that exchange rate undervaluation should be part of a comprehensive growth strategy. However, exchange rate manipulation to gain unfair competitive advantage—the practice that led to the currency war in the 1930s—goes against the spirit of international cooperation, is prohibited by international agreement, and is likely to be unsustainable in the long run. In addition, there is a strong possibility that prolonged undervaluation of the exchange rate leads to a build-up of inflationary pressures, thereby jeopardizing growth in the medium term. Furthermore, maintaining an undervalued exchange rate makes imports of essential capital and intermediate goods and services more expensive, affecting not only the tradable but also non-tradable sector, such as housing and transport.

Countries experience real appreciation of the currency as their productivity, output and income increase relative to the rest of the world (Balassa-Samuelson effect). While the tradable sector may lose price competitiveness, it would be wrong to conclude that export boom-driven appreciations are necessarily making the overall economy uncompetitive. A country’s external competitiveness—simply put, its ability to sell its products on international markets—goes beyond notions of real exchange rate competitiveness. Measures of export competitiveness also include unit labor cost, the level of complexity or technology content of exported products, and the ability of firms to charge higher prices for similar products due to higher quality perception.<sup>21</sup> Furthermore, behind-the-border measures, trade facilitation, as well as many other factors that constitute “institutions” are growing their importance in determining a country’s international competitiveness.

Those who are worried about the negative impact of real appreciation also ignore an important aspect of today’s increasingly interconnected global marketplace. With the rise in global value chains, production processes are increasingly fragmented across different countries, and imported goods and services are an essential input for exports, either for final sale or as intermediate inputs into further stages of production.<sup>22</sup> A boom-induced real appreciation—an increase in the relative prices of _final_ products— makes goods and services more expensive to sell abroad, but reduces the cost of imported _intermediate_ inputs.<sup>23</sup> With a sufficiently large volume of foreign inputs, the benefits of cheaper access to imported inputs can potentially offset the negative effect of real appreciation. The non-booming tradable sector may be able to stay competitive and expand production to reap the benefit of the spending effect.

# **Myth 8.  Dutch disease is synonymous with resource curse.**

Dutch disease and resource curse are two separate issues, although frequently thought to be synonymous. Dutch disease describes a pure economic phenomenon, in which the economy adjusts to the new equilibrium following large-scale inflows of foreign exchange (of any kinds). Resource curse is a thesis that interprets natural resource abundance to cause intrinsically negative impact on growth and

> 21 World Bank (2014).

> 22 Trade in intermediate goods and services now accounts for more than two-thirds of total international trade flows (IMF, 2013a).

> 23 It is increasingly recognized the real exchange rate fails to appropriately measure export competitiveness in today’s world.  Standard CPI-based real effective exchange rates are based on the assumption that goods traded are _final_ consumption goods only, and it does not account for the fact that real appreciation could boost competitiveness through cheaper imported inputs.  Various efforts are under way to find alternative measurements of competitiveness.  See, for example, IMF (2013a) and Dupeyras and MacCallum (2013), for further discussion.

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