Dutch Disease as an impediment to Economic Growth of Pakistan

Abstract

INTRODUCTION Shahid Hussain Javaid1 Iqbal Panhwar2 1Shaheed Zulfikar Ali Bhutto Institute of Science & Technology, SZABIST, Karachi. Email: Shahid.Hussain1@sbp.org.pk 2Bahria University, Karachi. Dutch disease is a phenomena when increase in natural resource abundance or foreign inflows which leads to appreciation in real effective exchange rate (REER) first. In the second step, this appreciation contracts the size of tradable and non-tradable sector expands. Cordon and Neary (1982) explained the idea as “adverse effect of non-booming (natural resources) sector to booming (agriculture & industrial) sector. The booming and non-booming sectors further explained in broader perspective. Booming sector includes existed available resources e.g. mining and non-booming involved agriculture and industrial sectors. These booming and non-booming sectors are called as traded sector. The non-traded sector is services sector, which consists of transport, financial services etc. Real exchange rate appreciation reduces the value of imported goods and domestic goods become expensive. This boosts the import expenditure and exports may be reduced and lead to contraction in the tradable sector. This contraction leads to decrease in output and employment level in the economy. Hence, Dutch Disease becomes harmful for economic growth of the country. The mechanism of Dutch disease can be elaborated as: A) starting from increase in foreign financial inflows, it raises the income of different households. This improves the demand for goods and services and for labor. It would reduce the supply of labor in the market for other sectors. If the expenditure of household increases means services sector expand and this leads to increase the cost of producing industrial and agricultural goods and contract the tradable sector. Many economists through spending and the resource movement effect explain this channel. This may have positive/negative linkages by improving the productivity in production sector. B) Consumption effect is the other channel in explaining Dutch Disease effects. Consumption effects can be explained as; Increase in prices of goods & services within the country boost the demand for imports. This raises the demand for more foreign currency,