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ECO2EDC Tutorial 11 - Answers 1. Read the article “Africa’s youth can inoculate it from Dutch disease” and answer the following questions: a. How does the matching skills argument explain, at least in part, the high youth unemployment rate experienced in Africa? b. The authors state that the resources wealth “wipes out” all other forms of economic activity. This is clearly an exaggeration but we know that a boom in exports of primary goods can negatively affect other production sectors. Explain how this may happen through the following effects: i. The appreciation of the nominal exchange rate ii. An increase in the prices of non-tradables (Spending effect) iii. Resource movement effect c. What do the authors suggest in terms of avoiding the Dutch disease?

Answers a. The authors argue that the large investments of multinational corporations in Africa and the high and increasing youth unemployment rate may be explained by the mismatch of the job requirements of these companies and the capabilities of the African young population. They state that over 50% of African youth are illiterate and have limited skills required for the emerging business economy. b. *See the lecture notes for a more detailed description of the effects. A summary is provided here: i.A boom in exports of primary goods (due to sudden increases in prices or discoveries of natural resources) produces an inflow of large amounts of foreign currency that is exchanged in the local market for domestic currency. This increase in demand for the domestic currency bids up its value, leading to a nominal exchange rate appreciation (less of the local currency is needed to buy one unit of the foreign currency or equivalently, more of the foreign currency is needed to buy a unit of the domestic currency). An appreciation of the nominal exchange rate discourages exports, as it makes domestic products more expensive to foreign buyers (think of a tourist coming to Australia after the Australian dollar has appreciated). Then, exporting sectors will be negatively affected by the boom in exports of primary goods. ii.A significant part of the new foreign currency inflow is usually spent in the domestic market on non-tradables (think of energy, real estate, transportation, etc.). This increase in demand puts upward pressure in domestic prices producing inflation, which creates economic instability and rises the costs of production of exporting sectors. Inflation discourages exports even further. iii.The exports boom in the primary goods sector usually absorbs resources from other production sectors, reducing the supply of non-tradables and lagging tradables. The decrease in supply of non-tradables fuels inflation even further. c. The main suggestion of the authors is to invest the additional income produced by the boom strategically. By strategically they mean: i.Build a framework of education and infrastructure optimising revenues from the booming sector but enhancing agricultural production (usually a lagging sector in

Africa) as well as promoting linkages between the booming sector and the rest of the economy. ii.The authors argue that the tendency to spend the additional resources from the boom on consumption should be resisted. iii.Their most important suggestion is to invest the additional resources in increasing capabilities: “skills and businesses that will provide a future”. This implies promoting a structural transformation of the economy to reduce dependency on primary goods exports and investing in education and training that will help incorporate the increasing unemployed youth to the rest of the economy....