'Dutch Disease' in a 'small' open economy: The case of oil in Saudi Arabi

The effects of 'Dutch Disease' come through two channels: real wage rate and real exchange rate. A sector export boom induces both resource movement and spending effects which reinforce each other in raising higher real wage and real exchange rates. In the case of an oil boom, only the spending effect is in operation because the oil sector does not employ domestic mobile factors. After a great deal of theoretical surveying and consolidation of 'Dutch Disease', an empirical study was used to reflect the sectoral structural effects of 'Dutch Disease' on Saudi Arabian economy throughout the period of 1970s and 1980s. In other words, we are trying to see whether or not the oil boom was an obstacle to economic diversification. The empirical part of our study was estimated through both an econometric model and statistical descriptive analysis. The theoretical reason behind the oil-boom induced structural changes comes through spending effect that induced an appreciation in the real exchange rate following the acceleration of spending on goods and services. The excess demand for non-oil traded goods induced by the boom is satisfied by imports at constant world prices while the excess demand for the non-traded goods will be offset by both a rise in their relative prices and their production.;Our empirical finding support the theoretical prediction. The real exchange rate of Saudi Arabia has appreciated throughout the period of the oil-boom and in turn it induced an expansion in the non-traded sector and a contraction in the non-oil traded sector. The indirect effect of the oil boom came through the use of oil wealth to import technology. This effect induced further expansion in the non-traded goods at a faster rate than the non-oil traded goods. This implies that the imported technology not only has taken place in the non-traded sector as it was asserted for the OPEC countries, but also in the non-oil traded sector at slower rate.;There are some factors which mitigate the adverse effects of 'Dutch Disease' on the Saudi economy, among them the generous government loans and subsidies to the non-oil traded goods, the Saudi foreign investment and the huge inflow of foreign labor and capital to Saudi Arabia. The slump in the oil market in the 1980s has been stimulating the growth rate of the non-oil traded sector and discouraging the growth rate of the non-traded sector. This helps the government to diversify its resources away from the oil sector.