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5.1 Macroeconomic stance is crucial to diversification outcomes: Economic Report on Africa 2007

Guest post by: United Nations Economic Commission for Africa

Article Overview: An important aspect of the diversification debate and of Africa’s experience has to do with the role that macroeconomic policy plays. This has also been investigated at the continental level in the results that are presented in table A5.1. Two important indicators of macroeconomic stability, depending on the macroeconomic policy in operation, are inflation and real effective exchange rates and these are found to be among the most critical determinants of diversification outcomes in Africa.

5.1 Macroeconomic stance is crucial to diversification outcomes: Economic Report on Africa 2007

An important aspect of the diversification debate and of Africa’s experience has to
do with the role that macroeconomic policy plays. This has also been investigated at the continental level in the results that are presented in table A5.1. Two important
indicators of macroeconomic stability, depending on the macroeconomic policy in
operation, are inflation and real effective exchange rates and these are found to be
among the most critical determinants of diversification outcomes in Africa.

High levels of inflation damage diversification
High levels of inflation damage diversification prospects and the tendency under
such circumstances is for increased concentration with little opening-up to new
export sectors. This is not surprising, given that diversification in itself requires the
emergence and growth of new industries or sectors which are able to meet not just
the domestic demand for their products but also the competition on the international
market. A high inflation environment is not conducive to the development
and maturation of new sectors, nor is it supportive of an environment that fosters
other determinants of diversification so that they have significant impact. Ordinarily,
it is reasonable to expect that high inflation could lead to diversification as an
economy diversifies away from sector-specific income shocks. Due to incomplete
markets, economies can be led to diversify for insurance purposes, and to specialize
again as financial markets deepen (Saint-Paul 1992).


Effects of the exchange rate depend on existing export potential
The exchange rate affects diversification prospects as there is a significant relationship
between the two. The positive relationship between the exchange rate and the
diversification index suggests that a depreciating currency is not always supportive of
diversification efforts. These results might appear to be counter-productive in the sense
that depreciation underpinned by appropriate macroeconomic fundamentals should
support increases in existing exports and ease potential exportables into new markets.
Such a result supposes two elements. First, it pre-supposes that the country already
has this export potential and that the depreciation has the price effect of making the
exports cheaper for the foreign markets. It further assumes price-elastic export demand.
Second, it also assumes that the depreciation is supported by sound macroeconomic
fundamentals with the depreciation being more than a process of building or maintaining
competitiveness in the international market of the economy in question. The
positive relationship between the two means that the depreciation does not lead to
deepening of diversification. This could be interpreted in one of two ways.

In the first instance, it could mean that African countries have a narrow export
potential base and the depreciation simply makes the narrow export base more concentrated
and specialized. The second explanation could be that the depreciation is
symptomatic of macroeconomic instabilities whose consequences create an environment
that is not conducive for diversification. The implication of the results for inflation and the exchange rate is that macroeconomic stability is crucial for the
emergence of a diversified economy.

Related Articles
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  Overview IX: Economic Report on Africa 2007
  Overview VIII: Economic Report on Africa 2007
  5.1 Determinants of diversification in Africa: Economic Report on Africa 2007

Article Tags: concentration, continental level, critical determinants, depreciation, diversification efforts, emergence, exchange rate, exchange rates, export sectors, financial markets, incomplete markets economies, insurance purposes, macroeconomic policy, macroeconomic stability, maturation, prospects, saint paul, significant impact, table a5, tendency



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