When large reserves of natural gas were discovered in the Netherlands in the 1970s it boosted government revenue, funding the “good times” without the pain of taxation. However, it brought its own economic, social and environmental problems. These gave rise to the term the “Dutch disease” to describe the economic challenges of a boom based on exploiting natural resources – as such resources are generally finite, such booms are essentially temporary.
Natural resources such as oil or gas eventually run out. In the meantime, as the flow of money from gas or oil builds up, it adds to demand in an economy. If there is an independent exchange rate, there is an appreciation of the currency. Once that economy reaches full employment, the increased demand leads to a rise in inflation.
The combination of inflation and a stronger currency, in turn, results in the closure of many traditional firms who cannot stand the loss of competitiveness. This is not a major problem if the staff concerned are already leaving for higher paid jobs in the natural resource-based economy. However, the end result is an economy hooked on the natural resource income.
This is okay while the flow of income from exploiting the gas or oil continues. However, once it begins to run down, the problems set in. Traditional firms, who were trading successfully before the boom, are no longer there to take up the increasing slack. It is easy to shut down a business but much more difficult to start it up again.
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The field of economics that studies how to manage these temporary booms was led from the 1980s by the late Prof Peter Neary of UCD. That work shows the economic recipe to avoid this boom-bust cycle. Instead of immediately spending the proceeds of a natural resource boom, it is wiser to invest the income abroad, easing demand pressures and the stress on the exchange rate. When the income from the boom begins to dry up, a country can then live off the income coming from its foreign investments.
Norway is a very good example of how to deal with the problems of success. While it has used some of the oil income to boost the already high standard of living, its sovereign wealth fund has built up huge investments abroad. By reducing the upward pressure on the exchange rate, it has ensured that traditional businesses continue to be successful in export markets. All of this will ensure a soft landing as oil revenues run down over the coming decades.
However, many other resource-rich economies have not shown the same wisdom. Russia is an example where the riches from oil and gas have had a serious negative impact on normal domestic business. If Europe manages to shut down much of the flow of income from Russian fossil fuels in the coming months, the Russian economy will have little to fall back on. Its oil-fuelled boom has prevented normal exporting businesses from developing. Having become dependent on oil revenues, it is very difficult to return to a more normal economy.
US multinationals
Ireland is also currently enjoying temporary windfall revenues, not from natural resources, but from possibly time-limited tax receipts from US multinationals who have located intellectual property here. The recent report from the Irish Fiscal Advisory Council (IFAC) highlighted the danger that the Republic may be suffering from early-stage “Dutch disease” from the boom in corporation tax receipts. The council pointed out that, like depleting oil and gas revenues, between €6 billion and €9 billion in tax revenue could disappear quite quickly if US tax policy changed. If the Government continues to spend this revenue, it will keep the good times rolling while the revenue lasts, but a consequence would be some traditional exporting firms would lose competitiveness and close. If the tax receipts then disappeared, we would have a major problem, both for employment, and for sustaining public services.
It looks as if the Government could run a surplus this year and Department of Finance projections suggest a growing surplus out to 2025. As IFAC suggests, the obvious solution is that the Government should invest the exceptional revenues in a fund. If the revenue continues, the Government could safely spend income from that investment fund as it builds up. However, if the revenue suddenly stopped, the fund would help provide for a gentle transition to a more normal world.
This is the right strategy to adopt. However, the temptation to buy popularity by spending the revenues will build as we approach the next general election.
