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SOURCES OF DUTCH DISEASE: : EVIDENCE FROM TRANSITION ECONOMIES, 1990-2007 Lo Bue Maria Carmela, M.A. Chair of Development Economics Georg-Augusta Universität,

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Presentation on theme: "SOURCES OF DUTCH DISEASE: : EVIDENCE FROM TRANSITION ECONOMIES, 1990-2007 Lo Bue Maria Carmela, M.A. Chair of Development Economics Georg-Augusta Universität,"— Presentation transcript:

1 SOURCES OF DUTCH DISEASE: : EVIDENCE FROM TRANSITION ECONOMIES, 1990-2007 Lo Bue Maria Carmela, M.A. Chair of Development Economics Georg-Augusta Universität, Göttingen Contact.: EADI-DSA 2011 Conference 1 Working Paper, June 2011 19 - 22 September 2011, York, UK

2 Outline I.Introduction II.Theoretical background III.Capital inflows patterns in the EE-FSU region IV.Empirical methodology V.Interpretation of the results VI.Concluding remarks 2

3 Introduction During the last decade, the countries which have emerged from the former communist bloc of Eastern Europe and the former Soviet Union (EE-FSU) have all received large inflows of foreign currency, in the form of either aid, remittances, FDI, portfolio inflows or revenues from exports of oil minerals and metals. On one hand these currency inflows could have raised investment and encouraged economic growth. On the other hand, destabilizing side-effects could have been brought about by the appreciation of the Real Exchange Rate (RER) and its detrimental effects on countries competiveness. Real Exchange Rate problem It is the possibility that capital inflows bring an appreciation of the real exchange rate with adverse effects on traded-goods production in the domestic economy [Corden, 1994]. 3

4 Need to consider differences in the forms of inflows received, differences in the types of recipients, differences in neutralizing/alleviating options at the disposal of policy makers. InflowsRecipients Revenues from natural resources exports Government - Oil companies AidGovernment Remittances Households FDI & Portfolio inflows Government MNCs and national enterprises Individual agents Aim of the paper: To ascertain whether these different types of currency inflows generate a greater or smaller real exchange rate appreciation. To identify which of those is likely to affect the most the RER and-through it- the prospect for growth in the EE-FSU region 4 Introduction

5 The Dutch Disease: one curse, different sources (A short theoretical excursus) Most agreed definition of D.D. : reduction in a countrys export performance as a result of an appreciation of the real exchange rate after a rapid increase in the export and /or in the price of a natural resource. (Traditional form of D.D.) As depicted in Corden and Neary model (1982): Three sectors in the economy: Booming B Lagging L Non – Tradable NT Two effects: Spending effect Resource movement effect PNT /PT Direct De- industrialization Indirect De- industrialization 5

6 Non-Traditional forms of Dutch Disease Aid Two Sectors : Tradable and Non Tradable Three Effects: 1.Spending effects 2.Resource-Movement effect T NT 3.Expenditure-Substitution effect 4.Destination of aid (import of capital goods, inputs; expenditure in infrastructure …) D T TD D N P N /P T Remittances Motivation: self-interested vs. altruistic purposes Recipients propensity to save/consume ( effects on interest rates) Households' expenditure pattern (biased towards NT goods) FDI & Portfolio inflow Possible adverse effects on the Terms of Trade, Instability in the Balance of Payments and on the domestic rate of saving/ investment Exchange rate regime and monetary policy 6

7 Capital inflows patterns in the EE-FSU region. (A short overview) 7

8 Net currency inflows (trend) 8

9 9 Real Exchange Rate

10 The model 10 Data: 19 EE-FSU countries; 1990-2007 Variable NameVariable LabelSourceUnit of measure RERReal Exchange RateAuthors compilationIndex, 2000=100 Net Export Net Export of fuels, ores, metals, precious stones and non-monetary gold UNCTADPercentage of the GDP Aid Net Official Aid/GDPDAC-OECDPercentage of the GDP Remittances Workers Remittances/GDPWorld BankPercentage of the GDP FDI Foreign Direct Investment/GDPUNCTADPercentage of the GDP Government Expenditure General Government Expenditure/GDP EBRDPercentage of the GDP Employment in informal sector Share of informal sector in total employment ILOPercentage of total employment WTO dummy Dummy denoting a year/country joining WTO Authors compilation (1=access to WTO, 0=all other cases) CRISIS dummy Dummy denoting a country/year hit by the Russian and Albanian financial crisis Authors compilation (1=years of Russian and Albanian crisis for countries identified as Russian and Albanian main trade partners, 0=all other cases)

11 11 Econometric specification of the model and estimation approach i. Linear and Non Linear effects ii. Time Lag effects In both cases we implement generalized least squares (GLS) serial correlation and heteroskedasticity robust method.

12 12 Table 1: Model I, Non Linear Effects

13 Interpretation of the results (Table 1) 13 One point percentage of increase in remittances leads to an appreciation of 4.11% in the RER, One point percentage of increase in FDI leads to an appreciation of 1.78% in the RER, One point percentage of increase in aid leads to an appreciation of 4.9% in the RER (see col.1). Any significant effect of net exports of mineral resources on the dep.var. Effect of saving and stabilization funds, Increased imports (in capital goods) to enhance productivity in the oil sector, Extra revenues stemming from rents increased the demand for imported goods (i.e. cars, luxury goods). Oil price has a significant effect (but relatively small).

14 14 Interpretation of the results (Table 1) cntd. Non Linearity trend for remittances and FDI. Keep in mind that recipients in these cases are mostly private agents (household and firms) for very large inflows incentives to save/invest money and/or to increase the demand for imported goods. Estimated turning point: 22.6 (for remittances) and 19.7 (for FDI). Negative effect of the abolition of trade barriers greater incentives for the foreign counterparts to trade and relatively small incentive from the import side (limiting the outflows of money from the country).

15 15 Interpretation of the results (Table 1) cntd. Negative effect of the financial crisis Trade effect (deterioration in trade exchanges after the crisis) > depreciating effect (following the removal of foreign-owned capital Positive effect of government expenditure increased the volume of import. Provision of social assistance and pension funds (benefiting mostly low-income households) Negative effect of employment in the informal sector expansion of the NT sector as suggested by the resource movement effect

16 16 Table 2: Model II, Lagged Effects

17 Interpretation of the results (Table 2) 17 Inclusion of lagged variables leads to significant and large appreciating effects on the RER. The results reported in columns 2 to 7, emphasize that only FDI, aid and remittances have a significant positive impact on the RER, where 1 point percentage of GDP increase in FDI, aid and remittances occurred in the previous year will lead to a 1.9%, 4.2% and 3.5% increase in RER respectively This results confirm our initial hypothesis on the existence of time effects (i.e. due to the limited absorbing capacity in recipient countries)

18 Concluding Remarks (1/4) 18 Dutch Disease effects may differ among themselves because of differences in the recipients of the inflows, their average volume, destination and the ability of policy makers to moderate their effects. For resource-endowed countries, the resource curse seemed to have been not in place (or not very important) Use of stabilization funds Existence of slack in these economies and /or limited factor mobility between sectors Use of tax windfalls to improve the competiveness of the manufacturing sector.

19 19 Other countries (Albania, Armenia, Bulgaria, Kyrgyz Rep., Moldova, Mongolia and Tajikistan) relied on foreign aid assistance up to late 90s and on a large inflows of remittances later on. Difficulty in establish off-setting policies. Unpopular measures (i.e. discouraging agents to convert remittances in domestic currency, or levying taxes on remittances). A more feasible measure is the sterilization (i.e. the sale of State or Central Bank bonds) to drain liquidity and cushion the inflationary spiral. Concluding Remarks (2/4)

20 Concluding Remarks (3/4) 20 Increasing supply of foreign funds has lead to increase in the demand ( RER appreciation and high real wages). As also noted by Grafe and Wyplosz (1997), the RER appreciation in this case could not be the result of a Balassa-Samuelson effect (given that under central planning services were very underdeveloped, productivity gains in the NT sector must have been very large).

21 21 Concluding Remarks (4/4) Off-setting policies in the case of FDI can be more easily implemented : sterilization through reinforced controls and /or taxes on capital inflows, intervening through the banking system (i.e. increasing the reserve requirements on banks or shifting government deposits from commercial banks to central bank). For the prospect of future research, need to rely on more data (REER, portfolio inflows, destination of consumption) to give a more accurate explanation of the dynamics of the DD in EE-FSU transition economies.

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