Intermediate Macroeconomics
Christopher A. Robinson
[Brazil and Dutch Disease]
What is Dutch Disease? Is Brazil in danger of falling Ill with the disease? And How can they defend against the disease? /
Introduction
With the certainty of oil becoming a large part of the Brazilian economy, there is the possibility that Brazil could build on its past economic success and become on the globes next superpowers. According to an article in the economist, Brazil’s president Dilma Rousseff would like to use the money from the oil and invest it into education and infrastructure. A sound plan because there is overwhelming evidence that investing in the infrastructure and human capital can set a country on the path to prosperity. People who are better educated get better jobs and the investment in infrastructure ensures that the economy can absorb and maintain the extra output produced. However, if Brazil mismanages its new found wealth it could find that itself in a very bad position economically. Brazil is not the first to discover liquid gold off of its shores. There have been many that came before, and allbecame victims to a phenomenon called Dutch Disease.
What is Dutch Disease?
Dutch Disease, named after the events that ransacked Holland’s economy, is a phenomenon that occurs when a country discovers a new natural resource and that resource raises the value of the home country’s currency. This causes good manufactured in the country to become less valuable those goods from other nations. Increasing overall imports and decreasing exports. The discovery of a new, valuable natural resource does not always spell doom, but if there are no checks and balances set up economic peril is sure to follow.
The surname of disease is appropriate because if the problems of Dutch Disease remain unchecked it can give rise to a whole host of issues that can slow economic progress down. There is the possibility of corruption (as shown in the case of Venezuela) and the host country can hinder its own progress by overprotecting its infant industry. If all three of these ailments occur
An example of Dutch Disease
To better illustrate what Dutch disease is let us create a fictional country called Naboo. Naboo is a mostly agricultural and manufacturing based economy. They export many of their products around the globe but maintain a trade balance. Naboo has just discovered that it has an abundance of plasma that can be used as a fuel source in a variety of ways, making it extremely valuable. The prime minister of Naboo believes that they should both harvest and export the plasma because it can lead to a new era of wealth and prosperity for Naboo.
The first implication of these actions would be a shift in the labor market. They would need to disturb the current labor market and move workers from their current industries to a new one. This shift has a few consequences. One being the fact that if production in agriculture and manufacturing are to remain constant workers are needed and in order to entice those workers to stay in their current industry firms would need to raise wages. However the labor would have to come from somewhere so the laborers in the agricultural and manufacturing will likely have to work longer hours to maintain production levels. At any rate, the agricultural and manufacturing firms will have an issue that will be brought to light soon.
The harvesting and exporting of their new found wealth will cause Naboo to take in increasing amounts of foreign income. This foreign income is used to purchase their imports. The more foreign income that Naboo has the easier it is for them to purchase imported goods at low prices relative to their currency. Their home currency is has less purchasing power as a result. There are a number of consequences following these events. The first being the overvaluation of their currency makes it cheaper to purchase imported goods, leading to the increased consumption of those goods, and the increase of the importing of those goods. Second, goods produced within the country have much higher prices because of the increased wages that must be paid and because of the overvalued currency. This leads to less demand of home country goods, the cutting of labor (which are most likely just shifted to the natural resource harvesting industry), and the further increase of foreign goods which create trade deficits.
The example of Naboo is an expression of the damage Dutch disease can do to an economy. There could be the possibility of corruption and rent-seeking behavior, or the protecting of the newly founded industry from outside competition. The example could go in so many different directions and almost all of them are bad.
Why Brazil is a candidate for Dutch disease?
It is no secret that Brazil has discovered oil close to its shores and it plans to excavate and export the oil. Those conditions alone make it a candidate for the disease. If they do not institute policies to regulate and control their economy as they are reaping the benefits of their new found wealth they could suffer dire consequences. The Brazilian government seems to be well aware of the danger of Dutch Disease because according to a research report done by the HSBC, the government has already taken steps to enact policies that can help them weather the economic storm. The natures of the policies are to enhance the competitiveness of the Brazilian industry.
There are many sources that show that the Brazilian economy is already fighting a tide of currency value increases and shrinking shares of exports being manufactured goods. The first chart from emergingmarketmusings.com shows Brazil’s currency is already becoming relatively strong compared to the US dollar, which makes it easier for them to consume imported goods and makes their nontradble goods more expensive. The next chart from the same source shows that manufactured good are becoming a smaller portion of Brazil’s exports.
I believe that this is compelling evidence that Brazil is already in the early stages of Dutch Disease and they are attempting to deal with it. The steps that they have already taken may not be sufficient enough to fully stem the tide of Dutch Disease or the other side effects that it can cause, however only time will reveal if the policies are effective.
How can Brazil avoid Dutch Disease?
There are a few ways that Brazil can avoid making the same mistakes as Holland, Venezuela, and in numerous parts of Africa. First they should avoid the idea of making the oil industry a state enterprise. If the chose to let the government run the industry there would be far too much waste because of a lack of efficiency, which would lead to a loss of tax revenue, which then lowers investment and ultimately slows down economic growth. What they should do is privatize the industry and tax it. Privatizing the industry will allow for efficiency (lowering of costs), private investment (not using government funds), and the increase of tax revenue. The government could then use this new revenue to proceed as they planned and invest in the human capital and infrastructure of Brazil.
Second, Brazil should regulate the oil industry to guard against rent-seeking behavior, corruption, and other crime. The regulation should consist of policies and oversight committees to ensure business is practiced legally and fairly, regulate prices, and adjust taxes on the industry as needed. These regulations and adjustments can be used to keep the country’s exchange rates and other macroeconomic factors in check.
Lastly, the government needs to keep a very close eye on their currency and manually control the exchange rate if necessary. Keeping the currency at a controlled value will be significant to keeping their nontradble industries competitive and keep the manufacturing sector alive.
Conclusion
In conclusion, Dutch Disease is an economy killer that seems to always show up when a country discovers a new natural resource and plans to export that resource. There is already evidence that Brazil may be coming down with the disease but they are not in any true danger yet. If they can institute policies than can protect their nontradble goods industries, prevent corruption, and control its currency then Brazil may have a foundation for future economic success, rather than doom.
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