Question

Critically comment on the following statements as they refer to middle-income developing countries 

"When an economy faces dutch disease the market exchange rate fluctuates around the current account equilibrium exchange rate and the economy goes through a process of de-industrialization."

Answer 1

The Dutch disease is a country’s exchange rate overvaluation caused by the exploitation of cheap and abundant resources of the country. The currency inflows due to these abundant products leads to currency appreciation, which makes the country's other products less price competitive on the export market. No matter how updated or new technology a country uses ,the abundant commodities will still rule in this case. Dutch disease leads to de-industrialisation.

Dutch disease is a market failure that implies the existence of a difference between the exchange rate that balances the country’s current account and the exchange rate that enables the existence of efficient economic sectors of tradable goods and services. It is a market failure that even currency crises are not able to correct because it is compatible with the long-term equilibrium of the country’s current account. Only when the Dutch disease is cured the market will be able to draw the market exchange rate closer to the competitive equilibrium which is called industrial equilibrium.

Commodities give rise to the Dutch disease with the long-term current-account equilibrium which only pulls away the exchange rate from the industrial equilibrium to the current equilibrium.