Working Paper: CEPR ID: DP2364
Authors: Tryggvi Thor Herbertsson; Marta Skuladottir; Gylfi Zoega
Abstract: This paper presents a dynamic model that gives an account of some of the forms that the Dutch Disease can take through both product and labour markets. These involve an effect of primary sector output - through real wages and the level and volatility of real-exchange rates - on secondary sector employment, output, and investment. We then look at data from Iceland - which is probably the only OECD country that may have a serious problem of this sort - and look for evidence supporting our hypotheses. We find a clear effect of primary sector output and its volatility on real wages but not on the real exchange rate, defined as a ratio of the prices of traded and non-traded goods. Moreover, real wages are shown to impede output, investment and employment in the secondary sector.
Keywords: Dutch disease; Exchange rate volatility
JEL Codes: F41; O23; Q33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher primary sector output (E23) | Appreciation of the real exchange rate (F31) |
| Appreciation of the real exchange rate (F31) | Decrease in secondary sector employment and output (O14) |
| Increased volatility in primary sector output (E32) | Greater volatility in the real exchange rate (F31) |
| Greater volatility in the real exchange rate (F31) | Increased investment threshold for the secondary sector (E22) |
| Increased investment threshold for the secondary sector (E22) | Decrease in likelihood of investment in the secondary sector (O14) |
| Higher wages in the primary sector (J39) | Increased wages in the secondary sector (J31) |
| Increased wages in the secondary sector (J31) | Impediment to output, investment, and employment in the secondary sector (E22) |