No. 8/2006

RESOURCE BOOM, PRODUCTIVITY GROWTH AND REAL EXCHANGE RATE DYNAMICS - A dynamic general equilibrium analysis of South Africa

Hildegunn Ekroll Stokke

We study the impact of a natural resource boom on structural change and real exchange rate dynamics, taking into account the indirect effect via relative sectoral productivity changes. Our contribution relative to the Dutch disease literature is threefold. First, the productivity specification is extended from simple learning by doing to include trade barriers and technology gap dynamics, consistent with the modern understanding of productivity growth. Second, we offer a dynamic general equilibrium model with imperfect substitution between domestic and foreign goods. Third, the model is applied to South Africa and analyzes the macroeconomic impact of the gold price increase in the 1970s. Political pressure for rapid domestic spending after a surge in resource rents tends to generate myopic government behavior with unsustainable high consumption spending. Such fiscal response to higher resource income is captured by the model specification. Numerical simulations show how the resource boom can help explain the structural change and real exchange rate path observed in South Africa. Due to productivity effects the initial real appreciation is followed by gradual depreciation of the real exchange rate.