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Table of Contents

  1. Topic pack - Development economics - introduction
  2. 4.1 Economic development (notes)
  3. 4.1 Economic development (questions)
  4. 4.2 Measuring Economic Development (notes)
  5. 4.2 Measuring development (questions)
  6. 4.3 The role of domestic factors in economic development (notes)
  7. 4.3 The role of domestic factors in economic development (questions)
  8. 4.4 The role of international trade (notes)
    1. Role of international trade - introduction
    2. Trade problems (LDCs)
    3. Problems - over-dependence on primary products
    4. Price volatility of primary products
    5. Consequences of price volatility
    6. Price increases can also be problematic!
    7. Price volatility case study - tomatoes
    8. Price volatility case study - copper
    9. Trade strategies for growth and development
    10. Import substitution
    11. Import substitution case study - sorghum
    12. Export promotion
    13. Export promotion case study - Thai toy industry
    14. Trade liberalization
    15. The role of the World Trade Organization
    16. Background information
    17. The Doha round
    18. Case study - trade sanctions
    19. Bilateral and regional preferential trade agreements
    20. Case study of a bilateral preferential trade agreement
    21. Case study of a multilateral preferential trade agreement
    22. Some background reading
    23. Diversification
    24. Case study - diversification
    25. Diversification in Malawi - video
    26. Some background reading
  9. 4.4 The role of international trade (questions)
  10. 4.5 The role of Foreign Direct Investment (FDI) (notes)
  11. 4.5 The role of foreign direct investment (questions)
  12. 4.6 The role of foreign aid and multilaterial development assistance (notes)
  13. 4.6 The role of foreign aid and multilateral development assistance (questions)
  14. 4.7 The role of international debt (notes)
  15. 4.7 The role of international debt (questions)
  16. 4.8 The balance between markets and intervention (notes)
  17. 4.8 The balance between markets and intervention (questions)
  18. Print View

(f) Diversification

S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_microeconomics\images\choice_change.jpgDiversification 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:

  1. Horizontal, where producers within a country expand the range of goods and services they already produce, thus spreading the potential risk.
  2. 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:

  1. Reduce the risks associated with:
    1. reliance on one or a few products
    2. volatile prices
    3. downward long term trends in prices,
    4. resource exhaustion
    5. changes in consumption pattern.

  2. Expand production and exports by exploiting opportunities in new and growing sectors of economic activity.

  3. 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.