The Dutch disease, natural resource booms and policy adjustments: The case of Indonesia
Date
2020
Authors
Pasaribu, Donny
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The role of natural resources in economic development has sparked debates amongst economists for decades. While theories such as the natural resource curse thesis and the Dutch disease have been developed to explain the adverse effects of natural resources, the empirical findings are mixed. This thesis consists of one theory chapter (Chapter 2), one background chapter about Indonesia (Chapter 3) and three distinct but closely related empirical chapters (Chapters 4, 5 and 6) on natural resources and their impact on the economy. The theory and Indonesia chapters provide some background on relevant theories and on the case study of Indonesia, which will be discussed and applied throughout the thesis. The theory chapter (Chapter 2) focuses on the Dutch disease theory and natural resource curse theory, along with their development and related empirical studies. The Indonesia chapter (Chapter 3) discusses the complex relationship between natural resources and economic development in Indonesia's modern history.
The first empirical chapter (Chapter 4) explores and compares various methods to construct the real exchange rate as a tool to measure the effects of the Dutch disease in natural resource booms in Indonesia. Theoretically, a natural resource boom will lead to an appreciation of the real exchange rate, defined as the price ratio between non-tradeables and tradeables. Real effective exchange rate data (REER), as published by international organisations such as IMF and BIS, is therefore not suitable for measuring the effects of the Dutch disease because it is constructed differently from its theoretical definition. This study uses Indonesia as a case study and constructs trade-weighted REER, CPI-based, and GDP-deflator based price ratios. Indonesia is an interesting case study because, in the last fifty years, it has experienced two very different resource booms. The study finds that, while each method has its advantages and disadvantages, the GDP-deflator price ratio is the most appropriate method to measure the effects of the Dutch disease.
The second empirical chapter (Chapter 5) tests the total effect of natural resource extraction on manufacturing in a cross-country setting. The total effect of natural resource extraction can include the Dutch disease and natural resource curse effects, both of which may have adverse effects on manufacturing. However, it can also include the effects of backward-and-forward linkages and productivity spillover, which may have positive effects. The test is done by estimating the effect of natural resource rents on manufacturing value-added. It uses an instrumental variable method that utilises fluctuations in world resource prices, weighted by each country's resource exports. Using data from 149 countries over the period 1970-2014, the study finds that natural resource rents have a mildly positive effect on manufacturing value-added. The findings are then compared to the experience of Indonesia and Australia, two relatively resource-dependent countries.
The final empirical chapter (Chapter 6) measures the welfare impacts of coal and palm oil prices in Indonesia during the 2000s commodity boom. The welfare outcomes include the poverty rate, household consumption, employment, and wages, all measured at the district level. The study exploits the within-country variation in exposure to each commodity, interacted with exogenous changes in global commodity prices. The study focuses on coal and palm oil prices because they were the main driver in Indonesia's export growth during the 2000s commodity boom. The results suggest that both coal and palm oil prices have strong poverty reduction effects. While palm oil price affects poverty mainly through employment creation effect, coal price affects poverty mainly through the wage effect.
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