Preventing Dutch Disease in Southeast Asia

Manufacturing latecomers Laos and Myanmar can avoid the pitfalls of a resources boom by learning from their ASEAN neighbours, Hiroyuki Taguchi writes.

According to the World Bank’s classification, all of the economies of the Association of South East Asian Nations (ASEAN) except Brunei and Singapore now belong to the middle-income class.

These countries are expected to sustain their economic growth to escape the ‘middle-income trap”. Those among them that have abundant natural resources would naturally like to utilise them for productive purposes and to the maximum extent.

History, however, tells us a paradoxical story. It reveals the problem of a ‘resource curse’, whereby resource-rich economies show poor economic growth performance.

The namesake example is ‘Dutch Disease’: the story of the Netherlands in the late 1950s, which discovered natural gas in the North Sea. In the aftermath, its manufacturing activities were ‘crowded out’ through an export boom leading to the appreciation of its currency.

Policymakers in resource-rich economies face a critical question at their initial stage of development: should they continue to depend on natural resources to drive their growth, or should they reform their economic structure in more sustainable ways? In other words, how should a potential resource curse be transformed into a resource blessing?

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When we look at the long-term economic trends in individual ASEAN economies, we find some interesting diversity. Indonesia and Malaysia, forerunners of ASEAN, were formerly oil-producing economies in the 1970s and 1980s. Today, their economies are driven by manufacturing.

On the other hand, Laos and Myanmar, latecomers to ASEAN, are resource-based economies, focusing respectively on hydro-power production and natural gas development.

Did Indonesia and Malaysia previously suffer from Dutch Disease, and have they escaped from it? Do Laos and Myanmar currently suffer from the disease, and if so, can they learn lessons from the forerunners to help ensure sustainable growth?

My recent study provides some evidence on this issue. It identifies the existence of the Dutch Disease in Indonesia from 1970 to 1996 and in the modern day Laos and Myanmar, but not in today’s Indonesia and Malaysia.

The study also identified the following lessons from the experiences of Indonesia and Malaysia that could be applied to Laos and Myanmar.

First, a resource-rich economy should put its resource revenues to productive use – namely, investment needed for its future development. Indonesia directed its oil revenues to rural infrastructure, and to large-scale school construction in particular. Malaysia, meanwhile, achieved resource-based industrialisation by directly allocating natural resource revenues to investment in heavy industries.

Institutionally, Indonesia has had a ‘Revenue Sharing Fund’ since 2005, while Malaysia has managed the ‘National Trust Fund’ since 1988, for the purpose of setting aside natural resource revenues and using them for specific development projects. Laos and Myanmar are far behind Indonesia and Malaysia when it comes to ‘revenue management’ as evaluated by the Resource Governance Index. Based on this experience, some system of allocating resource revenues for investment and development projects should be established by Laos and Myanmar.

The second lesson is that developing economies should adopt strategic policies to diversify their industries so as not to depend too heavily on the resource sector. Indonesia and Malaysia succeeded in escaping the resource curse in part by diversifying their economic structures. The most effective way to diversify domestic industries is to invite foreign direct investment (FDI), especially if the domestic economy is lacking in technological capability and entrepreneurship.

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The business environment to attract FDI is far better in Indonesia and Malaysia than in Laos and Myanmar, according to the World Bank’s ‘Doing Business’ ranking. As latecomers, Laos and Myanmar should improve their business environments as a way to diversify their industries.

The third lesson is that a developing economy should improve the quality of its institutions to transform its economic structure. In Indonesia for instance, the national oil company Pertamina – the largest state-owned enterprise – fell into a crisis in 1975 due to its mismanagement in the resource curse era. Since then, technocrats have taken over the control of oil and gas revenues and carried out a series of reforms to reduce the country’s dependence on these resources and diversify the economy.

According to the World Bank’s Worldwide Governance Indicators for institutional quality, in the past two decades, Indonesia has improved and Malaysia has maintained high scores, while Laos and Myanmar have remained well behind.

This comparison shows that Laos and Myanmar could cure their Dutch Disease, turning the resource curse into a resource blessing, if they direct their resource revenues to productive investments, diversify their economies, and implement good governance through quality institutions.

This article is based on the author’s recent paper in Asia & the Pacific Policy Studies, ‘Analysis of the “Dutch Disease” Effect on the Selected Resource-rich ASEAN Economies’, co-authored with Soukvisan Khinsamone. All articles in the journal are free to read and download.