 1960s, Nigeria was the second-biggest exporter of cocoa and palm

products and the top exporter of groundnuts (World Bank) The great amount of oil exports, however, not only rendered other exports of solid minerals ineffective in the economy but also severely neglected other sectors of the economy, particularly agriculture This negligence resulted

in the disappearance of groundnut and cocoa pyramids and a significant decline of palm oil harvests

Graph 2.2: Nigeria’s oil and non-oil exports from 1981 to 2021

(Unit: ₦' Billion)

Source: Central Bank of Nigeria, Statistical Bulletin (2021)

Between the period of 1981 to 1988, the export of petroleum and non-oil products were close to each other Since 1995, the gap has become more and more significant The result is, when global oil prices bottomed down in 2014 Nigeria went into recession and it’s still struggling

to get out until now

2.2 Outbreak of Dutch disease in Nigeria

The Dutch Disease did not start to spread in Nigeria until much later, in the middle of the 1970s This was brought on by the industrialized nations' increased demand for oil

* Domestic currency becomes stronger (appreciates)

Graph 2.3: Real effective exchange rate index

(Source: World Bank)

Starting in 1973, when an oil shock caused energy prices to skyrocket, between 1973 and

1974, oil prices quadrupled, and even though the actual embargo only lasted for six months, prices stayed high At that time, Nigeria experienced an oil shock that lasted until the middle of the 1980s, resulting in an abundant flow of money within the country

The country’s real effective exchange rate index increased dramatically to its peak in 1984 Although effort to enhance foreign exchange market management, which resulted in negative pressure on the native currency in later years This number increased again in the 1990s and a rising trend existed from 2000 until now Nowadays, despite its poverty and high level of crude oil export, the exchange rate between Nigeria Naira and United States Dollar of 769.2-naira dollar

* A growth in the economy's actual wages

Graph 2.4: Nigeria Wage and salaries workers, total (% of total employment) from 1991 to 2021

(Source: World Bank)