Concerns about Dutch Disease in Brazil may be uncalled for. The South American country is recouping all of the benefits.
BY WALTER T. MOLANO
Many analysts worry that a heavy emphasis on natural resource development can trigger the formation of Dutch Disease. The economic ailment supposes that increased revenues from commodity development can lead to deindustrialization and slower rates of development. Strong capital inflows can trigger an appreciation of the currency and reduce the competitiveness of the industrial sector. The theory was developed after the events that occurred in the Netherlands during the late 1960s and early 1970s, when it developed its natural gas fields. The guilder appreciated; there was a loss of competitiveness and manufacturing declined. Economists applied the Dutch experience to explain the lack of development in other commodity-rich countries—particularly Venezuela, Nigeria and Indonesia.
WARNINGS ON BRAZIL
The recent discovery of large oil deposits in Brazil recently produced warnings about the perils of Dutch Disease. However, economists have not been able to find statistical data to support the argument that commodity production can have an adverse effect on development. Nevertheless, many commentators cite the examples of Venezuela, Nigeria and Indonesia to argue against too much emphasis on commodities. However, the histories of these three countries shows that their oil sectors were purposely developed to ensure a low level of industrialization.
The internationalization of the oil sector at the start of the 20th century was fraught with risks. Early on, the large multinationals, particularly Standard Oil and Royal Dutch Shell, realized that the development of an oil industry in a foreign country was a dangerous proposition—especially if it was located in a developing country. The opportunities for political risk and nationalization were extremely high. The forced appropriation of the Russian oil sector in 1918 and the subsequent expropriation of the Mexican oil industry convinced the multinationals to separate their upstream and downstream operations in high-risk countries.
Venezuela, Nigeria and Indonesia were very good examples of countries where the multinationals purposely moved all (or most) of the refining capacity offshore. Given the fact that the Netherlands held several colonies in the Caribbean, Royal Dutch Shell concentrated its Venezuelan refining operations in islands such as Aruba and St. Maarten; thus giving a new perspective to the so-called Dutch Disease. It was not so much that the countries contracted symptoms similar to what occurred in the Netherlands during the 1960s and 1970s; it was that the Dutch left them with a deindustrailized legacy that was difficult to overcome. The same pattern occurred in Asia, where most of the refining was centered in European colonial strongholds, such as Singapore—although the oil fields were in “high risk” regions such as Indonesia and Malaysia. Ironically, Indonesia was another Dutch colony.
Likewise, Nigeria only utilizes a small fraction of its refining capacity. Coincidently, Royal Dutch Shell was the dominant player in the development of the Nigerian oil sector. Hence, the inability of these three countries to refine their oil removed an important source of industrialization and development. There is a long chain of downstream products, such as petrochemicals, plastics and manufacturing, that add enormous value to the petroleum that is extracted from the ground. Many countries, such as the U.S. and Russia, were able to accelerate their economic development thanks to their oil sectors. The petroleum sector at the end of the 19th century helped the U.S. and Russia leapfrog over some of the European superpowers that had industrialized 100 years earlier, thus moving into the vanguard of the global economy and emerging as the victors of the Second World War.
Fortunately, Brazil is in a different situation. The development of the Brazilian oil sector is under the domain and control of Petrobras—a national oil company. It is taking the lead in the exploitation of upstream opportunities and downstream products.
Not surprisingly, Brazil is recouping all of the benefits. Although foreign oil companies are being invited to develop some of the new offshore oil fields, Petrobras is taking the lead. New oil rigs are being built near Rio de Janeiro, creating thousands of jobs and advancing the country’s manufacturing base. Brazil will also be able to take advantage of more downstream opportunities, leading to further industrialization and development.
Therefore, the concerns about Dutch Disease may be uncalled for, as long as Brazil does not allow a certain European company to shape the evolution of its oil sector.
Walter Molano is head of research at BCP Securities.