# **1.  Introduction**

This paper takes a fresh look at Dutch disease. Dutch disease is a term that is well-known to economists and development practitioners. But it is also a concept that is often conflated with “resource curse” and misinterpreted as a “disease” that necessarily causes adverse impacts on the economy.<sup>2</sup> A review of World Bank reports confirms that there are some persistent myths about Dutch disease. While these reports do not engage in some of the most damaging myths found in other economic literature, the rigor they exhibit is inconsistent.

The objective of this paper is to provide a concise overview of Dutch disease, synthesizing empirical literature and latest policy debates, and clarifying some of the typical misunderstandings about Dutch disease. The target audience of this paper is development practitioners, who are working to support countries facing surges in foreign currency inflows of any kinds, as well as government officials and anyone interested in learning about the operational implication of Dutch disease.

This paper is organized as follows. Section 2 presents a brief review of the standard Dutch disease theory with no international factor mobility and factor accumulation. Section 3 translates the theory into practical implications, and examines the myths of Dutch disease that often surface in the development literature and policy discussions. Section 4 presents a general policy package for countries that are subject to large influxes of foreign currency, and argues that such a package should be comprehensive and designed to target country-specific concerns. Finally, Section 5 concludes the paper.

# **2.  Theory: What Is Dutch Disease?**

In the original sense of the term, Dutch disease refers to a situation in which an extra wealth from an export boom—such as a discovery of major resource deposits—leads to _a contraction of other tradable activities_ by giving rise to a real appreciation of the home currency.

Although Dutch disease is generally associated with mineral resources, the analytical framework of Dutch disease is equally applicable to a wealth increase that results from large inflows of foreign currency— foreign aid, remittances and capital inflows—as well as a non-extractive export boom, such as one associated with the displacement of older industry by technologically more advanced activities.

## **_The “Core Model”_**

The Dutch disease theory was established by two Australian economists, Corden and Neary. Their seminal paper, published in 1982, provides the first systematic analysis of the Dutch disease mechanism—that is, how an export boom causes a structural shift in an economy.

Their simplest static framework, known as the “Core Model”, considers a small open economy that produces two types of goods—one booming and the other non-booming tradables—and non-tradable goods. The booming and non-booming goods are traded at exogenously given world prices, whereas the price of non-tradable goods is determined endogenously by domestic supply and demand conditions.

> 2 In some cases, the resulting anxieties and political pressure to “cure” Dutch disease have led to a protectionism argument.  For example, there is a heated debate in Canada about the potential impact of oil sand production on manufacturing employment.

2