Dutch Disease In America

    

A long bout of inertia seems to have ended in the U.S. Economic activities are picking-up. People are finally out in search of jobs and they are succeeding in getting them. With unemployment vanishing and economic indicators improving, a mood of optimism & jubilation prevails all over the country. Technically, the U.S. is out of recession and it is treading on recovery-path. However, this path of recovery is not smooth. It is still fragile and threatened by a number of factors.

Of all the factors that may derail the process of recovery of American economy, the immediate threat is from ‘Dutch Disease’ the economy is slowly heading towards.

Dutch disease is an economic phenomenon which occurs when an industrial nation begins to exploit domestic natural resources that it previously imported. It is the result of resource boom or heavy production of natural gas, petrol, coal etc. Contrary to the popular belief that exploitation of own resources causes economic progress, Dutch Disease, if a nation is in its grip, may result in contraction in industrial and agricultural output and even de-industrialization of the economy. Let us understand how it happens:

Discovery and use of domestic natural resources by a nation may

1.     Obviate its need to import costly natural resources from other countries. This result in reduction in import bill and, hence, a reduction in supply of its currency in international market.

2.     Increase the earnings of the nation by exporting resources, if it is in excess of domestic requirements.

 This would put an upward pressure on currency and it value would appreciate. Appreciation of currency has its own disadvantage. It makes domestic goods costlier than foreign goods. Consequently, export of the country falls and import increases, resulting in reduction in demand for domestic goods. The export-based industries, thus, suffer in terms of loss of revenue and employment.

The term ‘Dutch Disease’ was coined in 1977 by ‘THE ECONOMIST’ to describe the decline of the manufacturing sector in the Netherland after the discovery of large natural gas field in 1959 and its consequent fall in its currency, Florin.

There are, however, several instances of occurrences of this phenomenon in the world economy. Cairns was the first to document Australian Gold Rush in 1859 and its possible impact on its currency. The UK and Norway became the victim of this disease when they extracted substantial quantities of petroleum from the North Sea during 1975-1990. Chile’s currency also appreciated in the late 2000, due to boom in mineral commodities prices.

And, now the US is slowly moving towards embracing the disease after shale gas revolution.

According to Energy Information Administration of US, crude oil production has increased by a little more than 61% since 2010. It is now producing 9.1 million barrel per day and the production is forecast to rise by 300,000 barrel a day during the next year.

Shale gas revolution in America has significantly reduced its dependence on imports from other countries. According to Energy department of US, the country consumed 20.8 million barrel per day in 2005. Out of this, 12.5 million or 60 % of total consumption was imported. In 2013, its total consumption was 19.0 million barrel / day and import was 6.6 million barrel or 35% of consumption. It is estimated that in 2015, the US would consume 19.1 million barrel per day and import only 4.1 million barrel per day (only 21% of consumption).

If these figures are to be believed, the US is able to reduce its import by (12.5-4.1)= 8.4 million barrel on daily basis as compared to a decade back. The dollar value of 8 million barrel at $ 60 per barrel is $ 480 million.

It, thus, implies that the US is saving this huge sum of money and consequently, supply of dollar has reduced by $ 480 million/ day, leading to its appreciation.

The US currency has been gaining strength against major currencies of the world for some time now. Its rise, while not extraordinary, is certainly significant. As this is being written, on a year-to-date basis, the dollar is up 8.8% versus the euro, 3.2% against the British pound and 2.4% against the Yen, with almost all of the gains coming since May.

At a recessionary time when euro-zone, Japan and China are offering heavy discount to overseas buyers to promote their export, appreciation of greenback has certainly hampered the global competitiveness of the USA. This has reduced its export and increased imports as is clear from given table:

Export/Imports of Goods	November, 2014	December, 2014	Direction
Export value	$193.4 billion	$194.9 billion	Down by $ 1.5 billion
Import value	$236.1 billion	$ 241.4 billion	Up by $ 5.3 billion

Source: Bureau of Economic Analysis

Goods and service deficit of the US has also increased from $ 39.8 billion in November to $ 46.6 billion in December and from $ 476.3 billion in 2013 to $505 billion in 2014.

Reduction in aggregate demand of US goods has caused industrial & agricultural output to fall. A comparison of industrial performance of US in 3^rd quarter, 2014 with that of 2^nd quarter, 2014 has been shown below graphically.

The graph shows that except mining, finance & insurance and real estate, all other segment of the industry has shown downward trend. Agriculture, forestry, fishing and hunting increased at 14.2% in 2^nd quarter as compared to only 7.6% only in 3^rd quarter. The performance of non- durable industry is very dismal in 3^rd quarter: from a positive 5% growth rate in 2^nd quarter, it entered the negative territory at around -6% in 3^RD quarter.

Though there could be other reasons also for dollar-appreciation, trade-deficit of US and its declining performance of industry, there is no denying the fact that dollar has shown an upward trend since the nation started reducing its imports of petroleum products.

The Fed decision, therefore, to hike the rate may further aggravate the global competitiveness of US.

 Though the ‘Dutch Disease’ poses real threat to the economy, it also offers an opportunity for them to set a path for long-term growth& development by promoting savings and utilizing funds in health and education sector.

As the price of crude oil has started moving in an upward direction, it would be interesting to see how the US economy manages its resource curse paradox.