2003:024 SHU BACHELOR’S THESIS The Dutch Disease in a Small Economy The Case of Jamaica DANIEL WIKSTRÖM HENRIK ÖSTERBERG Social Science and Business Administration Programmes ECONOMICS PROGRAMME Department of Business Administration and Social Sciences Division of Economics Supervisor: Bo Jonsson 2003:024 SHU • ISSN: 1404 – 5508 • ISRN: LTU - SHU - EX - - 03/24 - - SE SAMMANFATTNING Syftet med denna uppsats är att undersöka om Jamaica lider av, eller har lidit av Dutch Disease samt vilken policy den jamaicanska regeringen använt sig av för att diversifiera strukturen på den inhemska ekonomin. Uppsatsen undersöker också vilka effekter fokuseringen på bauxit- och aluminaproduktion har haft på andra, icke-mineralbaserade, sektorers relativa konkurrenskraft jämfört med konkurrerande länder. Uppsatsens begränsning utgörs av att det är den jamaicanska bauxitmarknaden under åren 1970 till 1999 som undersöks. Tillämpade teorier är traditionella och moderna handelsteorier, växelkursteorier samt teorin om Dutch Disease. Under tiden som studien omfattar är det möjligt att dra slutsatsen att Jamaica inte har lidit av Dutch Disease. Den jamaicanska regeringens försök att diversifiera ekonomin, med hjälp av inkomster från bauxitskatten, har inte lyckats. För att Jamaica skall bli mer konkurrenskraftiga inom bauxit- och aluminaindustrin, krävs en ökad produktivitet av arbetskraften samt en förnyelse av de fabriker som förädlar bauxit till alumina. I ABSTRACT The purpose of this thesis is to determine weather Jamaica has, or has had a Dutch Disease problem and examine what economic policies have been used by the Jamaican Government in order to diversify the structure of the economy. The thesis also examines what effects the high focus on bauxite and alumina production has had on other sectors´ relative competitiveness towards competing countries. The scope for the thesis is based on the Jamaican bauxite market during the time period 1970 to 1999. Applied theories are traditional and modern trade theories, exchange rate theories, and finally the theory of the Dutch Disease. During the time period of this study, it is possible to conclude that Jamaica has not suffered from the Dutch Disease. The Jamaican Governments’ attempt to diversify the economy, with help of the bauxite levy revenues, has not been very successful. For Jamaica, in order to become more competitive within the bauxite and alumina industry, productivity must be improved and the plants where the bauxite is refined to alumina must be equipped with more advanced technology. II ACKNOWLEDGEMENTS The authors would like to thank all people who helped them in the preparation of this study. Without their assistance and contributions the thesis would never have been realized. Special thanks to: Chris; who bigheartedly introduced the authors to the streets of Kingston and to the Jamaican way of living. Mr. Wilberne Persaud; at the University of West Indies, Mona Campus, who provided housing and an introduction to the Jamaican economy. Mr. Dennis Morrison, for explaining the structure of the Jamaican bauxite industry, and Ms. Olive Johnson, for providing information in great manner, both employees of the Jamaica Bauxite Institute. Further, the authors would like to thank Mr. Franklin Brown, at the Office of Utilities Regulation, for taking time to explain and giving them essential information. Stefan Hellmer and Bo Jonsson at Luleå University of technology, division of economics, for discussions, critical comments and guiding throughout the preparation, and finally, the Swedish International Development Agency (SIDA) for granting the authors the scholarship needed in order to conduct this thesis. III TABLE OF CONTENTS SAMMANFATTNING.................................................................................................... I ABSTRACT ....................................................................................................................II ACKNOWLEDGEMENTS ......................................................................................... III LIST OF FIGURES AND TABLES ........................................................................... IV INTRODUCTION .......................................................................................................... 1 1.1 Background............................................................................................................. 1 1.2 Purpose ................................................................................................................... 1 1.3 Method.................................................................................................................... 2 1.4 Scope and Limitations ............................................................................................ 2 1.5 Reliability and Validity .......................................................................................... 2 1.6 Outline .................................................................................................................... 2 JAMAICA AT A GLANCE........................................................................................... 3 2.1 Brief History of Jamaica......................................................................................... 3 2.2 Some Demographic Data........................................................................................ 5 2.3 The Jamaican Economy.......................................................................................... 6 2.4 An Overview of the Mineral Industry of Jamaica .................................................. 9 2.5 Jamaica’s Bauxite and Alumina Industry............................................................. 12 2.5.1 Total Production of Bauxite .......................................................................... 15 2.5.2 Total Production of Alumina......................................................................... 16 2.5.3 Total Exports of Bauxite and Alumina.......................................................... 17 2.6 The World Bauxite and Alumina Industry ........................................................... 18 THEORY....................................................................................................................... 20 3.1 Theory of the Dutch Disease ................................................................................ 20 3.2 International Trade ............................................................................................... 21 3.2.1 Absolute Advantage ...................................................................................... 22 3.2.2 Comparative Advantage ................................................................................ 22 3.2.3 Production, Demand, and Trade in a Sector under Perfect Competition ...... 23 3.2.4 Relaxation of the Assumptions in the Heckscher-Ohlin Model .................... 25 3.3 Exchange Rate Theory.......................................................................................... 29 3.3.1 Demand Side.................................................................................................. 29 3.3.2 Supply Side.................................................................................................... 29 3.3.3 The Foreign Exchange Market ...................................................................... 30 3.3.4 Flexible Exchange Rates ............................................................................... 30 3.3.5 The Effects of Fiscal Policy under Different Capital Mobility Assumptions 33 3.3.6 Effects of Monetary Policy under Different Capital Mobility Assumptions. 35 EMPIRICAL DATA AND ANALYSIS...................................................................... 38 4.1 Data....................................................................................................................... 38 4.2 Gross Domestic Product ....................................................................................... 39 4.3 Unemployment ..................................................................................................... 40 4.4 Consumer Price Index .......................................................................................... 41 4.5 Average Annual Exchange Rate........................................................................... 42 4.6 Alumina and Bauxite’s Contribution to Total Exports......................................... 43 4.7 Total Exports of Banana and Sugar...................................................................... 44 CONCLUSIONS........................................................................................................... 46 CONCLUDING REMARKS....................................................................................... 48 REFERENCES ............................................................................................................. 50 LIST OF FIGURES AND TABLES Figure 2.1, Total exports and imports for different time periods ..................................... 9 Figure 2.2, Total production of bauxite in million tonnes, 1973 to 1999....................... 16 Figure 2.3, Total production of alumina in million tonnes, 1970 to 1999...................... 17 Figure 2.4, Value of total exports of bauxite and alumina, 1970 to 1999 ...................... 18 Figure 3.1, The physically capital-rich country is biased towards producing the capital-intensive good..................................................................................................... 23 Figure 3.2,