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Overview VIII: Economic Report on Africa 2007

Written by: United Nations Economic Commission for Africa

Article Overview: Evidence on the determinants and stages of diversification

Overview VIII: Economic Report on Africa 2007

The diversification process in Africa is highly influenced by investment, per capita
income, degree of openness of trade, macroeconomic policy stance and institutional
framework. To begin with, investment is vital for an economy to diversify.
Two stages of diversification with respect to investment can be observed for Africa,
with a U-shaped relationship between investment and diversification. Unfortunately,the turning point for Africa was found to be at 12.5 per cent of GDP, indicating that
if the continent is to deepen its diversification process, much higher levels of investment
to GDP ratios are required.

A second important finding in this report relates to income effects on diversification.
Like in the case of investment, the two stages of diversification as established in the
literature were confirmed in the case of African countries. The report also argues
that trade openness does not necessarily lead to deepening of diversification, based
on existing literature and the experience in openness for Africa. It is evident that a
strategic trade policy is needed to strengthen this process in Africa.

Rapid liberalization in Africa has put a break on the diversification process
Rapid liberalization could have acted as a constraint to diversification on the continent.
The results suggest that the debate on optimal trade policy is highly relevant.
Specifically, the evidence for African countries suggests that there is merit in the
argument for policy space with respect to trade liberalization. African countries may
wish to adopt a gradual approach to liberalization. Indeed, historical evidence indicates
that countries that promote diversification first before specializing enjoy much
higher and more sustainable levels of welfare.

Macroeconomic stability is necessary for diversification

Industrialization helps to deepen diversification, which fits well with the established
development theory that a country evolves from specialization to diversification
through industrial deepening before starting to specialize again. Some elements of
macroeconomic stability are critical to diversification. In particular, fiscal conservatism
appears to be an important constraint to diversification.

The institutional environment is critical for diversification

Good institutions provide an enabling environment for diversification. In particular,
good governance enables economies to diversify while conflict stifles diversification.
Therefore, consolidation of institutional reforms both at the aggregate (e.g., the legal
system) level and at the microlevel (e.g., business and banking regulation) constitutes
an important part of the national agenda to promote diversification.

Diversification contributes to growth through productivity

It is well established that economies grow faster when there is an increasing share in
the contribution of productivity to growth. Indeed, the rates of economic growth
among developed economies are differentiated mainly by the rate of growth of productivity
rather than the rate of factor accumulation. Growth in African economies can, therefore, be scaled up by enhancing diversification, which in turn leads to an
improvement in productivity. Deepening diversification is as important as eliminating
conflict and investing in human capital, in terms of improving productivity and
by extension, economic growth.

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Article Tags: Africa, African countries, diversification



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