Vangie Bhagoo-Ramrattan Manager (Research)

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Trinidad and Tobago's Natural Resources: Breaking the 'Dutch' Cycle

By Vangie Bhagoo-Ramrattan Manager (Research)

A country endowed with natural resources is commonly considered to be quite fortunate since these God-given resources usually have the potential to generate considerable profits. However, the old adage; 'too much of something is not always good' holds true, as the experience of many countries throughout history would have shown us. There are many economic and social issues which can arise from having 'too much', so much so that the term 'Dutch Disease' (DD) was coined for countries which suffered the fate of a natural resource 'curse'. The concept of DD originated in the Netherlands during the 1970s when the significant natural gas find which yielded substantial revenue resulted in an erosion in the competitiveness of the other, non-booming tradable sectors. Despite the sizeable revenue windfall generated by the discovery of natural gas, economic growth sharply declined in the Netherlands. This economic paradox largely occurs as a result of exploitation and export of natural resources. Essentially, the flows of these external 'rents' result in an overvaluation of the domestic currency; this then leads to loss of competitiveness and deindustrialisation of the non-booming, tradable sectors of the economy.

Analysis of the DD theory has been extensive over the years, as many countries over the boom and bust of their economic cycles have suffered its ill effects. There are two major components of the DD, including the resource movement effects and the spending effect (Corden and Neary, 1982). The first relates to the movement of productive factors among sectors. In essence, mobile factors, like labor would gravitate towards the booming sector, away from other tradable non-booming sectors, resulting in direct deindustrialisation which in its simplest form refers to a shift in an economy from producing goods to producing services. The spending effect is related to the increase in real income caused by a boom, which then leads to a rise in demand for services. The prices of services then increase, leading to real appreciation. Furthermore, an increase in the demand for services may diminish demand from other tradable sectors, resulting in indirect deindustrialisation (Ueno, 2010).

Theory now aside, Trinidad and Tobago has undeniably suffered at the hands of DD. And history has in fact repeated itself. The oil boom of the 1970s resulted in a shift in the composition of the country's GDP. In the five year period prior to 1970, energy's contribution to GDP was just around 25%. During the 1970's oil boom, energy's contribution rose to 33%. During this time, economic growth averaged around 6%. The subsequent economic bust of the early 1980s then pushed energy's contribution back to an average of 26%. At the same time, the services sector's contribution to overall GDP rose by almost 10 percentage points. Interestingly, the next two decades indicated the identical pattern as the preceding 20-year period as shown in Figure 1. The years 2001 - 2010 largely represented boom years; during this 10-year period, significant investments were notably made in the downstream petroleum sector, such as the expansion of liquefied natural gas production facilities. Furthermore, energy prices surged, jumping from USD20 per barrel to USD90 per barrel. During this eventful decade, the contribution of energy to GDP rose to 37%, considerably higher than the 26% a decade earlier.

Other important trends can be clearly gleaned from Figure 1. Over a 40-year period, the manufacturing sector has more or less remained stagnant, averaging around 7.5% of GDP over the period, while the agriculture sector has declined from about 5% of GDP to almost 1% in 2001 - 2010. Herein lies a key issue. These are considered the tradable sectors of the economy, which have the potential to provide a sustainable source of value-added to the economy, as well as employment. The energy sector currently contributes about 35% to GDP, about half of government revenue, but only accounts for 5% of total employment. Moreover, the agriculture sector has lost 11,500 jobs from 2000 to June 2010, while the manufacturing sector had 5,200 fewer for the same period. While activity in the energy sector mushroomed, employment in the sector grew by a mere 1,700. The major reason for this is the nature of the energy sector - which is highly capital intensive. The services sector continues to contribute the largest to overall GDP and consists of subsectors like construction, finance, insurance and real estate, distribution and retail, government, tourism, etc.

As theory dictates, the decline in the key tradable sectors during the boom years was largely as a result of loss of competitiveness. The World Economic Forum's (WEF) Global Competitiveness Index, which ranks approximately 130 countries worldwide indicates that Trinidad and Tobago's competitiveness over the years has deteriorated, moving from 76 in 2006/ 2007 to currently 82, even deteriorating to 92 in 2008/ 2009. The WEF defines competitiveness as the set of institutions, policies and factors that determines the level of productivity of a country. Another determination of a country's competitiveness is its real exchange rate. Analysis done by the International Monetary Fund (IMF) shows that Trinidad and Tobago's real effective exchange rate 'appears to be in line with fundamentals', but the Fund also cautioned for the need to significantly reduce the non-energy current account deficit in order to preserve long-term sustainability. Furthermore, the IMF in its latest Article IV, noted that 'unless there is significant scope to grow exports outside the exhaustible resource sector, future real income (or consumption) per capita will fall below current levels.' It further highlighted a need for greater exchange rate flexibility over the medium term to support the expansion of non-energy exports and to rebalance consumption. Close to 90% of Trinidad and Tobago's total exports are generated in the energy sector.

While the commodity price boom provided a significant boost to government coffers, spending patterns were altered, and public spending on capital projects rose sharply. The result was a deterioration in the underlying fiscal position, as measured by the non-energy fiscal deficit, which simply excludes the impact of energy revenues on the overall fiscal performance (non-energy revenue less total expenditure). This deficit as a ratio of GDP rose from 17% in 2004/ 05 to 27.9% in fiscal 2010. And based on the budget for the current fiscal year, we forecast that this deficit will moderate slightly (albeit still high) to 24.7%. Capital expenditure rose from around 4% of GDP in FY 2004/ 05 to 9% of GDP in FY 2009/ 10. On the positive side, Trinidad and Tobago's 'Heritage and Stabilisation Fund' (HSF) accumulated USD3.7 billion by the end of December 2010.

We have heard it a thousand times before, but I believe it is worth saying just once more. As we move forward into another phase in Trinidad and Tobago's economic cycle, hopefully we learn from the painful past so that the mistakes are not repeated. A natural resource endowment need not necessarily be a curse for countries. Even though the tides have turned on us again with the advent of the global recession, it may not be too late to initiate a transformation process for this 'rentier' state. As it stands, fiscal flexibility and strength of the external accounts principally (and precariously) rest on the buoyancy of international commodity prices, and does not depend on a strong domestic productive sector. As a result, the country's key tradable sectors have been 'crowded out', evidenced by the fall off in employment and their stagnancy over the years. Dutch Disease is often described as a situation of 'too much wealth managed unwisely'. As we recover from another round of a commodity price bust, we add to the 'mistakes log' of yet another bout of recession. Hopefully this second time around, we make notes of the lessons we can learn from the misfortunes. And it is with optimism that we look for a shift in thinking of our leaders and policy makers.

All information contained in this article has been obtained from sources that First Citizens Investment Services believes to be accurate and reliable. All opinions and estimates constitute the Author's judgment as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by First Citizens Investment Services in any form whatsoever.

First Citizens Investment Services and/or it employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed shall be construed to be, or constitute an offer or a solicitation to buy or sell.

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