SOAS Research Online

Abstract

The subject of this study is the influence of favourable exogenous shocks on the structure of prices and output composition in small open economies. The study is based, theoretically, on the Dutch Disease theory; and, empirically, on research conducted on Jordan. Under general equilibrium conditions, a boom in a traded sector is likely to produce a contraction of output and employment in non-booming traded sectors - de-industrialisation. This is the essence of the Dutch disease theory, its conclusions valid only within its particular set of assumptions about factor-market underpinnings of the model, including macro-equilibrium and full employment, fixed national stock of labour and capital, and perfect capital markets; and unchanging technical conditions of production. Furthermore, changes in the structure of demand that underlie the process of industrialisation are ignored, as the model assumes growth, other than that generated by the windfall gain, away. The present study contests this analytical approach, and offers an alternative that considers initial conditions of disequilibrium and conducts dynamic analysis to show the effects of demand expansion, with its disproportionately large stimulus to manufacturing, on these conditions. Demand-led output growth combined with supply-side changes induced by booming conditions leads to rapid productivity growth in manufacturing, by both increasing production efficiency and inducing technological advance. The outcome of these inter-linked supply-demand changes is an acceleration of industrialisation. The study thus presents an antithesis to the Dutch disease hypothesis. After an overview of the Dutch disease theory, the study discusses the necessary modifications when certain characteristics of industrialising economies are taken into consideration. The focus of the analysis is the Dutch disease theory's assumptions, its level of abstraction, and the static nature of its analysis. Various countries' experience of booms are presented to show that the outcome of sectoral shifts is crucially dependent on the pre-boom economic conditions; and thus to show also that boom experiences of industrial and industrialising economies differ considerably. The discussion of Jordan starts by outlining that country's historical experience of sectoral shifts. The counterfactual to the Dutch disease is established with the aid of trend analysis, and it is shown that at the end of the boom, the share in aggregate output of agriculture was smaller, and that of manufacturing larger, than 'expected' from historical trends. Dutch disease analysis is used to show that resource mobility and the spending effect have induced currency appreciation, as would have been predicted by the theory. Contrary to the theory's predictions, however, the examination of the commodity trade balance reveals significant growth in agricultural and manufacturing exports during the boom. The study then examines the reasons behind the discrepancy between the theory and this empirical observation. The performance of agriculture and manufacturing are examined separately. In both sectors booming conditions brought about rapid technological advance which expanded profits in these sectors. In addition, the disproportionately large demand for manufactured goods, both for consumption and investment, led to a rapid expansion of this sector's share in aggregate output; which was compensated for by a decline in that of agriculture. Seen in this light, the decline in the share of agriculture was a manifestation of successful industrialisation, rather than the Dutch disease effect.