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Macro Research for Development: An IMF-DFID Collaboration

Topic 6. Growth through Diversification

Last Updated: October 17, 2014

Why is economic diversification important for LICs?

LICs have historically been heavily dependent on a narrow range of traditional primary products and relatively few export markets for the bulk of their export earnings. Such limited diversification may result in narrowly based and unsustainable growth, with production and exports concentrated in sectors characterized by low technology spillovers and slow productivity growth. Further, lack of diversification may increase exposure to adverse external shocks and vulnerability to macroeconomic instability.

While diversification has long been an ambition for many LICs, we have limited understanding of what aspects of diversification are important, what drives it, and how to promote diversification without resorting to the risky practice of "picking winners."

The project has the following objectives:

Diversification and Structural Transformation: Broad Trends and Case Studies

First, we will review the evidence on the successes of LICs in achieving diversification and promoting structural transformation—that is, the continued, dynamic reallocation of resources from less productive to more productive sectors and activities. The focus is on differences between countries and over time, and in particular on identifying positive or negative outliers. The project will also examine the extent to which continuing changes in the world economy (in particular the broad process of globalization and China's emergence as a global economic force) create opportunities or obstacles for diversification in LICs. A number of case studies from sub-Saharan Africa and East Asia (e.g., Tanzania, Angola, Vietnam and Bangladesh) will be instrumental in learning from country experiences.

Macroeconomic Relevance of Diversification

Second, the project will analyze the relationship between diversification and macroeconomic performance, broadly interpreted to cover both medium-term growth and short-term volatility. While we are far from reaching a consensus regarding the determinants of growth and stability in LICs, what we know with certainty is that the new wave of trade and financial globalization in the early 1990s was accompanied by significant structural reforms and structural change in many developing countries trying to take advantage of the new opportunities.

Quality Upgrading

Third, the project will build on the notion that diversification involves significant changes not only in the type but also in the quality of goods produced and exported. Producing higher-quality varieties of existing products can constitute a way of building on existing comparative advantages. It can boost countries' export revenue potential through the use of more physical- and human-capital intensive production techniques. Therefore, for LICs at early stages of development, diversification into products with longer quality ladders may be a necessary first step before large gains from quality improvement can be reaped. On the other hand, LICs' small economic size and limited potential to exploit economies of scale may result in a high cost of moving into many new products, making quality upgrading within existing products all the more important.

Determinants of Diversification and Quality Upgrading

In addition, the project will identify distortions that hamper diversification and quality upgrading and identify measures that may remedy such failures. The focus will be on both structural rigidities in labor and product markets and other policy barriers such as inefficiencies in public investment, obstacles to FDI, and inappropriate macroeconomic stances.

Policy Messages

The ultimate goal is to inform the policy debate on how diversification could help LICs enhance both macro stability and their resilience to shocks and promote a transition to higher and more sustained growth.

Looking Forward

A Staff Discussion Note was published in December 2012, summarizing work on the project to date. This will be followed by several working papers dealing with each of the sub-topics. For 2013, additional plans include a conference on LICs' diversification challenges. Staff are also considering plans for an IMF Board Paper on diversification and structural transformation, focusing on policy challenges and responses.

Applications
Country Status
Angola Starting
Bangladesh Starting
Malaysia Starting
Tanzania Starting
Vietnam Starting

Papers

Working Papers

Published Papers

Diversification Toolkit

Export diversification and quality upgrading datasets can be downloaded from: