Dutch Disease-cum-financialization Booms and External Balance cycles in developing countries

Abstract

We formally investigate the medium-to-long-run dynamics emerging out of a Dutch disease-cum-financialization phenomenon. We take inspiration from the most recent Colombian development pattern. The "pure" Dutch disease first causes deindustrialization by permanently appreciating the economy's exchange rate in the long run. Financialization, i.e., booming capital inflows taking place in a climate of natural resource-led financial overoptimism, causes medium-run exchange rate volatility and macroeconomic instability. This jeopardizes manufacturing development even further by raising macroeconomic uncertainty. We advise the adoption of capital controls and a developmentalist monetary policy to tackle these two distinct but often intertwined phenomena.