Is Colombia Suffering the Dutch Disease?

Despite the global economic situation, Colombia has shown resilience to external shocks in recent years, with reasonable economic performance in its region, in part due to responsible monetary policies conducted by the Central Bank.
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Despite the global economic situation, Colombia has shown resilience to external shocks in recent years, with reasonable economic performance in its region, in part due to responsible monetary policies conducted by the Central Bank. Capital inflows to the country have increased dramatically, mainly as a result of the exploitation of natural resources and the signing of several international free trade agreements. Additionally, the country has demonstrated political and monetary stability, which has generated investment scenarios desired by institutions and international investors. The high capital movements however, can have adverse effects on the domestic economy, making it necessary to maintain a responsible monetary policy to exert control over these phenomena.

But why might high capital inflows be undesirable in Colombia, or for that matter, in anyone's case? The influx of investment should, in theory, generate wealth for the country and increase its economic growth. These benefits will be realized in the short term, but if there are no policies governing these transactions, there will not be a positive effect in the long run. A significant increase in the country's income can negatively impact factors such as the trade balance, employment, the exchange rate's behavior and the country's overall economic performance.

Colombia's economy has shown clear positive behavior in recent years. According to the country's Central Bank, Colombia's gross domestic product grew a total of 4.0 percent for 2012. The figures are above Latin America's average -- 3.1 percent -- and show good performance given the global economic situation, with the recession in Europe and the slowdown of the economies in the U.S. and China. The inflation rate has remained within its accorded limits and the issuers' intervention rate has been declining since 2012 to more stable levels. Monetary policies implemented so far have, in part, controlled the amount of circulating money in the economy and maintained healthy indicators for the country.

However, there are other factors that indicate that potential problems are occurring and they should be thoroughly considered. Foreign direct investment has rapidly increased in the past two years -- USD 6,889 Million in 2010 to USD 13,234 Million in 2011 -- and the Ministry of Trade and Industry announced a total of USD 16,683 Million for 2012. Disaggregating these figures by sector reveals an interesting pattern in their distribution and how they have shifted recently. Most FDI flows are targeted at the mining and oil sectors, with a total of USD 7,704 Million for 2011 and a total of USD 6,375 Million for the first three quarters of 2012, figure that is expected to rise well above last year's total.

What is the effect of these flows on the economy? As mentioned above, the short-term effects are positive, which is reflected in the significant increase in GDP for 2011. But the effects of this sudden increase in foreign direct investment begins to cause problems in the medium term for the country's economy, and may continue to do so in the long run if a way to fix it is not devised. The behavior of the Colombian peso is undergoing a revaluation that is affecting the country's trade balance and limiting the competitiveness of its exports. The exchange rate of the Colombian peso against the U.S. dollar has been declining in the past five years, indicating a revaluation of the local currency of approximately 21 percent. As exporters receive their payments in U.S. dollars, this translates to less income in Colombian pesos, reducing their operating margin and making it harder to compete in the international market.

Excluding the mining and oil sectors, employment levels in Colombia are being adversely affected by FDI flows. Mining and oil generates only 1 percent of total employment in the country, while industry creates 13 percent and agriculture 17 percent. It is alarming to identify the disaggregated composition of the total gross domestic product for the third quarter in 2012, where sectors such as industry (-5.80 percent), construction (-31.15 percent) and financial institutions (-2.38 percent) show considerable contractions against the previous year for the same period. The country's main exports are being sectored; while mining, oil and gas sectors are increasing in an inversely proportional fashion to other sectors.

Coffee exports have declined USD 487 million from the first three quarters of 2011 against 2012 -- equivalent to a decrease of 23.2 percent -- while the oil and derivatives sector has increased by 12.3 percent for the same period. In fact, this detrimental effect of FDI flows and the subsequent decrease in coffee exports has led to a nationwide strike in the coffee sector that resulted in the granting of subsidies by the government. This has not only affected coffee, but also other economic areas that are entering into what has been considered by some "the agro crisis", referring to the agricultural sector as a whole and its continuous decrease in productivity, exports and earnings.

All this refers to what is known in economic literature as the Dutch Disease, or in more technical terms as economic specialization. It refers to a distortion in the economy, where inward flows are concentrated on a single sector, making the rest of the economy suffer in real terms. In the specific case of Colombia, a spiking increase of investments has seen its way into the oil and mining sectors, generating positive effects in the short term but affecting the overall economy in the medium and long term. Symptoms of this longer term detriment are becoming evident: GDP is contracting, the Colombian peso is revaluing against the US dollar, job generating economic sectors are shrinking, traditional goods exports are decreasing, exporters are becoming less competitive, and the trade balance is contracting.

The government has implemented measures to counter these effects, such as the daily dollar purchasing policy that seeks to stabilize the exchange rate, along with a policy of issuing government bonds to boost domestic borrowing and slow the appreciation of the Colombian peso. According to the Central Bank's director, the Colombian peso's appreciation is not controlled solely through monetary or exchange policies, making it necessary to generate solutions for the medium and long term that increase savings, improve productivity and add value in real terms. In parallel, measures, policies and subsidies should be devised in order to allow affected sectors to regain their competitiveness in the international market, create jobs and economic stability in the medium and long term for the Colombian economy.

All statistical data, references and specific facts were retrieved from:
Banco de la República (Colombia's Central Bank)
DANE (Colombia's National Department of Statistics)
Portafolio (Colombia's leading newspaper in Business and Economics)

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