Export Diversification and Economic Growth

Export Diversification and Economic GrowthOne of the soonest ideas in the theory of frugal developing is that the degree of specialization or variegation of a bucolics mathematical product and trade coordinate is important for its economic development (Wim Naud and Riaan Rossouw, 2008). But, the question whether developing countries should diversify their export production to achieve economic growth or rather specialise in order to achieve comparative degree degree advantage has been a debatable issue. Some researchers find that export diversification is better for economic growth in developing countries as their dependence on direct commodity production and exports leaves them vulnerable to commodity shocks, price fluctuations and declining terms of trade, particularly since the income elasticity of the demand for primary commodities is low (Prebisch, 1950 Singer, 1950 and Rosenstein-Rodan, 1943). While others advocate for specialisation, for example, from decade Smiths r ecognition of the importance of the division of labour and specialization for economic growth and development, to the standard Heckscher-Ohlin Samuelson (HOS) model of international trade, the position in neoclassical economics has been that countries should delineate in producing and exporting according to their comparative advantage (Wim Naud and Riaan Rossouw, 2008). Thus, many theories are based on Should developing countries focus on diversifying their export basket or should they rather specialise their exports according to their existing comparative advantage?2.1. DefinitionsExport diversification, by definition is the changing of a countrys export structure. This elicit be deliver the goods by changing the existing basket of commodities or by embellishing them done innovation and technology. Dennis and Shepherd (2007) define export diversification as widening the image of products that a country exports. As a matter of fact, export diversification back end take two fo rms, namely, crosswise and vertical. Export diversification has different dimensions and provide be analysed at different levels (Ali et al., 1991). Herzer and Nowak-Lehnmann (2006) explain that export diversification can occur either horizontally or vertically.Horizontal diversification causes changes in the primary export mix in order to reduce the effect of the fluctuation of global commodity prices. It also implies that the number of export sectors has increased. This reduces the dependency on a few sectors to lead export-oriented growth (Marianne Matthee and Wim Naud (May 2008). It brings forth stabilisation in export earnings (Al-Marhubi, 2000). If growth is to be achieved though horizontal export diversification, a country can either enlarge the share of products with increasing growth rates in export earnings, or it can add in the altogether products based on the growth rates of world prices (Ali et al., 1991).On the other hand, vertical diversification involves contrivin g further uses for existing and new innovative commodities by means of value-added ventures such as processing and marketplaceing (Poverty and Development Division, United Nation, June 2004). Vertical diversification occurs when the export mix of a country shifts from primary products to construct products. The production of primary exports does non result in as many spill-overs as the production of manufactured exports (Marianne Matthee and Wim Naud, May 2008). In the latter, externalities on, for example, knowledge and new technologies are created. These externalities benefit other economic activities (possibly creating horizontal diversification) and improve the ability of all industries to compete internationally (Chuang, 1998 Al-Marhubi, 2000 Herzer and Nowak-Lehnmann, 2006). Vertical export diversification also contributes to stabilisation in export earnings, as the prices of manufactured exports do not fluctuate as much as those of primary exports (Ali et al., 1991). If gr owth is to be achieved though vertical export diversification, a country can either introduce, expand value-added activities, or it can choose new products based on their value-added potential (Ali et al., 1991). Hausmann et al. (2005) conclude that the composition of a countrys exports matter, as countries that produce higher(prenominal) productivity goods experience great export performance and are subsequently able to benefit more from the gains of globalisation.Both horizontal and vertical diversification can be favourable for a countrys economic growth however their performance would vary in terms of technological, managerial and marketing skills. Vertical diversification policy, compared to horizontal diversification policy, requires more advanced technology, skills and initial capital authorisement than horizontal diversification policies do. In result of that, vertical diversification may produce greater dynamic externalities than that of horizontal diversification.2.2 The oretical ReviewThere are many theoretical reasons, put in advance by researchers, which says that export diversification leads to higher per capita income growth. Because of fluctuations in export, many developing countries opt for export diversification. As mentioned is made above, this instability arises as commodity products are often subject to very volatile market prices so that countries that are dependent on these commodities may suffer from export instability (Heiko Hesse, 2008). As a result of the stated instability, risk-averse firms might not invest in the country which can create macroeconomic uncertainty and in turn can be disadvantageous for long run economic growth. To foresee this instability many countries have liberalised trade. Michaely (1958) studied export and import concentration using GINI co-efficient on the dataset for 44 countries and 150 Standard International Trade mixture commodities and notes that countries with more diversified export structure are more developed in terms of income per capita, and more industrialized in terms of primary commodity share in full(a) export. Export diversification could therefore help to stabilize export earnings in the longer run (Ghosh and Ostry, 1994) Bleaney and Greenaway, (2001)). According to geomorphologic models of economic development, countries should diversify from primary exports into manufactured exports in order to achieve sustainable growth (Chenery, 1979 and Syrquin, 1989).However, the concept of export diversification seems to contradict trade theory, especially Ricardos theory of comparative advantage where a country should specialise (Salvatore, 1998). Ricardo laid emphasis on the role of specialization in international trade and increases total productivity. According to him, export is said promote economic growth by specialising in sectors in which a country has a comparative advantage. In the identical way, Helpman and Krugman (1985) pointed out that greater economies of sc ale due to increased exports can lead to an increase in the productivity level. In spite of the relationship identified in the midst of trade and productivity, the impact of specialization on the long run growth remained uncertain to many scholars. Sachs and Warner (1997), for example, identified a negative impact of a comparative advantage in raw materials on economic growth.More recently diversification and specialization has been studied as the part endogenous outcome of a countrys stage of development (e.g. Acemoglu and Zilibotti, 1997 Imbs and Wacziarg, 2003). This theory is based on countries production and therefore has an effect on their export, as there is a relationship between production and export. Ramacharan (2006) finds that a one standard deviation increase in diversification is associated with about a 0.81 standard deviation increase in the level of confidence to the private sector. Thus, diversifying the sectoral composition of the economy, ordain benefit financi al development, which in turn, as shown by Chang (1991) may allow countries to engage in more specialization of exports, wedded that developed financial markets may provide insurance against risk. This analysis may lead one to conclude that countries export structure may go through phases, from less diversified to more diversified, followed by a phase of less diversification and more specialization, as the financial sector development deepens (Saint-Paul, 1992). Diversifying the production structure of the domestic economy may therefore be a requirement for export diversification and later export specialization.Another theory has been put forward by Marianne Matthee and Wim Naud which states that, this trend in trade has led to spatial inequality. This is so because, with trade liberalisation, small local businesses suffer which can result in a decrease in Gross Domestic Product (GDP) and eventually economic growth. Marianne Matthee and Wim Naud (May 2008) mentioned that in a more open economy with firms being able to export more, local firms become less reliant on the local market with a subsequent reduction in the forces of agglomeration. Furthermore, not all developing countries will gain with high export as their location can be an important determinant for their export propensity. But, export diversification contributes to growth in a country (Herzer and Nowak-Lehnmann, 2006) and many studies have proven so on a country level.Related to export diversification, there could be knowledge spill-overs from new techniques of production, new management, or marketing practices, potentially benefiting other industries (Amin Gutierrez de Pineres and Ferrantino, 2000). Producing a growing basket of export commodities can be seen to have an active effect of export diversification on higher per capita income growth. Agosin (2007) develops a model of export diversification and growth where countries with low technological frontier widen their comparative advantage by imitating and adapting existing products. Furthermore, models in the product cycle literature (Vernon, 1966 Krugman, 1979 Grossman and Helpman, 1991) obtain diversity of export products by the North innovating and the South predominantly imitating and exporting the products from cheap labour countries.