Alvin Hilaire Angela Henry Krishendath Ramlochan Research Department, Central Bank of Trinidad & Tobago © Copyright 2012 Central Bank of Trinidad and Tobago www.central-bank.org.tt Dutch Disease  1959 – Discovery of a large gas field in the Netherlands led to a slump in other economic sectors, particularly manufacturing.  Natural resource boom leads to a large inflow of foreign currency.  Local currency strengthens relative to other countries.  Exports become more externally uncompetitive.  Manufacturing sector becomes less competitive, and declines as a result. 2 Dutch Disease Model  1982 – First economic model developed to describe Dutch Disease – Corden and Neary Booming Tradeable Sector Non- Tradeable (oil, gas, gold, Sector copper, cocoa, (services) coffee) Non-Booming Tradeable Sector (manufacturing, agriculture) 3 Dutch Disease Model - Mechanism Resource Boom leads to Dutch disease via two effects: Resource Movement Effect  Spending Effect  4 Dutch Disease Model - Mechanism  Resource Movement Effect:  Increased demand for labour in booming sector  Wages increase in booming sector  Labour migrates from non-booming tradables sector to booming sector  Production declines in non-booming tradables sector.  This effect not significant in hydrocarbon booms since the sector accounts for a small share in total employment 5 Dutch Disease Model - Mechanism  Spending Effect:  Increased revenue from booming sector  Increased demand for non-tradable goods (services)  Demand for labour increases in non-tradable sector. Wages increase in that sector  Labour migrates from non-booming tradable sector to non-tradable sector  Price of non-tradable goods increases relative to tradables.  REER appreciates  Manufacturing sector becomes less competitive 6 Dutch Disease: Relevant to T&T? Trinidad & Tobago: Sectoral Economic Contribution – Energy Contribution to Real GDP Sector, 2011 Energy % of Nominal GDP 46.8 Non-Energy Petrochemicals % of Government Revenue 57.5 1966 % of Exports Receipts 82.3 25.6% % of Total Employment 3.0 75.9% 1990 Sources: CSO and Ministry of Finance 29.6% In Trinidad and Tobago, 68.7% the heavy concentration in 2011 energy warrants a check-up for 36.4% 55.5% Dutch Disease effects. 4.7% Source: CSO 7 Trinidad & Tobago presented a “classic” case i. A large oil sector with a boom in 1970s ii. Transmission via government budget iii. Relative prices changed in favor of nontradeables iv. Factor rewards followed suit v. Factors moved into nontradeables vi. (Non-booming) tradeables sector squeezed vii. Post-boom problems due to rigidities—not easy to reverse patterns created during boom times! e.g. Hilaire, ―The Effects of Trinidad & Tobago‘s Oil Boom on Relative Prices, Wages and Labour Flows‖, Social & Economic Studies (1992) 8 So what’s the story 25 years later?  There was another boom in the 2000s.  Did the Dutch disease hit again?*  In answering this let‘s compare: 1. Characteristics of the 2 booms 2. Fiscal activity 3. Relative price changes and extent of real appreciation 4. Wage and labour movements 5. Changes in the structure of the economy  Based on this, let‘s see what lessons there could be for the future. *A related question is posed by Céspedes and Velasco ―Was this time different?: Fiscal Policy in Commodity Republics‖ , mimeo September 2011. 9 1. There were similarities but also differences in the origin of the second boom Crude Oil Production  Boom I (73-82) was Crude Prices (US$/barrel) (m bbls) 120 90 based on an oil price 100 80 shock and incorporated 80 70 60 60 an increase in oil 50 40 production 40 20 30 0 20  In boom II (02-08) oil prices also jumped but Natural Gas Prices Natural gas production oil production slipped (US$ /000 cu ft) (b cubic feet) 10.0 2,000 8.0 1,500 6.0  Moreover in boom II 1,000 4.0 there was a surge in 2.0 500 natural gas production 0.0 0 and prices. 10