Dutch Disease - Minimization

Minimization

There are two basic ways to reduce the threat of Dutch disease: by slowing the appreciation of the real exchange rate and by boosting the competitiveness of the manufacturing sector. One approach is to sterilize the boom revenues, that is, not to bring all the revenues into the country all at once, and to save some of the revenues abroad in special funds and bring them in slowly. In developing countries, this can be politically difficult as there is often pressure to spend the boom revenues immediately to alleviate poverty, but this ignores broader macroeconomic implications.

Sterilisation will reduce the spending effect, alleviating some of the effects of inflation. Another benefit of letting the revenues into the country slowly is that it can give a country a stable revenue stream, giving more certainty to revenues from year to year. Also, by saving the boom revenues, a country is saving some of the revenues for future generations. Examples of these sovereign wealth funds include the Australian Government Future Fund, the Government Pension Fund in Norway, the Stabilization Fund of the Russian Federation, the State Oil Fund of Azerbaijan, Alberta Heritage Savings Trust Fund of Alberta, Canada, and the Future Generations Fund of the State of Kuwait established in 1976. Recent talks led by the United Nations Development Programme in Cambodia – International Oil and Gas Conference on fueling poverty reduction – point out the need for better education of state officials and energy cadres linked to a possible Sudden Wealth Fund to avoid the Resource curse (Paradox of plenty). Another strategy for avoiding real exchange rate appreciation is to increase saving in the economy in order to reduce large capital inflows which are able to cause an appreciation of the real exchange rate. This can be done if the country runs a budget surplus. A country can encourage individuals and firms to save more by reducing income and profit taxes. By increasing saving, a country can reduce the need for loans to finance government deficits and foreign direct investment.

Investments in education and infrastructure have the ability to increase the competitiveness of the manufacturing sector. An alternative is that a government can resort to protectionism, that is, increase subsidies or tariffs. However, this could be a dangerous strategy and could worsen the effects of Dutch Disease, as large inflows of foreign capital are usually provided by the export sector and bought up by the import sector. Imposing tariffs on imported goods will artificially reduce that sector's demand for foreign currency, leading to further appreciation of the real exchange rate.