The Dutch Disease and Nauru

The Dutch Disease is a term coined in 1977 by The Economist to describe the contrast between Holland's external economic health at the time — a strong currency resulting from the discovery of a large natural gas field — and its internal ailments, including the decline of other sectors of the economy and growing unemployment. More technically, it refers to a pattern where one sector of an economy grows tremendously, causing the currency to appreciate compared to foreign currencies. This appreciation makes exports from other sectors more expensive and less competitive, creating a situation where one sector flourishes while others languish. When the "balloon" pops, economic troubles ensue.

A prominent example of the Dutch Disease is the island nation of Nauru. Located in Micronesia and about the size of Manhattan, Nauru was discovered in the early 1900s to be rich in phosphate. Soon, companies from around the world came to mine it, and by the 1960s, nearly a third of the small island had been strip-mined, causing irreversible damage to the environment. Recognizing the damage and the potential for the island to become uninhabitable within 30 years, Australia offered to relocate all Nauruans and grant them Australian citizenship. However, Nauru rejected the proposal, declared its independence, and proceeded to nationalize all assets related to phosphate mining.

Externally, the Nauruan economy was flourishing, and by the 1970s, the country's per capita GDP ranked second highest in the world, just behind Saudi Arabia — a prestigious position for GDP, even in today's world. A national trust was wisely established to manage the nation's wealth, which was estimated to be worth over $635 million USD at the time. The Nauruan phosphate industry peaked in 1981 but then experienced a rapid decline.

Internally, however, Nauru was in conflict. The remaining phosphate to mine was dwindling, and everyone knew it would eventually dry up. The national trust, meant to provide for the Nauruan people after all the phosphate was mined, suffered from mismanagement and corruption. By 2002, its estimated value had dropped to only $87 million USD, and it might never recover. Today, the government is essentially bankrupt, with the national bank insolvent. The government employs 95% of those with jobs, many of whom work at an Australian detention facility on the island, which has an uncertain future itself. Nauru has become a victim of the Dutch Disease.

While the phosphate industry boomed, the government failed to manage an economy stricken by resource wealth — a very temporary wealth. As their phosphate-driven economy inflated and their currency appreciated, other sectors became uncompetitive. Milton Friedman's assertion that inflation is always a monetary phenomenon could not be more relevant here.

Although there are many nuances to the Nauruan economic story, I specifically want to highlight the national trust. On paper, it was a brilliant idea. Revenues from the phosphate industry boom could have been spread out over a much longer period, minimizing the amount of money introduced into the economy (thereby limiting inflation and mitigating the effects of the Dutch Disease) and providing more certainty in revenues year after year, rather than relying on uncertain booms.

However, Nauru isn't the only resource-driven economy in the world. So, how do others survive the Dutch Disease? Middle Eastern countries rich in oil, such as the United Arab Emirates, Qatar, and Saudi Arabia, effectively manage their sovereign wealth funds and invest heavily in infrastructure to support other sectors of their economies. Given their desert geography, their bid to diversify relies on tourism. These countries construct stadiums, hotels, and racetracks to position themselves as entertainment capitals and boost tourism.

Is it as simple as saying that if Nauru had effectively managed its sovereign wealth fund and invested in infrastructure to support its lagging industries, it would have been fine? Probably not. No economy is simple, nor is there a straightforward solution to economic troubles. However, it makes one wonder what their economy would look like today had they taken a different path. In any case, it stands as a compelling economic case study.