Searching for a New Theory of Dutch disease after Corden and Neary

ABSTRACT

In three articles (1982 and 1984), Max Corden and Peter Neary exhibited the theory of Dutch disease which aroused vast interest across the world until today. The theory about the consequence of a commodity boom is based on neoclassical and partly monetarist grounds. This article reconsiders this theory thoroughly. It is static, formulated in terms of a barter economy, does not integrate money and currencies, refutes anything like a “disease” in the sense of a long-standing handicap of an economy and is not in line with the stylized facts of commodity cycles. It suffers under a set of too restrictive assumptions. An alternative theory is proposed here which uses parts of Corden and Neary’s theory and goes far beyond in order to integrate commodity trade in theories of economic development in resource-rich countries and repercussions on the world economy. It shows that in some – not all – resource-rich countries indeed a long-standing structural deformation can occur that is difficult to cure.

JEL Classification: B31; E32; F11; F31; O11; Q02; Q43.

KEYWORDS:
Dutch disease; commodities; financial cycles; industrialisation; manufacturing

Corden and Neary (1982) (CN in the following) are considered the inventors of the theory of Dutch Disease (DD), which had played a big role in many debates after their publication 44 years ago. The article has aroused innumerable academic publications and debates (Mien and Goujon 2022; Reisinezhad, 2024). CN had addressed a theme that was not completely unknown but insufficiently researched and loaded with diverging opinions and arousing curiosity right after two oil price explosions in 1973 and 1979-1980. Why can the blessing of the discovery of more natural resources or an unexpected price increase of them have detrimental long-run consequences which can be considered an economic disease? In actual fact, CN rejected this hypothesis and were cautious, almost mute regarding future effects. So, they had not only not invented a theory on DD but critiqued the “disease” proposition raised by the journalists of The Economist in 1977 for the case of the Netherlands. The true title should have been “The Dutch Boom to more Welfare” or similar, if one reads their papers carefully.

CN wrote a purely theoretical paper, based on neoclassical theory at the height of the neoclassical and monetarist counter-revolution against Keynesian macroeconomics. They used a mix of sector-based meso-economics and macroeconomics. The disease narrative for the medium and long-run effects came later from many authors, especially with empirical research. Yet, many issues remain open. This is the challenge of the insufficient inclusion of the economics of natural resources – presently still comprising more than 40% of global trade – in sector-neutral macroeconomics. These resources have proved to be a core of global instability that goes far beyond DD and have a special relevance for commodity-heavy developing countries. To understand these linkages, we need a new theory of DD that may incorporate some ideas from CN. Although it has little to do with Netherlands, we use the old term DD.

In the centre of what follows is the careful analysis and interpretation of CN’s approach, exposed in three articles of which only the first stood in the limelight. This part ends with hinting to five focal points of critique, mainly relevant for the medium and long term. The second part elaborates on the critical points one by one. The last part concludes.

THE BASIC MODEL

CN had written a neoclassical and implicitly monetarist model in three articles, seemingly far off reality even though the consequences and messages do approach reality. The title of the main article by both authors is “Booming Sector and De-Industrialisation in a Small Open Economy”, hence a general theory for any small open economy including developing countries but seemingly excluding large economies, though without a clear justification of this caveat in the text. The basic model is built on a barter economy or “real” economy without money, without a currency, hence without a monetary exchange rate, without cross-border capital flows, hence with a trade balance of zero, without domestic or foreign saving and without “money prices” and without inflation. Money is in this approach a veil, hence apparently irrelevant for the real economy, or even misguiding since a veil hides the face, the core of the issue.

In the model, three representative products are produced in three sectors, E for the boom sector for energy (or other booming product markets), M for manufacturing, and S for services representing all non-tradables. E and M together form the tradable sector. World market prices for E and M are given. M is the numeraire, the barter exchange rate is the relative price of S, hence S-units per unit of M. If one unit of M can buy three units of S, the real rate of exchange is 3, and if it falls to 2, the domestic currency would appreciate in real terms. The model is only short-term, meaning a one-off rise of the boom output, be it by discovery of new resources or an improving production function. This kind of boom stands representative also for a higher world price for E which is supposed to have the same effects (CN 1982, section V). A reduced world price for E is considered equivalent to technical regress under Hicks-neutral technical change. Nothing is known about the following period. There are no government, no banks and no central bank, no institutions. Full employment is assumed, guaranteed by competitive real wages and perfect competition. The model refers to any market economy, no matter whether developed or developing. The small country restriction is necessary to justify the country as a price-taker on the E-market, and also on the M-market. Hence it is assumed that the world market for E and M is perfectly competitive. This implies that E-price-fixing countries, which are partly also small, such as OPEC-members and similar countries with monopolies or oligopolies, are by assumption excluded.

If the output boom occurs in an economy with full employment, more labour is needed to extract more E out of the ground; hence, real wages rise since labour is lured in from M and S. This is the resource movement effect, which may be small or close to zero if the E-output is raised (almost) without additional costs. The output of the economy rises, the transformation curve – depicting all combinations of tradables (E+M) on the vertical axis and for non-tradables S on the horizonal – shifts upward. The additional output of the economy in E is either directly consumed in the economy, or exported against an equivalent number of imports of M. It is assumed that ΔE is completely exported against ΔM. A part of ΔM is then exchanged against S, thus S rises by ΔS – the spending effect – which requires more labour in S, attracted from M with a second increase of wages. Hence wages rise twice and labour moves to this extent from M to E and S. In other words, the resource boom mutates into a consumption boom at the expense of M – the direct resource movement from M to E and the indirect movement via the spending effect to S, with direct as well as indirect deindustrialisation. The production of M drops due to shortage of labour, which came about by rising real wages in E and S, and then also in M in a competitive labour market. There is no price increase or inflation in S or M since there are no money prices. Yet, the relative price of S compared to M rises. Since ΔE is matched by ΔM which equals ΔIM (imports), the trade balance remains unchanged at zero.

In the model economy there is no saving, thus all output is consumed, hence no investment and no investment goods. Since general equilibrium with full employment is assumed, all markets are cleared, hence no “saving” in the form of inventories. Therefore, the trade balance must always be balanced. A trade surplus would mean that – by national accounting rules – assets and liabilities against foreign countries differ so that net capital flows emerge aka net foreign investment or net debt in the deficit countries. This assumption requires that a big leap in ΔE must lead to a huge leap of imports, that is in ΔIM. No surprise that domestic production of M is crowded out by ΔE and mainly by ΔS – the spending effect for non-tradables. So far, the model seems at the first glance consistent and plausible, given the set of assumptions. If one assumption were changed – e.g. no investment goods – so that tradable goods embrace now two types of M, consumer and investment goods, ΔE can be exchanged partly for modern investment goods usable in the M sector, alleviating thereby the demand pressure for S. This allows a productivity increase in M which may dampen the appreciation and the deindustrialisation. Similar advantages arise if a government and taxes were introduced: more tax revenues due to ΔE could be used for improving human capital or infrastructure with positive externalities.

However, the main assumption has not yet been mentioned: the real economy (the no-money-no-saving economy with balanced trade) is considered the blueprint of a monetary economy. We will see what this means.

At a second glance, first doubts pop up. The model is not completely a “real” model like in a complete barter economy, since two prices are introduced via the world markets for M and E. These prices are fixed and not influenceable by the boom country. Furthermore, the model represents an incomplete market economy since there is no foreign exchange market. Furthermore, saving the boom revenues abroad in other currencies is methodologically impossible. Yet, money is involved, foreign money as the ultimate unit of account. However, CN use instead the price of M as the numeraire, this is the commodity money, say M$. It is the precondition that all three goods in the economy, E, M and S, can be aggregated; also, real wages are defined implicitly by a basket of these goods counted in M$. The value of the M$ is set by the world market, like E, so that the ratio of the E and M price is constant and the shadow unit of account is the $, standing for global money.

The model rests on the purchasing power parity (PPP) theory of exchange rates. Under the law of one price for the same product in a competitive market economy, exchange rates adjust the local price of a basket of goods to the foreign country’s basket price. The basket includes tradables and non-tradables. That tradables should have the same price, with the exception of transportation (or transaction) costs, is plausible under perfect competition, while for non-tradables the Balassa-Samuelson effect is needed which holds that prices of non-tradables tend to adjust to those of tradables. However, in reality most nominal exchange rates deviate markedly from PPP, especially when comparing developed and developing countries. This means that the real appreciation of the currency of the boom country is much less. Then the ratio of S-units to M-units may not be the appropriate measure of the real exchange rate.

Furthermore, if not all revenues of ΔE are used for ΔIM (=ΔM), a positive trade balance with net capital exports aka saving abroad would occur, so that the spending effect is smaller than assumed previously. If some surplus labour force exists, as un- or underemployed persons, the stress to reallocate labour from M to S would be alleviated. Yet, these caveats do not deny currency appreciation but mitigate it. The issue, whether this appreciation is a disease or a blessing, is still open. At this stage of the analysis, it is only structural change from M to E and S, i.e. to a new and positive comparative advantage.

Let us now look at the dynamics of the boom. Since we are in the initial boom period in a macroeconomic equilibrium, nothing will change afterwards. If it was a one-off change, maintained in the next period at the elevated level of E, employment and technology remain as it was in the boom period. If ΔE vanishes in the next period and returns to the lower initial level, everything would reverse, including the exchange rate appreciation. The boom was only a temporary blip. However, even then it is likely that some hysteresis effects do not allow a smooth reversal, especially not in the M sector. Labour has moved away, knowledge was lost. Short-term effects can have long-term effects – in the extreme: killing someone is done quickly, death is eternal.

Many authors claimed that the boom is the starting point for the disease, and that the disease turns out to become a “resource curse”, which could be even worse than DD. CN refrain from this debate. They stop at the end of period 1 confirming that the resource boom is by definition welfare enhancing: the economy owns more goods and services than before. CN discuss some modifications of the model, look at the functional income distribution and capital mobility among the three sectors, but the essence remains unchanged until the end of the boom. So, a comparative static or a dynamic version – including at least period 2 after the boom – does not exist. The model does neither refute the proposition of a disease nor purport that it is a disease.

NEARY’S MONETARIST VERSION OF THE CORDEN & NEARY MODEL

Neary (1982) in his essay “Real and Monetary Aspects of Dutch Disease” had attempted to present a monetary model of the CN (1982) real model including some dynamics. Again, it is general without a focus on special countries. It remained much less prominent than the original CN model which is often interpreted – by followers and critics – as the general model of a resource boom disease coined DD. Apparently, Neary saw the limitations of the CN model, the lack of money and the lack of dynamics, not even in the form of comparative statics, and the exclusion of the possibility of trade imbalances, in particular a trade surplus in the course of a resource boom.

Therefore, Neary added a liquidity effect to the resource moving effect and the spending effect. A trade surplus may emerge if the absorption capacity for imports is limited or delayed, if inflation is looming or for other reasons. In general, a trade surplus is an increase of foreign money or other assets and of liabilities of wealth owners in the deficit country. The trade surplus provides more savings than investment; in the case of the no-investment-assumption in the model, the trade surplus (in terms of E and M) is a surplus of saving, meaning – in the tradition of monetarism – inflation, unless money is willingly hoarded with a change of the velocity of money. This would likely be only temporary, so that sooner or later the central bank must neutralise money or outright curtail the quantity of money with restrictive effects. If the authorities are inclined to protect manufacturing by protecting the nominal exchange rate, Neary argues, the spending effect would be dampened and thereby the old structure of the economy preserved. Such an undervaluation of the currency would tend to be inflationary, or leading to piling up of foreign exchange reserves which would strangle domestic demand, i.e. consumption, and could even be deflationary. Eventually, real appreciation of the country’s exchange rate cannot (and should not) be prevented against the market forces. It is remarkable that Neary considers any trade surplus as contractionary and deflationary. Any intertemporal reallocation is thereby excluded, hence using present saving gradually for future consumption (or investment), thus smoothing the explosive effect of the resource boom. This is not in line with the claim of looking at monetary aspects of the resource boom. It is the opposite of a monetary theory of resource booms if the benefits of intertemporal allocation are negated.

Moreover, if all additional revenues from the resource boom are used completely for imported M thus achieving balanced trade, the question pops up, who wants to buy so many M if ΔM exceeds domestic M-production, which would be completely crowded out. The preferences of households for either M or S are – realistically – supposed to be constant in the model. Especially in countries with a small industrial sector, full crowding-out is not unrealistic under a flood of M-imports. The same argument must be applied to the original CN-model.

Neary’s semi-dynamic version of the theory of DD argues that appreciation is the best of all worlds available. ‘Dutch disease’ is neither Dutch nor a disease. One should regard it as a new comparative advantage, eventually as a blessing. Possible problems of adjustment could be alleviated with budgetary support. “Hence, de-industrialization following a resource boom is a ‘disease’ requiring treatment only if a large manufacturing sector is desired for the sake of some non-economic objective, or if distortions (such as wage stickiness) impede the smooth reallocation of resources” (Neary, 1982, p.26). The Achilles heel of this narrative is the disregard of a causal link among industrialisation, technical improvements and the balance of payments. Economic history offers plenty evidence. A similar case would occur with non-industrial tradables, be it from agriculture or the service sector were included in the model. A benign interpretation of Neary would be like this: “If there were an economic theory that can prove that industrialisation, hence growth of manufacturing, is in general a necessary precondition for developing countries, so-called DD would apply to this country group.” Maybe Neary would rightly deny this for small economies since CN (1982) theorised only for this country group which can live well with little or no manufacturing.

So, neither have CN (1982) presented a theory of “Dutch disease” which explains a disease due to a resource boom which is more than a short episode with open end, nor have they claimed to do so. Neary (1982) concludes that a resource boom is per se welfare-increasing structural change.

CORDEN’S EXTENDED MODEL

After intensive discussions of CN 1982 in the literature, Corden (1984) responded. The basic model was repeated but then many assumptions were changed in order to reduce the distance to reality. In principle, the deindustrialisation hypothesis is reiterated and corroborated, in most cases considerably mitigated or almost avoided. He seems to attempt to defuse the gravity of the problem and to oust the “disease”. Corden rushes through eleven modifications and includes also dynamic versions, all incomplete, with other assumptions and in great brevity. Yet it opens the door to much more complexity and impact. His terminology has changed somewhat. The manufacturing sector is now called “lagging sector,” which could mean that it catches up with a delay. We concentrate here only on a few of the eleven points which deem most important.

Immigration: The resource boom with higher wages and growth of the non-tradable sector could attract immigrants who increase the labour force and impede real wage increases. This would reduce the price increase in the non-tradable sector and dampen appreciation. Corden adds that this effect is reduced if the additional demand for non-tradables by immigrants is taken into account so that some degree of appreciation remains.

Saving abroad: Corden allows for saving additional incomes in the booming sector to some extent abroad, thereby using monetary categories, with a trade surplus due to less imports during or after the boom. This would reduce the spending effect, the real appreciation and the deindustrialisation. Still, the resource movement and the spending effects would remain, but with a reduced dose. Is the increase in the output of the booming sector anticipated as permanent (e.g. due to technology change), it would not be sensible not to use the revenue now, he argues. However, if export prices for the booming sector rise, in a small economy, the level of domestic absorption (A) of ΔE (A=C+I+IM) might drop in face of uncertainty about future prices.

International capital mobility: Resource booms might attract foreign firms to invest in the country, in the booming sector or in non-tradables, expecting higher profit rates and demand on the domestic market. Prices of non-tradables might rise less or remain fixed due to higher productivity, thus avoiding or mitigating appreciation of the currency.

Decomposition of the lagging sector: Instead of assuming only one tradable sector, besides the booming sector, several sectors might exist with different productivity. Some sectors could withstand appreciation while others falter.

Dynamics: Corden models dynamics by allocating the spending, the output change and the resource movement effect to three separate periods, instead of simultaneous changes in one period as in the core model. The periods are connected by expectations which are set in period 1 and which induce spending of additional E. This occurs in period 2. In period 3 output falls back on the pre-boom level, apparently a correctly expected temporary oil boom (representative for any other boom). It is the same as the static model, arbitrarily distributed on three time periods – one could assume the same model in 60 minutes, 20 minutes for each phase, and call it dynamic. After the boom with appreciation comes the depreciation so that apparently the deindustrialization is reversed, like building blocks in a model kit for children. In period 1 there is a trade deficit, in period 2 the surplus, and in 3 again a deficit – combined over three periods this leads to a deficit of zero. In the following period, one must assume, it starts at point zero. In this model, Corden suddenly introduces monetary variables – like a world interest rate, financial assets, thereby mixing it with the categories of the non-monetary “real world” from the basic model. Also, other goods, like investment goods come to the fore, and many ad hoc assumptions are made. This part makes clear, the dynamics is fictitious, like a fairy tale. The true CN-model is static and therefore not usable to detect and explain the medium and long run features of resource booms which can lead, under specific circumstances, to deep and persistent disease.

Corden does not see a special reason to protect or promote the lagging sector, i.e. manufacturing, like Neary (1982). There would have to be special unforeseen positive externalities of industrialization. If policy makers want to support manufacturing exports for whatever reasons it should be done by temporary subsidies, at best financed by taxing the boom sector. Protectionist policies, including infant industry arguments, are rejected, as well as protection of the exchange rate.

It is the merit of Corden and Neary to have brought the issue of resource booms to the academic fore which has provoked debates for more than four decades. That welfare enhancing resource booms can emerge with deep and potentially growth-limiting structural change is an intriguing proposition in the framework of neoclassical and Ricardian theorizing.

Our fundamental critique of the CN-model, including the extensions of both authors, rests on five objections.

1. Since CN’s focus on the boom period, they cannot assess the medium- and long-run effects. They do not diagnose a “disease” in the sense of a long-standing growth-constraining consequence, especially, but not only, compelling deindustrialization and a strong link of real exchange rates and deindustrialization. The role of industrialization for development is not only under-estimated; it is not even analysed.

2. Their analysis is not in line with the stylized facts of resource booms. Most booms, especially in energy and metal resources, are price-based with an extreme magnitude which run over a longer period and end in crashes. Resource booms of crops are different. So, the type of natural resources matters, also whether they are price or output booms. CN are blind regarding resource downturns and crashes.

3. The type of countries experiencing resource booms does make a difference (large, small, advanced, developing, price-taking or -making), in contrast to CN.

4. CN’s methodology is based on “real” variables and barter trade, except Neary (1982) which is monetarist. This prevents an analysis of the monetary exchange rates, balance of payment effects, inflation and speculation on financial markets.

5. Overall, the instability of the world economy resulting from commodity markets, especially for developing countries, is overlooked. In other words, DD can trigger mega-macro effects, hence global effects under very realistic conditions.

We elaborate on these points one by one. We begin our own analysis with a brief narrative in three stages which incorporate the “disease”: the boom, the continuation and the crash.

A NEW NARRATIVE

From boom to bust – the “disease”

Our narrative differs somewhat from CN’s analysis of the boom phase. We distinguish the boom sector E, manufacturing M, agriculture A_G and services S. Assume a positive exogenous demand or supply shock which increases real output of E by ΔE in quantity terms while the world market price p_m is given. Price elasticity of demand is low, as we know from energy. Trade of E, M and A_G is in foreign currency, say dollar ($). The boom leads to more exports, more $-inflows which are used in part for more imports of M and A_G, in part according to consumer preferences to more S which requires more labour. Additional labour is to some extent available from unemployed persons, from underemployment especially in developing countries or via immigration. So far, the boom goes smoothly without price hikes and inflation, GDP rises by ΔY = ΔE + ΔS – ΔM – ΔA_G > 0. ΔM and ΔA_G are imported, but local production might fall too. In the case of balanced trade (with X for exports and IM for imports) which is in the focus of CN: ΔY = ΔE = ΔS + ΔX – ΔIM; X-IM is the trade balance. GDP would rise due to ΔE which is in part exchanged in ΔM and ΔA_G. In the case of a trade surplus in the boom, ΔX > ΔIM, the surplus denominated in $-currency, is saved abroad, either by private exporting firms or by the Central Bank (CB). A part of the boom revenues is spent for S, according to consumers’ preferences. ΔS requires more local currency (LC), provided by the CB which receives the payment in $.

Another type of initial exogenous shock could be a pure price shock. It can come with monopolistic action of domestic or foreign resource owners, by mere announcement, by the menace of war or national uprisings or international conflicts which signal future price hikes. Forward prices often translate immediately into spot prices. With low price elasticity of demand, price hikes trigger higher E-revenue. Price booms are much more hazardous than technology shocks since there are no ceilings for prices of E and they tend to ignite global inflation in the case of imperfect competition on the world market. Often price booms, technology shocks and discoveries of new resource reserves occur in combination. Higher E-prices make new resource-suppliers with higher extraction costs competitive, vice versa in the case of falling prices in the bust.

Assume the boom is initiated by a supply shock in a single country while the E-price is given, i.e. the Corden-Neary case. If the boom reaches a certain degree of strength, employment and production capacities become scarce, local prices for S (p_S) tend to rise, also wages, and also the E sector needs more labour. The CB will raise interest rates, which makes the sale of LC against $ more costly. Capital inflows rise, attracted by the higher interest rate and higher GDP growth. Real appreciation of the LC is set in motion which reduces exports of M and A_G with less domestic competitiveness and by more competitiveness of foreign competitors which might affect the world market price for exportables M and E. More LC enables more IM of M and A_G, which dampens the trade surplus to some extent. Unemployment could rise if more foodstuff is imported and less produced domestically. If the rise of E continues, due to price expectations of the type “the hausse feeds the hausse” (a path-dependency), p_E might become the driver of the boom instead of the output of E. Especially if the global market leaders, such as OPEC in the case of oil, push with their oligopoly or even monopoly power for higher p_E , they will likely materialise. Metal and crop prices might follow on the global market. One has to look carefully at the price formation mode; more important than the spot prices are forward prices, which also incorporate expectations, i.e. bets on the future.

Booms can have different forms and different drivers, they could also be demand-led for quite some time, especially in agriculture. They drive p_s and p_AG, also wages and interest rates, but the real exchange rate, e_r , appreciates. e_r is by definition e(p_f / p _h), the nominal exchange rate e = LC per $ (appreciation is falling e) and the ratio of the foreign inflation rate p_f to the home inflation rate p_h. Note, that appreciation can come about either by falling e on the forex market or by a falling fraction of p_f / p _h or by both falling. It remains constant if the difference in inflation rates is exactly compensated by the change of the nominal exchange rate. This would be the case if e_r is always in line with the purchasing power parity (PPP) which CN had in mind. In CN, there is no forex market and in the base version no trade surplus, as saving in money is not possible in a barter economy. Resource booms do not always appear as shock. The cause may be on the demand or the supply side. The increase can also come gradually. Of course, resource owners normally have a strong interest in such booms and in their continuation once they have emerged.

Commodity booms in prices could be so strong that balanced trade, as in CN’s base model, would lead to extreme hikes in prices of non-tradables, triggering strong inflation, strong appreciation – with a time lag probably a turn to devaluation – and strong deindustrialisation. The normal of the booms is the emergence of high trade surpluses and recycling of export revenues in energy importing countries. CN cannot see inflation in their static analysis without money, a key downside of the boom (inflation coming with the E-boom for both exporting and importing countries) and with booming demand for S in the booming country. They also ignore that E in the case of fossil energy is a key input for any kind of production.

The crashes come as – seemingly – exogenous shocks, but normally they come with economic or political crises with global impact. At a certain stage everybody knows that the boom cannot go on forever – “the party ends when the music stops”, as the phrase goes. The cause for the crash is endogenous, but the trigger and the timing are exogenous.

It goes without saying that such instability is detrimental for E consuming countries, also for the booming countries and the world economy at large. It is also a strong impediment for developing countries when agricultural and metal commodities follow more or less in the same pattern. Besides the high level of commodity prices, it is the extreme cyclicality, the uncertainty and the impact of commodity prices for inflation and interest rates that hinders growth and development, including industrialisation (Harding et al., 2020; Ismail, 2010; Kilian, 2008). Energy booms and booms of other commodities resemble stock market bonanzas and real estate markets, partly also foreign exchange markets, and cannot be understood without understanding asset inflation and speculation. This is far beyond CN’s seminal model. So, it is an understatement to conclude that CN had an incomplete understanding of commodity booms and therefore not an understanding of the medium and long term which leads to crashes and crises which impinge on industrialisation of commodity-prone countries. They did not fathom the core of the problem, the disease. This was already seen clearly by Sachs and Warner (2001) and others.

The risk of appreciation and deindustrialisation could be alleviated in several ways:

• Saving abroad by less additional imports of M and A_G, hence allowing for a trade surplus. This would require taxes or tariffs on imports, perhaps selectively for consumer goods, exempting investment goods.

• A trade surplus raises GDP and concomitant tax revenues which could be used to modernise the export industry M and improve human capital or infrastructure.

• In case of appreciation of the domestic currency, rising unemployment in the M and A_G sectors could dampen labour scarcity, dampen wage-price increases and interest rate hikes. CN assumed unemployment away.

The “disease” of resource booms can be summarised as follows:

• Deindustrialisation occurs due to currency appreciation in the boom phase, which cannot simply be reverted via the crash. There is a ratchet effect, i.e. irreversibility. Considerable parts of manufacturing shrink and die, with no life after death. This can also happen to parts of agriculture.

• Manufacturing, hence industrialisation, had historically been the carrier of technical progress in most advanced and also developing countries, incorporated in the capital stock and in human capital of employees. It is the potential for GDP growth and also precondition for earning foreign currency for imports without foreign debt. These effects can be understood as future positive externalities. In mature economies, the need for further industrialisation lessens and the heart of technological innovation can move to other sectors. This could be called “mature deindustrialisation”.

• Resource booms are associated with inflation in the boom country and rising real interest rates, thus impeding growth of the non-booming parts of the economy. However, more supply of E on the world market likely leads sooner or later to falling E-prices of competing countries, i.e. resource price deflation, which infects other E-producing countries and benefits E-consuming countries. This would kill the domestic boom and reduce the E-price below the initial level.

• If the initial trigger is a price boom which infects the world market price for E, resource inflation will infect other resource exporting and also resource importing countries. This can ignite general inflation in the world economy and will eventually lead to a halt or reversal of E-inflation.

• Resource booms in both variants prepare crashes and boomerang on the prior booming economies. In the case of E-inflation they damage the world economy, in the case of E-deflation tentatively all E-producing countries. Countries with above average extraction costs might be thrown out of the market. The “disease” comes in three steps: real exchange appreciation and deindustrialisation, downsides of the boom, especially inflation or deflation and rising uncertainty, and the final bust. Of course, the case for resource deflation and the case for inflation have to be distinguished. Both were not foreseen by CN who were blinded by their assumptions.

The stylized facts of resource booms

As mentioned before, the CN-model is not in line with the stylized facts of resource booms. Most importantly, shocks due to resource discovery, technology change or price hikes have to be seen in international context. Figure 1 shows the world commodity prices for the main three classes of commodities, energy, metals and crops/food for the period 1992-2025. It seems that the oil price is most important for energy prices, and metal prices correlate with energy prices, while food prices are much more stable and only remotely connected to energy and metals via fertilisers. Explanations for oil and energy cycles can be found in Kilian (2008), Baumeister and Kilian (2016) and World Bank Group (2018) or Ross (2012). In this period, the average global GDP growth rate was 2.9% (with a range from -2.8 to 6.4% p.a.), the average inflation rate 4.5% with a range from 1.9 to almost 10% (GDP deflator). Inflation hikes seem to have co-moved with energy and metals prices except in the early 1990s.

Figure 1
Energy, metals and food price indices 1992-2025 and World GDP index in constant US 2015 US$

Resource booms can last long. The longest boom in oil prices, similar in metals and food, although with much less amplitude, occurred from 1999 (US$ 12 per barrel oil Brent) until 2008 (US$ 133 at the peak, 11-fold rise), with some interruptions. The peak periods are very short. CN themselves experienced the oil boom from US$ 3.5 per barrel in 1973 until US$ 32 in 1980, a 9-fold hike in many steps, two years before their essay was written (see https://www.macrotrends.net/datasets/1369/crude-oil-price-history-chart). The global quantity of crude oil performed steadily without any sign of cyclicality (Figure 2), copper performs similarly. Of course, single countries may deviate. Yet, booms in energy and metals are mainly price booms, strictly excluded by CN who saw resource countries as price takers – price booms would not differ from technology booms under their set of assumptions. Output grows smoothly over very long periods, on the global scale. Food differs, see below.

Figure 2
World oil production and oil prices (Brent) 1992-2024

Regarding energy price crashes, the three biggest came with high inflation and a strong inflation in 1980, later with the global financial crisis 2008, and then with the discovery of huge amounts of shale gas and oil in the US, especially after 2008. The crash in 2014 came at the height of the shale boom when the oil price was above US$ 100, triggered by Saudi Arabia’s decision to maintain her present output level. In the first Corona year the oil price stood at US$ 16, far below the level of extraction costs in the US (World Bank Group, 2018).

The longest oil slump followed after the peak in 1980 with many short ups until 1999. The downward phases had been much longer than the upward ones in the period analysed. It is clear that such price volatility has no anchor, no fundamentals with balanced and stable demand and supply which deserve the label equilibrium. There is no global governance tasked for resource-price stability, a policy failure in a global economy.

Regarding prices for agriculture and food, Figure 3 shows the development for the same period as in Figure 1, for 18 commodities and also the food price index already displayed in the previous Figure. The average annual price increase is only around 2%, less than inflation rates in most developing countries. However, there are ups and downs with higher positive and negative annual changes. While in the case of energy booms and similarly in metals, price booms dominate, but agricultural commodity markets have strong output fluctuations, as shown for the world soybeans market in Figure 4. It displays a strong medium-term cyclicality. They are stronger linked to global business cycles, but have their own cycles, sometimes similar to hog- or cobweb-cycles as observed already by Kaldor (1934) and discussed by Harlow (1960) and Rosen et al. (1994), among many others.

Figure 3
Agricultural commodity price indices for 18 commodities and for food 1992-2025, 1992 = 100

Figure 4
Soybeans: World production and world price index 1990-2025

The agro cycles in output are not boom-bust cycles with extreme amplitudes (see Figure 4 for soybeans as a representative commodity). Yet, with the higher frequency of downturns and booms they are – in commodity-prone economies specialised on one or a few commodities – similar to business cycles. They destabilise the economies and can hardly be smoothed by countercyclical monetary or fiscal policies.

The type of country matters

CN’s model is a very general one (apart from the strict assumptions), made not only for all types of commodities but also for all types of countries. Small and large, advanced and developing countries are seen through the same lens. In our view, small economies in terms of population, possessing large reserves of fossil commodities, are likely blessed with wealth for a long period. They can generate a high standard of living for the entire population without industrialisation until a remote future. If they invest their resource rents abroad, it might suffice for long. For Kuwait and Norway and similar countries, industrialisation is unnecessary luxury. In this way Neary is right that there is no general rule that industrialisation is a must-have for all countries alike. Amazingly, the main price-setting countries regarding oil- and gas prices include small countries. As mentioned, the core group of commodity-rich countries are excluded by assumption. The resource boom comes simply by exogenous shocks in CN’s model. This prevents understanding the genesis of resource booms and the full boom-bust-cycle.

The same applies for advanced populous countries that grew up with industrialisation, but reached at a mature stage a point when further industrialisation or maintaining the level achieved is no longer necessary. This is the case for mature deindustrialisation by which the service sector – or parts of it – take over the lead, often at a certain GDP per capita. Yet, this old theory developed by Clark (1940), also by Fourastié (1949) and – regarding developing countries – picked up by Rostow’s theory of stages of development (Rostow, 1959) is too simple to be valid. The authors argue that a change in the income elasticity for manufactured goods due to some kind of satiation, leading to stronger demand for services. Both advanced and developing countries differ within their country group. Even the US has still nowadays a large primary sector and a considerable industrial sector, especially as a share of GDP, which is strongly interwoven with some tertiary sectors which are part of global value chains that includes manufacturing. The latter may be outsourced to some degree.

The main country group that seems to need industrialisation in order to move upward from low-income to upper-middle income and eventually high-income country status require a certain degree of industrialisation. The East Asian “tigers” and particularly China are the showcases. The much-discussed middle income trap, reflecting the lack of competitive manufacturing, may be infected by some forms of DD and/or by other reasons for “premature de-industrialisation”: “Taken together, these features make manufacturing the quintessential escalator for developing economies” (Rodrik, 2016, p.3). Too early deindustrialisation in developing countries can have many causes, but DD has probably considerable weight (Palma, 2005, 2014).

Many developing countries are mainly commodity exporting. They differ from CN’s model in the following aspects: hidden un(der)employment is to some extent normal; the share of agriculture in employment is much larger than in most advanced countries, the share of manufacturing in GDP often lower although increasing; foreign trade is typically facilitated with foreign currency; public goods are scarcer than in advanced countries, especially with regard to education and professional training; commodity markets play a greater role than in most advanced countries, often with a mono-structure so that the degree of dependence on a few commodities and the respective world market is higher compared to diversified countries. All this makes developing countries more susceptible to DD than advanced countries (Collier and Goderis, 2012). Hence, it is likely that the boom- and bust impact on GDP, on the price level of the non-tradable sector and on the real appreciation is stronger.

A well-sized manufacturing sector fulfils for developing countries several functions: it earns foreign currency via exports that allow imports without foreign debt, hence a barrier against overloading debt in foreign currency; manufacturing facilities (capital stock, human capital, forward and backward linkages) enable embodied technology and technical progress with investment, and indirectly promote availability of modern technology by imports. The sectorial structure of an economy is not irrelevant for growth, as neoclassical endogenous growth theories as well as CN hold, neither a specific type of activity like research, training, infrastructure, as some theories believe (see Palma, 2005, p.103). Similar applies to advanced countries where the cooperation of research, engineering, soft- and hardware producers is key for marketable innovations. Other factors add to this: economies of scale, rising returns to capital, the size of research and development and the intensity of cooperation with scientific institutions. While manufactured products are tradable, most services are not. Tradability is key for extending the market share.

DD is not only abetting deindustrialisation; it can also impede industrialisation of latecomer developing countries which start from a low level. It can also baffle specific service sectors which offer tradables like tourism or financial services. Also, parts of agriculture can be crowded out by currency appreciation.

Methodology without money

Leaving money aside and concentrating on the quantities of three goods (E, M and S) and one factor of production is extremely reductionist and can only work if money is either misleading or unnecessary for the analysis. But the opposite is true. If prices of predominant commodities are more important than output quantities, the amplitude of booms and busts is much higher, sometimes more than tenfold price increases. Technology changes and price shocks have quite different, less extreme impact on the full boom-bust cycle. Long waves of E-price increases lengthen the boom phases and the process of appreciation. They are a specific type of inflation, often with worldwide outreach, undermine general price stability. Especially energy has a considerable share in the cost structure of manufactured goods, both investment and consumer goods. For all central banks, even the leading ones, managing commodity inflation is difficult and limited. The traditional instrument of central banks is adjusting short-term interest rates which translates sooner or later in global tightening of monetary policy due to the globally integrated financial markets. This has contractionary effects on growth, with the widespread global hierarchy of interest rates. The latter could trigger unwelcomed high real interest rates in commodity-heavy developing countries which could pull their currency into further appreciation. Speculation on expectations for further currency appreciation adds to second-round effects of DD. High real interest rates to inflation are an additional trigger for deindustrialization: manufacturing is more capital intensive and hence interest-rate-sensitive than other sectors.

In developing countries with a consumption basket for measuring inflation, food has a higher share than in advanced countries. Food inflation in developing countries is more common than in high-income countries. This adds to second round effects mentioned which are invisible in “real” models of DD. This applies also to the easiest and probably most efficient method to cope with DD: CB can purchase foreign currency in commodity booms at a targeted exchange rate and accumulate and invest them as special currency reserves in advanced countries. These reserves can be used counter-cyclically or selectively for priority programmes. Revenues from the reserves may be delivered to the state budget (Humphreys et al., 2007). Concerns could be raised if firms which have earned the revenues bypass the CB by investing the reserves in foreign money in the booming economy or investing them on their own directly abroad.

In Russia the Ruble crisis erupted in 1997, since foreign debt in hard currency could not be served, after oil revenues and oil prices fell in the course of the Asian financial crisis 1997. In Nigeria, political conflicts in the Niger delta led in 1998 to military and ethnic conflicts, also with foreign oil companies. Before both crises, real exchange rates rose by more than 700% within a few years. Beginning in 1999, a long recovery started, much stronger in Russia than in Nigeria. While in Russia old industries could be partly restructured, financing with oil revenues in a semi-planned economy took place, while in Nigeria industrialisation and diversification of the economy made only little progress.

The focus on DD is biased on natural resources. Similar phenomena can be found also in other sectors. A look at some non-commodity countries regarding the real effective exchange rates (REER) is telling (Figure 5). On the one hand, there are a number of economies with long episodes of real currency appreciation and high growth, most notably China (2005-2015) and India (2004-2022), Switzerland since 2007 or the United States since 2010 until 2022; on the other, countries like France, representing important parts of the European Union, or Japan devalued over longer spells in real term with a trend to deindustrialisation and subdued growth of GDP. China experienced many years of real undervaluation with high and rising trade surplus and turned then to appreciation with a small surplus. However, economic growth slowed somewhat, mainly due to the unresolved house price bubbles. India appreciates its currency continuously though cautiously, with a look at the trade and current account balance. A small deficit is considered sustainable. Switzerland has constantly an external surplus of around 10%, and is appreciating but considered as one of the most undervalued countries. Ireland has some similarities. Contrariwise, Japan has a trend toward real devaluation, with cyclical swings, but the trade balance has become – after long standing surpluses – slightly negative and growth remained weak.

Figure 5
Index of REER for 6 major non-commodity exporting countries 1992-2023

Obviously, there is not a straight simple link from the exchange rate to the trade balance and to GDP growth. The US, Switzerland, Ireland and also Netherlands represent financial centres that attract massive capital inflows, irrespective of the trade flows. If the inflows are in local currency, they do not touch the forex market. If foreign currency, say US$, is exchanged for Swiss Francs, the latter will appreciate. We can observe, that nowadays a special kind of DD exists which comes via financial markets to the foreign exchange market where they appreciate the local currency. The US is a case in point for financial market-led currency appreciation and ensuing deindustrialisation. The increased value of local currency raises local incomes and taxes, usable either for consumption or directly or indirectly for productivity gains and investment. The type of their usage is key for development.

From national to global instability

The national boom-bust-cycles create by definition macroeconomic instability, first and foremost for GDP growth. The cyclicality interacts with traditional business cycles and reinforces them, but they can also be overarching cycles like long financial cycles. They trigger inflation and inflation cycles, especially outside the booming countries or the world economy at large. The drivers are on the demand and supply side, and central banks can only indirectly cope with resource inflation with their normal tools. So, they are compelled to curb inflation, and thus to curb growth in all sectors, hence GDP. Of course, resource prices are not the only cause of inflation, but an additional and hard-to-battle type of inflation for central banks. Since central banks are in a hierarchical world interconnected, the lead is located in Washington D.C. which normally triggers global interest rate hikes.

Resource booms have also repercussions on trade balances (Harding and Venables, 2016). Surpluses in booming economies are paired with trade deficits in resources importing countries, and vice versa in times of backsliding commodity prices. High deficits imply increasing foreign debt, normally in hard currency.

In many resource-rich countries, the income distribution changes and often also the institutional structure. In boom times the rentier class, i.e. the owners of the land and the resource reserves benefit more than capitalists and workers from other sectors. Also, the stock of the reserves gains in worth, and lose in slumps but the trend goes upwards when speculators expect a long-term rising trend. Social conflicts will rise the more income and wealth distribution change. If resource mines are owned by foreign companies, it is likely that boom profits are siphoned off and repatriated. In many countries, boom profits flow into bribes and corruption.

CONCLUSIONS

In the short run, resource booms under constant prices due to technology change, rising demand or discovery of new reserves tend to push real currency appreciation, as shown by CN. Higher supply of resources can also trigger resource price deflation. Rising resource prices leading to price booms and resource inflation, no matter what the initial reasons are, have a quite different impact. A closer look at CN with more variables and sectors and some changed assumptions, among them elastic labour supply and mitigated real appreciation using imports for modernisation, shows that there is a connection from commodity booms to real currency appreciation, but not as tight as CN thought and much lesser if a considerable share of commodity export revenues is invested and accumulated abroad instead of being used fully for imports. Commodity-output booms differ from price booms which are predominant and connected to inflation. In CN’s model is no place for inflation or deflation. Furthermore, the boom is different for developing and developed countries, the former with little diversification, the latter with much more, and also different for small and large economies. This means that the notion of a balanced current account would be given up for this type of countries, although it forces other countries in deficits – one could call this “commodity mercantilism” (nowadays for heavy fossil energy exporters well accepted with the hint to the need for swift recycling of “oil dollars”).

In brief, DD is a true disease in the sense of deindustrialisation blocking further industrialisation for larger developing countries with huge resources, including arable land (Venables, 2016). Strong endowments with agricultural crops are a special kind of DD, with severe and long-standing problems. Even large and diversified advanced countries like the US can suffer from DD in various forms. Huge fossil energy resources since the shale boom on the one hand, strong dependence on traditional agriculture on the other, plus a super-hub of financial services lead to a problematic sectorial structure for employment, income and wealth distribution. This goes far beyond mature deindustrialisation. Apparently, DD in a wider understanding – call it “DD 2.0” – has many faces.

Most commodity booms are continued for many years, and then as price booms. There are no floors and no ceilings for prices. This increases the scope for currency appreciation, the deindustrialisation and the rents earned by the rentiers of the booming economies. Speculation on commodity prices related financial instruments complement and reinforce the boom. Resource inflation emerges which feeds into general inflation. Booms are doomed to crash. The boom-bust cycles develop way beyond national dimensions, firing global inflation, especially for energy and metal commodities. Over the entire full cycle, GDP growth of the booming countries tends to be flat or at least lower than in most non-commodity economies. This is worse than only premature deindustrialisation. Furthermore, global commodity boom-bust-cycles spill over into global macroeconomic instability, in face of lack of global governance. Even the most hegemonial country has limited political outreach. For small commodity-heavy countries like Norway or Kuwait, there is no DD, in fact it is the pathway to immense potential welfare – wealth rather than disease.

This group of countries indeed realises its comparative advantage. They seemingly stood in the limelight of CN. The populous commodity producing countries like Nigeria, Angola or Venezuela get deeply stuck in DD, due to a very low degree of diversification. Countries with a moderate share of commodities, especially energy, are also on the winner side, Indonesia or Mexico or formerly the Netherlands. They can support industrialisation and diversification with resource rents and enjoy importing more modern goods with only a small dose of appreciation.

However, it should be kept in mind that (de)industrialisation depends on many variables, not only DD-induced appreciation, and the same is true for the growth trend of GDP. The capacity of an economy to overcome the constraints from natural endowments is key, in other words to overcome their inherited comparative advantages and shape new ones, based on human capital, far beyond DD.

Lastly, the worst kind of DD was neither addressed by CN nor in this paper: the huge size of natural resources, mainly fossil energy reserves, which has the capacity to destroy the planet’s atmosphere. This kind of disease is an engine for negative externalities, that can only be overcome be leaving it in the ground, hence by devaluing it down to zero. This can be christened “DD-3.0”. It should be seen as creative destruction. It is truly a resource curse.

Data Availability Statement:

All data used are publicly available and mentioned above in the text and the references.

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• Editor responsible for the evaluation process:
  Luiz Carlos Bresser-Pereira

Publication Dates

• Publication in this collection
  10 July 2026
• Date of issue
  2026

History

• Received
  01 Apr 2025
• Accepted
  26 June 2025