is when a firm or country expands its production and/or sales into
other goods and services in addition to the goods and services it
already produces (exports).
We saw in an earlier section that a significant problem faced by many less developed countries is that of overdependence on one, or a few, primary products. This was identified as a high risk strategy on account of a tendency for the prices of primary products to be susceptible to large fluctuation (volatility) in prices: which has a negative effect on producers' incomes, savings, tax revenues and the country's balance of payments current account situation.
As a consequence, many less developed countries´ governments want their economies to achieve greater sustainability through diversifying into new areas of production. It is recognised by economists that there is a link between economic diversity and sustainability, and a policy of economic diversification can reduce a nation's economic volatility and increase its growth.
Diversification can be considered on a number of levels:
- Diversification of production - where a country expands the range of goods and services that are produced by firms within the country.
- Diversification of exports - where a country expands the range of goods and services it exports abroad.
- Diversification of markets - where a country looks to sell its goods into different markets.
It is also possible to consider diversification in terms of being:
- Horizontal, where producers within a country expand the range of goods and services they already produce, thus spreading the potential risk.
- Vertical, where producers within a country expand to undertake other areas of production associated with an existing good or service, but closer to the consumer or the primary producer.
By diversifying, countries and firms can:
- Reduce the risks associated with:
- reliance on one or a few products
- volatile prices
- downward long term trends in prices,
- resource exhaustion
- changes in consumption pattern.
- Expand production and exports by exploiting opportunities in new and growing sectors of economic activity.
- Expand production and exports in areas where there is greater opportunity for value added and income generation.
Given these clear economic benefits, why do some countries find diversification difficult?
- The discovery and exploitation of high price commodities, e.g. oil in Angola, reduces the pressure to diversify.
- Political unrest and conflict, e.g. in Ivory Coast, impedes diversification
- Lack of growing markets, e.g. Tunisia has been unable to diversify to take advantage of their proximity to a growing European market.
- Lack of a stable and sustained macroeconomic policy discourages diversification. Controlling inflation and exchange rates is essential if stability is to be achieved.
- Existence of a 'Dutch effect', when a buoyant primary sector exerts upward pressure on exchange rates and diverts resources from other sectors of the economy.
- Lack of finance available for public and private sector investment in productive and social infrastructure.
- Restrictive structural adjustment programmes, required by the World Bank and IMF, are thought to impede diversification as countries have to operate tight fiscal policies that discourage spending on infrastructure.