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In view of the alarm bells being sounded about the threat of Dutch Disease, what options are available to the country?
Since 2007, oil discoveries by Kosmos Energy and other partners in the western offshore region of Ghana have established Ghana’s emergence as an important oil province in the West African sub-region. Against a background of euphoric predictions of booming national wealth with commercial oil production starting in the last quarter of the year, there have been cautious remarks from some experts about some challenges that lie ahead for the country. The Centre for Policy Analysis (CPA) has warned against policymakers ignoring signs of Dutch Disease as Ghana comes to terms with its new identity as an oil economy.
In economics, Dutch Disease is a concept that describes the relationship between an increase in exploitation of natural resources of an economy and a decline in other productive sectors like manufacturing and agriculture. The decline in the non-oil sectors is brought about by the sustained rise of the nominal and real exchange rates of the domestic currency, which makes manufacturing and agricultural exports less competitive, and thereby chokes off the growth and employment potentials in those sectors.
Originally coined in 1977 by The Economist magazine to explain the observed decline of the manufacturing sector in the Netherlands after that country’s discovery of significant natural gas reserves in 1959, the term has gained currency wherever large natural resource reserves - typically oil and gas - have been found.
Is it a credible threat to Ghana?
The CPA has cautioned that the current appreciation of the Ghana cedi against major currencies (the US dollar, the euro and the pound sterling) indicates early signs of Dutch Disease. In the Bank of Ghana’s Monetary Policy Report of April 2010 for the period January to March 2010, the cedi appreciated by 0.7% against the United States dollar.
This compares with a depreciation of 11.9% over the same period in 2009. The domestic currency also stood strongly against the euro and pound sterling in the first quarter of the year.
Reliable indications are that interest and confidence in the economy by international investors is growing. Investors are upbeat about oil making Ghana a more attractive destination for investments. When oil production begins, significant amounts of foreign exchange income will start flowing into the coffers of the state - and this is what poses the risks associated with Dutch Disease.
As huge foreign exchange revenues come in, there will be a steady and creeping appreciation of the cedi against the major trading currencies, causing the exchange rate to become non-competitive. One consequence is that Ghana’s non-oil exports will lose price competitiveness on the international market, and this can reduce income from exports and have negative consequences for growth and job-creation in those sectors. Non-traditional exports could be particularly vulnerable to these effects as they remain at a nurturing stage before becoming strongly competitive and acquiring considerable market share.
Also, our imports will become cheaper; and that could shift resources from the production of import substitutes to direct importation for consumption locally. Local firms producing for the home market could also lose market share to imports. Another potential risk is that if abundant foreign exchange earnings make it easier to purchase imports, the country could lose focus on adding value to its raw materials and the economy could potentially be on the verge of de-industrialisation.
Two instructive examples will suffice. The structure of the Nigerian economy, before oil became a crucial part of it, was that of a strong agrarian economy. Before the oil era Nigeria was not only self-sufficient (up to 85%) in domestic food production, but also led the world in the export of palm-produce, was the second-largest exporter of cocoa, and ranked among the top-ten in the world in the production of timber, cotton, groundnut, tin and zinc. By the 1980s, Nigeria’s position had declined in all these areas, with the share of agricultural exports down to under 10% while oil had moved from below 5% share of exports to about 90%. The country lost its lead in palm oil and cocoa exports and had to rely on food importation for about 58% of its food and 72% of its industrial raw materials. Clearly, the economy had turned from agro-based to heavily oil-dependent - with depressing results for the welfare of its people.
The second example is anecdotal. The story is told of a foreign researcher by name of John Ghazvinian who entered a supermarket in oil-rich Gabon and asked for bananas. The store clerk replied that there were no bananas; not in the supermarket, nor in the local markets. For a week and a half, the man never found a bunch of bananas. And yet Gabon is largely rainforest, filled with banana trees. This narrative is telling both in its simplicity and extremity.
Economic development depends largely on a competitive exchange rate that stimulates exports and investments. A competitive exchange rate (other things being equal) makes for competitive exports, which are needed to generate income and create and sustain jobs. The empirical backing for this proposition is very clear: most of the countries that developed during the twentieth century, particularly the dynamic Asian countries, have done so under exchange rate regimes that enabled the development of their manufacturing industries.
China offers very useful lessons. A lot of China’s impressive growth rates are attributable to the considerable volume and value of its exports. This has provided, importantly, jobs for millions of its people and has helped lift millions more out of poverty. Japan’s development experience after the Second World War also epitomises the phenomenon of rapid economic growth through increased exports and trade.
Attacking the threat
Effective management of the exchange rate is critical to neutralising the ills of Dutch Disease. This is not incompatible with a floating exchange rate. To keep exports competitive, create jobs, and engender higher growth, the exchange rate should not be left to the whims of the market. The Bank of Ghana (BoG) will have to be more proactive in the coming months and years as the economy enters a new era.
Pragmatic management of the exchange rate in this context involves slowing its appreciation by sterilising boom-time revenues or keeping a domestically low level of interest rates. Sterilisation involves managing the flow of oil revenues into the country by saving some abroad in special funds and bringing them in slowly. This can minimise the impact of windfalls in foreign exchange earnings on the exchange rate - and ensure a stable revenue stream that can allow for better planning.
Saving some of the revenue in special funds will additionally serve as a fiscal policy tool for long-term management of Ghana’s petroleum revenue, while providing a bulwark to shield the country from the effects of oil price fluctuations. Finally, it is necessary to build a framework that allows today’s oil revenues to be accessed in the future to tackle unforeseen challenges.
Low interest rates are necessary to enable businesses expand and create more jobs. On the issue of exchange rate management, low interest rates coupled with higher saving in the domestic economy will restrict capital inflows which have the tendency to causing an appreciation of the nominal and real exchange rates.
Another strategy to combat Dutch Disease is to boost competitiveness of the agricultural and manufacturing sectors - the sectors most vulnerable to its impacts. This can be done through direct and indirect support. Direct support to agriculture can take the form of targetted assistance to enable farmers acquire much-needed capital and technology to boost output. Other strategies include reducing business taxes and sorting out present power supply irregularities, so prodding the manufacturing sector toward achieving greater price-competitiveness and growth.
Revenue from oil and other sources can also be used in ways that improve the supply side of the economy, enabling the country to grow its exports or enhance its capacity to compete with imports. This is possible through increased and efficient investments in education and infrastructure to enhance the competitiveness of the manufacturing sector. Well-targetted investments in education will achieve two important aims: they will fill the skills shortage/gap in the economy, and encourage innovations which are crucial to developing indigenous technologies that will bolster productivity.
Finally, adding value to oil and gas and rapidly developing the downstream sector can create a highly productive industry out of the commodities. The tentacles of the downstream sector reach many other sectors of the economy, providing possibilities for enhancing performance in all of them. These include construction, banking, tourism, food manufacturing and the manufacture of various inputs as well as transportation. Taking advantage of these opportunities will require government to provide the private sector with the necessary incentives so that they can go in and generate more growth and jobs for the economy.
Despite the threat of the Dutch Disease and the many challenges that lie ahead, Ghana stands on the brink of colossal wealth - and how it manages its balance will determine whether it falls or stands steady to grab all it can from the valley beneath.
PULL-QUOTE
China offers very useful lessons. A lot of China’s impressive growth rates are attributable to the considerable volume and value of its exports. This has provided, importantly, jobs for millions of its people and has helped lift millions more out of poverty. Japan’s development experience after the Second World War also epitomises the phenomenon of rapid economic growth through increased exports and trade.
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