Academic journal article Indian Journal of Economics and Business

Diamonds and Dutch Disease: A Case Study of Sierra Leone

Academic journal article Indian Journal of Economics and Business

Diamonds and Dutch Disease: A Case Study of Sierra Leone

Article excerpt

Abstract

Sierra Leone is resource rich in diamonds but remains one of the poorest countries in the world. This paper seeks to answer how a country with significant resource wealth can remain in poverty. To answer this question I have applied the Dutch Disease theory to Sierra Leone. This is done through the evaluation of Sierra Leone's key economic indicators, including GDP, variance in sectors including industry, agriculture, and services, terms of trade, inflation, and overall dependency on diamonds.

I. INTRODUCTION

The resource curse can be broken down into four common economic explanations: decline in terms of trade for primary commodities, the instability of international commodity markets, the poor economic linkages between resource and nonresource sectors, and the Dutch Disease theory (Ross, 1999).

A vast array of research has been conducted since the 1980's studying the relationship between resource wealth and economic development that has provided strong evidence that states with abundant resource wealth perform less well than their resource-poor counterparts, however there remains little agreement of why this is (Ross, 1999). In 1970, 80 per cent of the developing world's export earnings were from primary commodities; in 1993 that rate has fallen to 34 per cent, which is a result of the fast growth of manufacturing exports in East Asia. However, three-fourths of the states in sub-Saharan Africa still rely heavily on primary commodities for at least half of their export income (Ross, 1999).

DUTCH DISEASE

In 1977 the term "Dutch Disease" was first used in the weekly magazine, "The Economist" to describe the economic phenomenon of the Netherlands export boom and simultaneous decline of the manufacturing sector in the late 1970s. The Netherlands experienced a rise in their natural gas exports as a result of increasing oil prices in the early 1970s. Inflation occurred as the foreign exchange reserves increased the domestic money supply. Simultaneously the Netherlands increased their major imports, which led to a rise in the cost of production and overall decline in aggregate supply (K. Kulkarni, P. Brijesh, 2009). The decline of aggregate supply in the economy resulted in an increase in domestic unemployment. Although the Netherlands had substantial export growth, the Dutch economy experienced stagflation, now known as the Dutch Disease (K. Kulkarni, P. Brijesh, 2009).

Generally speaking, today Dutch Disease refers to three sectors, the boom sector, lagging sector, and non-traded sector. The booming sector refers to exported goods from resource extraction and the lagging sector refers to manufacturing or agricultural exports (Cordon and Neary, 1982). The non-traded sector refers to the non-resource sector or services. The international market sets the prices of the traded sectors; raw resources, manufacturing goods and agriculture. The prices of non-traded goods such as services and other non-resources are set domestically since they are used within the country. Dutch Disease evaluates the coexistence of all three sectors within an economy and their relation to economic growth. The theory is that as exports in raw extractive materials increase, such as oil and minerals, there is a decrease in the export of manufactured and agricultural exports due to added pressure on the sector.

According to Sachs and Warner, capital and labor are used in the manufacturing and non-traded sector, but not in the natural resource sector (Sachs & Warner, 1997). The higher the natural resource endowment a country has the greater the demand on non-tradable goods. Thus labor and capital move from the manufacturing sector to the non-traded sector. When an economy experiences a resource boom, from either an improvement in terms of trade or the discovery of a resource, manufacturing industry decreases as the non-traded sector expands (Sachs & Warner, 1997). …

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