Gas reserves found off the northern coast of Israel

Israel is set to join the other natural reserve Middle-East nations after discovering a gas field under the eastern waters of the Mediterranean. On the surface this could provide a huge boost to the economy with revenue gains invested into other growing sectors of the economy. However, this has the potential for Israel to catch the ‘Dutch Disease’.

The term ‘Dutch Disease’ was coined by The Economist in describing the series of events a country often faces after discovering and extracting natural resource reserves. The theory suggests that a natural resource is discovered which boosts capital inflows through investment either within the sector or bonds. These capital inflows take the domestic currency off the market thus appreciating the value. With the domestic currency now stronger than other currencies (ceteris paribus) all domestic exports are more expensive. The sectors without the necessary subsidies to improve their competitiveness will slow and firms will close thus creating a situation where all investment goes into the natural resource sector. When this resource is depleted then it potentially renders the economy uncompetitive in all sectors and a slump could occur.

There are ways to combat this. Firstly the domestic economy could currency manipulate through quantitative easing or building foreign capital reserves. This would keep the domestic currency at a competitive rate thus maintaining export potential and inflation could be controlled in the future.

Secondly the central government could tax this sector meaning that the revenue gained could subsidise other sectors or could fund currency manipulation. It would also have the effect of slowing the capital inflows to a more manageable rate.

It looks as if the route chosen is to go hard on high taxation: http://online.wsj.com/article/SB10001424052748704804504575606751114647506.html?mod=googlenews_wsj

Given the geo-political issues surrounding Israel and its neighbours the discovery has raised more questions than answers. Lebanon is particularly wary of Israel drilling into its waters especially given that land borders and therefore maritime borders have not been fully agreed.

This could be a huge bonus for the Israeli economy so long as it outweighs the potential geo-political turmoil that would ensue.

 

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