Dutch disease is a term used to describe a condition in which the economy of a country is damaged after its income increases. This term was named after an incident in the Netherlands in the 1960s in which large amounts of natural gas were discovered. Dutch disease ultimately leads to a lack of competitiveness in other markets and the country begins to rely on imports.
In many cases, Dutch disease is used to describe a situation in which a large amount of natural resources is discovered in a country. Even though it is commonly used in regards to natural resources, it can apply to any situation in which a country suddenly becomes more wealthy. As a result of the newfound wealth, the country starts to suffer in other areas.
One of the first things that will occur during this situation is that the residents of a country will become more wealthy. In the example of finding natural gas or oil, many landowners will find themselves with larger incomes as a result of the find. This means that individuals who previously were involved in other trades are now going to focus solely on the endeavor which brings them the most money. When this happens, many industries that are not related to the primary industry start to suffer.
When many individuals suddenly have more money, this can take willing workers out of necessary industries. For example, individuals who previously worked in manufacturing plants will quit to pursue other endeavors. When this happens, it negatively impacts the ability of the factory to compete with the rest of the market place. The country will soon find that its exports are no longer competitive.
The second part of Dutch disease finds the country relying more on imports. Areas in which countries used to be able to rely on are no longer viable. In these areas, the country can no longer produce the assets needed at competitive prices. This results in the country having to purchase certain things from other countries.
At this point, the country relies on imports just to get by. Due to excessive reliance on imports, the country's economy starts to suffer. This can negatively effect the floating exchange rate between two currencies. As a result of Dutch disease, the country finds itself in a situation which is actually worse than before the newfound wealth was achieved by its residents.