The Dutch disease in Kuwait, 1973-88

• Main Author: Al-Yousuf, Ala'a H.
• Published: University of Oxford 1995
• Subjects: 330.95367
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.665302

Kuwait benefitted from positive oil shocks in 1973-74 and 1979-80 but also suffered from a protracted negative oil shock from 1982 to 1988. We analyse the impact of these shocks on the Kuwaiti economy with the help of the real Dutch disease model which we first adapt to better reflect Kuwait's institutional characteristics. We do this by relaxing three key assumptions upon which the model is based. These are: (i) the oil shock is permanent and therefore all income is consumed; (ii) capital and labour are fixed in total supply and homogenous; and (iii) the oil income accrues directly to households. Oil shocks also have monetary effects and the monetary Dutch disease model is also based on restrictive assumptions in addition to those pertaining to the real model. It is assumed that money is the only asset (financial or real) and that changes in the trade balance are the only source of changes in money supply under a fixed exchange rate regime. We relax these assumptions to allow for the monetary effects of fiscal policy, bank credit creation and the presence of domestic (nontradable) financial assets. After modifying the Dutch disease models to reflect the salient features of the Kuwaiti economy we use the resulting theoretical framework to analyse annual data for the period 1973 to 1988. The analytical approach of this study relies on the definition and measurement of quantity and relative price indices in line with the theoretical concepts in the Dutch disease literature. It seeks to improve on the methodologies used in previous studies. In the case of monetary effects this study goes beyond the traditional Dutch disease approach and explains the emergence and collapse the bubble in land and local share prices. We distinguish between five aggregates which comprehensively cover the components of GDP. These are: oil, tradables, private sector nontradables, public sector nontradables and public sector nonmarketables. We show that, contrary to the predictions of the real mode1.but in line with our extended theoretical framework, the output oftradables rose ) faster than that of private sector nontradables or public sector nonmarketables since it benefitted from subsidies (both direct and indirect) as well as from the influx of immigrant workers and capital. Using data on employment by sector we show that the unit cost in each sector reflects the employment pattern in that sector. We then analyse the impact of the oil shocks on investment and show that construction was more tradable than private sector nontradables. While the construction boom effect was weak, the property boom was significant. Data on land prices show that they rose sharply between 1980 and 1982 reflecting the impact of the second oil shock. The rapid growth in economic activity and bank credit following the two positive oil shocks increased the demand for nontradable domestic assets such as real estate and equity leading to an asset price bubble.