An increasing amount of experts warn Colombia for the Dutch disease, claiming its growing export of natural resources is appreciating the country’s currency and negatively affecting other export sectors. While there are alarming signs, it’s too early to diagnose the economic illness.
The term Dutch Disease was born in the 1960s when immense underground deposits of natural gas were discovered in the Netherlands. This resulted in a large economic boom for the tiny European nation, but this increase in wealth and foreign capital caused the Dutch guilder to rise in value eventually leading to a decline in most other exports as they became relatively more expensive on world markets.
The decrease in non-oil and gas exports led to deindustrialization or a contraction in the manufacturing sector of the economy.
Thus, Dutch Disease was born.
Britain was afflicted in the 1970s as the price of oil quadrupled making it profitable to drill in the North Sea off the coast of Scotland. The economy eventually fell into recession as non-oil exports declined and workers demanded higher wages.
In the late 1970s Colombia suffered from Dutch Disease as coffee production and sales doubled from their 1967 levels. The government waited until 1986 but successfully combated the economic ailment with a windfall tax on coffee receipts. Is Colombia suffering from Dutch Disease again and, if so, will the government act accordingly?
Some have recently cited this economic ailment claiming that Colombia is showing symptoms or that the onset of Dutch Disease has once again taken place in the Andean nation.
Is it a false alarm or should Colombia be taking measures to stave off this economic malady?
To begin with, it’s important to note that Dutch Disease is not only caused by the exploitation of natural resources but it can also be caused by large inflows of foreign capital, although the two tend to be related as foreign companies invest heavily in natural-resource rich nations that allow them to do so.
Colombia has seen a large influx of Foreign Direct Investment (FDI) over the past 10 years with FDI reaching a record $10 billion U.S. dollars in 2008 and it is expected to be near $10 billion again in 2010.
The recent rise in FDI is without a doubt helping to bolster the Colombian peso as it has soared in value nearly 13% against the dollar this year.
Colombian exporters are feeling the pressure as their sales are suffering and, as a whole, Colombian exports of non-traditional products (everything besides natural resources) have taken a hit causing some to sound the alarm bells and diagnose the current predicament as Dutch Disease.
According to an August 2010 report by Colombia’s Administrative Department of National Statistics (DANE), exports of non-traditional products between January and August actually decreased by 7% when compared to the same period in 2009 while exports of traditional products (natural resources) increased by 48%.
Looking closer at the statistics reveals even clearer symptoms of Dutch Disease as the 48% increase in traditional products was driven by an 80% increase in oil exports while textile shipments (non-traditional product) abroad decreased by an eye-opening 53%.
These are classic symptoms but are they enough for a diagnosis?
It is clear that Colombia has experienced both large increases in FDI and exports of natural resources over the past few years which has led to unprecedented strength in the peso but is this the cause of the decline in non-traditional exports?
A major factor in the 7% drop in non-traditional exports was the 82% drop in exports of live animals and animal products. This can largely be explained by a diplomatic dispute with Venezuela in late 2009 which eventually led to Venezuelan President Hugo Chávez announcing a complete freeze of economic relations with Colombia.
The DANE report notes that exports to Venezuela, once Colombia’s second-largest trading partner, dropped by 71.5% between January and August.
This significant plunge in trade with a key commercial partner accounted for a considerable part of the overall drop in exports of non-traditional products.
Nonetheless, as long as the peso continues to soar against the dollar, improved relations with Venezuela won’t be able to save Colombian manufacturers and they will continue to see their bottom lines shrink as their products become increasingly expensive on world markets. If this trend continues, it will inevitably lead to a decline in the overall manufacturing sector of the economy or full onset of Dutch Disease.
If we look at which sectors of the economy foreigners are investing in we only build a stronger case for those who are diagnosing Colombia with this economic infection. According to statistics from Colombia’s central bank, FDI in the nation’s oil and mining industries in 2002 accounted for less than 43% of total FDI while in 2009, FDI in Colombia’s oil and mining industries accounted for more than 77% of total foreign investment in Colombia.
This means foreigners are looking less towards Colombia’s manufacturing and service industries and are focusing instead on the extraction of natural resources – a classic symptom of Dutch Disease.
So what should the government do?
Heavily depending on commodities and non-renewable resources is a precarious situation to be in as prices for these tend to be volatile.
That being said, it is not “bad” to be a net exporter of raw materials. What is important is how the money that is earned from selling these products is spent in the country.
Take Chile for example. The Economist reports that this nation was able to accumulate $20 billion dollars (equivalent to 12% of GDP) in a stabilization fund by the end of 2008 due to high copper prices. It then used those funds to pay for a large fiscal stimulus package equivalent to 3% of GDP during the height of the global economic recession.
The Economist also notes that Brazil is considering new legislation which will require a portion of revenues generated from new deep-sea oil production to be placed in a special social welfare fund.
While a diagnosis for Colombia might be premature, the Colombian government will certainly need to decide how it is going to deal with these new large inflows of foreign capital and a stronger peso.
It must make sure that a portion of the money generated from the exploitation of natural resources is allocated to areas that will help the long-run competitiveness of the Colombian economy. The Santos administration should take note of what other countries like Chile and Brazil are doing in order to insure that the country doesn’t cripple itself by becoming too dependent on commodity exports.
Immediate relief for exporters that are suffering from a stronger peso could come in the form of tax cuts which would allow them to trim down their prices. This is only a temporary solution though as the peso is likely to maintain its strengthening trend over the long run.
Improved trade relations with Venezuela and new free trade agreements will surely help to alleviate some of the suffering from Dutch Disease but, in the end, sound policy from Bogotá is the only way to eradicate this economic ill in Colombia.
It will be important for the government to pay close attention to the behavior of the manufacturing sector of the economy over the next few years and to not let it die out in order to boost commodities exports. Colombia’s manufacturing sector still has much room to grow and it can play an important part in the economic development of the nation.
Dutch Disease or not, changes are certain to come and shifts in the industrial structure of the economy are to be expected. How the government deals with these changes and shifts will make all the difference to future generations of Colombians.