The 'Dutch disease': Theory and evidence from oil-exporting countries and its structural and fiscal implications

This dissertation studies the Dutch disease in oil-exporting countries, which may result in a decline of non-oil tradable production because of increased expenditure during oil booms. In Chapter 2, I derive structural implications of the Dutch disease in oil-exporting countries due to permanent oil price shocks from a two-sector model. I then test these implications in manufacturing sector data across a wide group of countries including oil- exporters covering 1977 to 2004. The results on oil-exporting countries are fourfold. First, I find that permanent increases in oil price negatively impact output in manufacturing as consistent with the Dutch disease. Second, evidence in the data shows that oil windfall shocks have a stronger impact on manufacturing sectors in countries with more open capital markets to foreign investment. Third, I find that the relative factor price of labor to capital, and capital intensity in manufacturing sectors appreciate as windfall increases. Fourth, I find that manufacturing sectors with higher capital intensity are less affected by windfall shocks than their peers, possibly due to a larger share of the effect being absorbed by more labor-intensive tradable sectors. An implication of the fourth result is that having more capital-intensive manufacturing sectors may help cushion the volatility in manufacturing due to oil shocks. However, labor-intensive sectors expand more during oil busts by absorbing the labor shed by declining non-tradables. Thus a manufacturing sector diverse in terms of factor intensity may balance the gains from the reduced exposure of capital-intensive sectors to the Dutch disease with the gains to the labor-intensive tradable sectors during oil busts that result in shrinking labor-intensive non-tradables.;In Chapter 3, I examine the behavior of expenditure policy during boom-bust in commodity price cycles, and its implication for real exchange rate movements. To do so, I introduce a Dutch disease model with downward rigidities in government spending to revenue shock. This model leads to a decoupling between real exchange rate and commodity price movement during busts. I test the model's theoretical predictions and underlying assumptions using panel data for 32 oil-producing countries over the period 1992 to 2009. Results are threefold. First, I find that change in current spending have a stronger impact on the change in real exchange rate compared to capital spending. Second, I find that current spending is downwardly sticky, but increases in boom tine, and conversely for capital spending. Third, I find limited evidence that fiscal rules have helped reduce the degree of responsiveness of current spending during booms. In contrast, I find evidence that fiscal rules are associated with a significant reduction in capital expenditure during busts while responsiveness to boosts is more muted. This raises concerns about potential adverse consequences of this asymmetry on economic performance in oil-producing countries.;In chapter 4, I consider whether capital costs of adjustment may be behind the slow response of manufacturing to oil shocks. Previous literature attempted to estimate these adjustment costs front within country data, but found the estimates of adjustment costs to be too high. This is partly because of the excessive adjustment that most investment models project in response to exogenous shocks such as tax announcements and factors prices. I first simulate a model of costs of adjustment to show the robustness of our empirical approximation of the capital adjustment costs parameter, then I estimate the parameters using the cross-country manufacturing sector data from chapter 2. I then compare these estimates with the size of overall output adjustment to determine the extent to which the slow response of these sectors to oil prices is due to capital costs of adjustment. I find that while there is evidence for quadratic costs of adjustments in the data, the size of these costs alone may be too low to explain the lag in the Dutch disease observed in Chapter 2. This result means that other factors such as the slow adjustment in fiscal policy to oil shocks may be a more relevant factor behind the slow impact of oil price shocks on manufacturing output.;Keywords: Dutch Disease, Exhaustible Resources, International Trade, Development, Fiscal Asymmetry, Capital Adjustment...