Avoiding the Dutch Disease: Chile’s Stabilization Fund

Bob Davis of the Wall Street Journal explores why a rise in the price of one’s exports might become a problem:

With copper prices soaring, Chile is flush with cash. That may not sound like a problem, but for a commodity-rich country, it can be a big one. Resource wealth has brought unstable nations in the Middle East and Africa to their knees by spawning war or corruption. Even wealthy nations have a tough time handling commodity booms, which can drive up their currencies, batter their exporters and produce unsustainable surges in imports. In a case much studied by economists, the Dutch economy stagnated after rich natural-gas deposits were discovered offshore in the 1960s. These days, Venezuela and other oil producers riding oil-backed consumption booms are vulnerable to “Dutch disease,” especially if oil prices decline.

Max Corden and Peter Neary’s 1982 publication – Booming Sector and De-Industrialisation in a Small Open Economy is often cited in reference to this so-called Dutch disease. It would seem Chile’s fiscal policy is addressing the implications of this revenue boom in a sensible way:

Chile is trying to inoculate itself. In essence, the government is saving what it calculates as windfall profits from its state-owned copper company and windfall taxes from privately owned mines. It is investing the money abroad in bonds and is also considering buying foreign stock funds. The idea is that when Chile’s economy inevitably falters, the government can tap this “economic and social stabilization fund” for revenue. “The question that plagues Latin America and other emerging markets is: How do you avoid the booms and busts from commodity cycles?” says Chile’s finance minister, Andrés Velasco. “In Chile we have a simple answer: spend that which is permanent and save that which is transitory.” So far, Chile has set aside about $6 billion for the stabilization fund and expects to add another $6 billion or so by the end of the year. The sum would be equivalent to about 10% of the country’s gross domestic product, the total value of goods and services it produces in a year. That’s an enormous political accomplishment. Try to imagine the U.S. government putting aside $1 trillion – about 10% of the U.S. economy’s annual output – in a rainy-day fund invested in foreign stocks and bonds. That would be nearly impossible, given congressional pressures to increase spending or cut taxes. In 1990, oil-rich Norway started a stabilization fund, which now has a portfolio of around $300 billion, a startling sum for a nation of 4.6 million. Chile copied Norway’s approach, but its fund didn’t begin to pile up assets until the past few years, as the price of copper soared to more than $3 a pound, triple its 2004 level. Banking part of that windfall requires far greater sacrifice by Chile, where the per-capita income in 2005 was $7,100, about one-seventh of Norway’s.

I happened to enjoy how Mr. Davis imagined “the U.S. government putting aside $1 trillion – about 10% of the U.S. economy’s annual output – in a rainy-day fund invested in foreign stocks and bonds.” If only!