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Will the US catch Dutch disease?

 
 
In economic parlance, Dutch disease isn't something you catch in the streets of Amsterdam, but is rather an economic malady whereby a country that has a natural resource boom experiences weaker manufacturing activity. The causation runs through the exchange rate: an increase in net exports due to increased resource production should strengthen the value of the country's currency. This, in turn, challenges the global cost competitiveness of the country's factory sector, presenting a structural headwind to industrial growth. The term got its name from the experience of the Netherlands, which developed large offshore oil and gas resources in the 1960s and 1970s, thereby placing persistent upward pressure on the value of the guilder. This currency strength was blamed for the slow decline of the Dutch manufacturing sector.
 
The US is currently in the midst of its own fossil fuel resource boom. Unlike the Netherlands, exports haven't surged, however imports have declined, and so the directional impetus to net exports is the same whether it's an increase in exports or decrease in imports. Thus the currency implication should be the same as the one diagnosed as Dutch disease. Of course, the shale boom can impact domestic manufacturers in another aspect as well: energy input costs should decline for US factories. Qualitatively, the current energy production boom has two opposing influences on the competitiveness of the American factory sector: a stronger dollar should make US-made goods more expensive on global markets, while lower energy costs should make American products cheaper. Which of these two forces is more important is a quantitative issue.
 
To address this we first need to develop an estimate of the impact of the energy boom on the dollar. Fortunately, our colleague in FX strategy John Normand has already done that. In a recent piece ("American energy independence and the dollar" 3/15/13) John notes a 1% reduction in the US current account deficit lifts the trade-weighted dollar by 1.5%. In an extreme scenario where domestic production soars enough to create true energy independence, the support to the dollar would be about 3%. Full energy independence, however, is probably a best case scenario. A more likely outcome in John's view is one which pushes up the trade-weighted dollar by about 0.5%.
 
Energy accounts for 1.9% of total manufacturing costs, according to the BEA's "KLEMS" data set. This means (by applying a rule known as Shephard's lemma) that a 1% reduction in energy costs should reduce total manufacturing costs by 0.019%. In order for the decline in energy input costs to offset the loss in competitiveness due to a 0.5% stronger dollar, total energy input prices would have to decline by 26%. This might be a tall order: over the past five years -- years in which energy production increased significantly -- manufacturing energy input costs increased by 2.5% annually. Even during the Great Recession, energy prices for factories only fell by 16%. It would thus appear it's possible the US could catch a very mild case of Dutch disease. (While the net effect on output prices may be negative, both gross effects are quite small). There are some potential mitigating factors; for example, the KLEMS data does not consider petrochemical feedstock as an energy input. However, the rough, back-of-the-envelope calculations presented above indicate that going from a partial equilibrium to a general equilibrium view of the energy boom may alter the implications for US manufacturing.
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