Diversification and policy variables constitute a two-way process in that diversification not only influences policy outcomes, but is itself influenced by policy variables.
This proposition naturally leads to the search for those economic and non-economic policy actions that are likely to affect the level and rate of diversification in a country.
What evidence is there that links economic and non-economic variables with national capacity to diversify?
Do more investments and higher income deepen diversification? Does the diversification process in Africa follow the two stages described in Imbs and Wacziarg (2003), suggesting that there is a turning point where diversification deepens as investment and income rise and economic specialization sets in? Are increases in trade and promotion of industrial products also significant determinants of diversification? Given the centrality of macroeconomic stability in the policy discourse over the last three decades, do macroeconomic variables such as competitive exchange rates deepen diversification? What about the balance on government budget and inflation?
Obviously, the answer to these questions depend to a large extent on whether the deficit is driven by expenditure that has a direct impact on the productive capacity of the economy. On the other hand, where deficits result from recurrent spending such as fiscal policy they could undermine the diversification process. What are the results for African countries with regard to this? In terms of inflation, a key question is whether its level falls within that band where it is not injurious to growth.
Moderate but stable inflation might not slow down diversification. Is it also possible that political violence and civil conflicts have proved counter-productive by slowing down economic growth, and therefore impeding diversification? How much does good governance and a good investment climate help in deepening diversification?
Table A5.1 shows results obtained from aggregate African data in seeking answers to these questions (see Ben Hammouda et al. 2006a for details). The key findings are discussed below.
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