The new Dutch disease

“Dutch disease” used to label the harm caused by the discoveries of natural resources, since the increased revenue can push up the value of the currency, thereby making the export of other goods and services less competitive on world markets. This happened in the Netherlands after the discovery of a natural gas filed in the North Sea in the late 1950ies. (The real value of the Dutch guilder increased significantly in the 1960s, while eg in the neighbouring Belgium and Germany the real effective exchange rate was broadly stable – see Figure 2.g in comparison with 2.a and 2.d in my recent working paper).

The ‘new Dutch disease’ is of very different nature and will likely be less harmful for the Netherlands, at least in economic terms. Recently, there was no agreement in the Dutch parliament whether fiscal consolidation should be speeded up to meet the 3 percent of GDP deficit target by 2013, as envisioned by the excessive deficit procedure (EDP), at a time when the economy is expected to shrink. As a consequence, Prime Minister Mark Rutte offered his resignation on 23 April 2012. In the Netherlands, where the quality of fiscal institutions is excellent (see Table 8 on page 162 here) and the gross public debt is below 70 percent of GDP, the economic rationale would definitely not call for faster fiscal consolidation. See my arguments from mid-2010 or the recent Fiscal Monitor of the IMF, which also presents evidence that the negative impact of fiscal consolidation on output is stronger in an economic downturn.

The IMF forecasts a 4.9 percent budget deficit for the Netherlands in 2013: if that would be the outturn instead of 3.0 percent EDP target, public debt sustainability would not at all be in danger, but the Dutch economy, as well as trading partner countries, would benefit from a smoother adjustment. Market yields on Dutch treasury bills and bonds have not much changed and the Netherlands can still borrow at super-low interest rates (eg 0.05 percent at the 3-month horizon, 0.7 percent at the 3-year horizon and 2.3 percent at the 10-year horizon), reflecting the strong underlying fiscal position.

But the new Dutch disease is more significant from the perspective of the eurozone’s new fiscal architecture, which lays a very strong emphasis on meeting nominal targets (even if the new fiscal compact considers the so called structural balance, which is the nominal balance adjusted by the impact of the economic cycle and one-time items). If the Netherlands will be given leeway, other countries would likely, and rightly, demand the same. This would undermine the remaining credibility of the reinforced fiscal architecture. A fine for the Netherlands would do the same, by signalling that a low-debt/strong-institution country is punished when economics would call for a higher budget deficit. Probably the outturn will be a compromise, as always in Europe, whereby additional efforts will be requested, but the target date would be extended from 2013 by one or two years.

Yet there would be a first best solution, which is, unfortunately, just a dream now. In the US, where states have to consolidate in an economic downturn due to balanced budget rules, most automatic stabilisers are run by the federal government, which also stimulates economic activity with discretionary measures in distressed states. Lack of such European functions is a major root of the euro crisis and unfortunately there are no discussions about them. We can just hope that the new Dutch disease will bring such discussions to the table.