The Importance Of Export Diversification

The Importance Of exportationationationinging Diversification to begin with a rural atomic number 18as scotch development was based either on the degree of forte or variegation of a countrys production and trade structure. Based on Adam Smiths concept towards division of labour and specialization for frugal egression and development to Heckscher-Ohlin Samuelson (HOS) place of worldwide trade, countries should specialize in producing and specializing in the goods in which they pick out a comparative vantage. However, after the Second World War, the idea was that scotchalal maturement and development whitethorn be achieved by export variegation (not specialization). in that respect were active efforts by the government to conjure up industrial enterp uprising and economic ontogeny.Export variegation is often the primary objective of many developed countries. Export diversification is alike equally serious for many underdeveloped countries. Some of the d evelop countries ar dependent on relatively small range of products, generally agricultural commodities. In some different words, primary products constitute a giving percentage of their overall export earnings. Some economists much(prenominal) as Prebisch acquit even conjureed that at that place is a persistent term tendency for primary product tolls to decline vis--vis those for cultivate goods. Countries that argon good dependent or extradite a narrow export basket usually faces export unstableness which arises from inelastic and unstable global film. This plenty consequently have a signifi nookyt adverse concern on the macro providence of least developed economies in terms of investment funds and employment. Thus export diversification is one actor to alleviate these constraints. Export diversification refers to the move from traditional to non traditional exports. ontogeny countries should vary their exports since this lowlife for example, help them to ove rcome export mental unsoundness. Diversifying the export portfolio could intensify and accelerate the economic fixth. Export instability could discourage needful investments in the deliverance by run a riskiness-averse firms, increase macroeconomic misgiving and be damaging to longer term economic branch. Export diversification could thitherfore help to stabilize export earnings in the longer run (Ghosh and Ostry, 1994 Bleaney and Greenaway, 2001). Countries with the slightest level of export diversification atomic come in 18 those which face instability in export earnings. Some examples of countries which have instability in export earnings delinquent to very heavy reliance on exports of one or two commodities atomic number 18 Kiribati, Samoa, Tuvalu and the Marshall Islands.Reasons for export diversificationExport diversification may be an of import issue for developing countries for several reasons. First, a modify big money of export products provides a hedge tow ards price waverings and shocks in specific product grocery store places (Bertinelli et al., 2006 Levchenko and di Giovanni, 2006). Second, the type of products exported mightiness go economic growth and the emf for structural change (Hausmann et al., 2007 Hausmann and Klinger, 2006 Whang, 2006). Third, export diversification in the manner of much sophisticated products may be beneficial for economic development. Given these potential benefits of export diversification, an important policy question is what a country can do to diversify its exports.For shortsighted countries to grow rich, it is important for them to modify the composition of their exports which leave alone enable them to look to a greater extent like that of rich countries. For over 50 years, economic and export diversification has been given high importance on the list of priorities for development policy. The disputation was based on the observation that dependence on primary good production and exporta tion by developing countries expose them to commodity shocks, price fluctuations and declining terms of trade. As a result, a countrys foreign win over reserves and the ability to have funds for imported inputs become subject to instability and uncertainty. The debates about the Prebisch-Singer possibleness (1959) and the need for industrialization gave priority to diversify economies away from primary commodities because of unfavorable and declining terms of trade, slow productivity growth, and relatively low value added. there argon several reasons for developing countries to have export diversification. Firstly, diversifying their bundle of exports allow protect them from the risk of unpredictable declining trend in international prices of primary exportable commodities that, in turn, trace to unstable export earnings. Export diversification could therefore help out to stabilize export earnings in the longer run (Ostry, 1994 Greenaway, 2001). FAO (2004) importanttains that callable to the absence of export diversification in developing countries, decline and fluctuations in export earnings have contradictly influenced income, investment and employment. Diversification provides the opportunities to extend investment risks over a wider portfolio of economic sector which eventually increase income (Acemoglu and Zilibotti 1997). Romer (1990) believes that diversification can be seen as an input factor that has an effect of increasing the productivity of other factors of production. Through exports it is also possible to shape an environment that creates competition and as a result acquire newfangled skills. Overall economic growth and acquisition of human neat may be slow if there is the absence of pressure from out-of-door competitive strong suits (Husted and Melvin, 2007).Diversification helps countries to hedge against adverse terms of trade shocks by stabilizing export revenue enhancements. It enables them to forecast positive terms of trade shocks into growth, fellowship spillovers and increasing returns to scale. Other industries in the country can also gain as export diversification can lead to knowledge spillovers from new techniques of production, management or marketing practices (AminGutierrez de Pineresand Ferrantino, 2000). Furthermore economic growth and structural change depends upon the type of products that is organism traded (Hausmann et al., 2007 Hausmann and Klinger, 2006 Whang, 2006). Thus by export diversification, an economy can progress towards the production and exportation of sophisticated products which may highly contributes towards economic development. Export diversification allows the government of an economy to achieve some of its macroeconomic objectives namely sustainable economic growth, satisfactory balance of payment situation, employment and redistribution of income.Strategies to promote export diversificationAs we see there ar potential benefits of export diversification, but the q uestion remains that what a country can do to diversify its exports. Potential determinants of export diversification, much(prenominal)(prenominal) as country size and level of development, trade bes, international distance, and the costs of domestic first appearance are all potentially associated with boastfullyr diversification. What can encourage export diversification? All successful high growth economies have had strategies to promote export diversification. These strategies implicate1. monetary sector development and orthogonal Direct Investment (FDI)Harding and Javorcik (2007) consider financial sector development and Foreign Direct Investment (FDI) can be helpful in promoting diversification. FDI can encourage exports of horde countries by boosting domestic capital for exports, serving to transfer technology and new products for exports, making access to new and liberal foreign markets easy and improving technical and management skills.2. Reduce CostsThe main deba te is associated to cost as export diversification is rather sensitive to costs. Kehoe and Ruhl (2003) with episodes of trade liberalization across 18 countries erect variable trade costs to be related with extensive growth margin. Lower cost means that there are fewer obstacles for domestic firm when exporting. The World aver Doing Business survey finished with(predicate) its Trading Across Borders section has included information on the number of procedures required for importing and exporting, as well as the time taken to comply with them. It also included trade costs such as document costs, inland transport costs, customs costs, ports costs, administrative costs and so on. In big terms, for the advancement of export diversification there must be incentive to make improvement on trade facilitation, i.e. set policy measures to reduce costs. Such policy measures include lowering domestic barriers to entry facilitate company registration by reducing number of procedures and ap plying a fixed registration fee, and removing the need for pre-tax payments.3. Lowering barriersLower barriers to firm entry and lower international trade costs, constitutes an important way in which developing countries can help diversify their export baskets. Export margin can be affect by changes in tariff rates and preferences (Debaere and Mostashari, 2005). In policy terms, one efficient way for developing countries to promote export diversification is to center regulatory reform efforts on making entry procedures simpler and slight expensive, as well as on trade facilitation measures.4. Learning-by-doingThe endogenous growth model states that exports can be more diversified through learning-by-doing and learning-by-exporting and by adopting practices of developed countries (Pineres and Ferrantino, 1997)5. Role of GovernmentThe government of an economy should playing period a leading function in the promotion of export. Investment should be directed into various sectors of manufacture. In so doing, the Government can make sure that investment is not being undertaken on more than just one specific sector so that a diverse industrial base can be built. The Government should provide a favorable environment to attracting new investment in the country. there may also be provision for favorable tax treatment to firms, tax holidays for export oriented undertakings, input used in the production of exports can also be exempted from value-added tax. Subsidies play an important role in promoting exports. Government can introduce cash incentive scheme which may benefit firms such as providing them with subsidies which will consequently encourage trade..6. Research and DevelopmentEfforts can be put into the RD activities to kindle the level of industry. This can be done by the help of fiscal and financial incentives which will pull in RD and technological innovation activities. Besides the Government, the banking placement and other financial authorities shou ld offer services to diversify and strengthen a countrys export. The banking system can facilitate diversification by its loan patterns. Schemes to diversify and promote exports need to be complemented by a suitable combination of fiscal, monetary and step in rate policies in order to be successful.7. Variation in the structure of demandImbs and Wacziarg (2003) proposed that a growing demand for a range of goods followed by an increase in a countrys income may lead to diversification. In other word, variation in the structure of demand leads to change in a countrys production pattern.Constraints to export diversificationIn spite of the liberalization in the export sector, there are still the presence of certain issues which bourne export diversification especially in least developed countries. Klinger and Lederman put together on Hausmann and Rodrik (2003) to enquire a causal family from market failures to inadequate diversification. There may be clash with other national polici es in an attempt to promote exports. Export diversification at times may be hindered by a number of factorsLow income elasticities of DemandSome developing countries are failing to export primary products due to the low income elasticities of demand for their primary products. Furthermore, prospects for developing countries to provide manufactured exports are poor because of the competition faced with the industrialized countries.Lack of financeLack of adequate export finance is determine as a major constraint. Small and medium exporters tend to be more severely touched by this constraint. A fundamental problem of export diversification is the lack of adequate investment in the country, both domestic and foreign. Exporters may face the problem of acquiring export finance. High rate of arouse on bank capital is also a constraint since it discourages them to take loan. In other words, exports are being restricted due deficiency in financing of trade by the countrys banking system.La ck of fitting InfrastructureEfficient infrastructure is the pre-condition for good export performance. Inadequate functioning of infrastructure may adversely affect enterprises in many ways. There may be difficulty in the transportation of goods due to limitations in infrastructure. It obstructs production activities, delays movement of goods and passengers, leading to delay in the delivery of goods. It adds to business uncertainty and risk and imposes additional costs.Bureaucracy and market accessGovernment rules and regulations relating to exports are complicated and too much composing work is needed. Considerable time is spent and officers should be appointed for sorting out matters with the government and agencies. commercialize access issues are complex. The major market access problems relate to i) non-tariff and para-tariff barriers, ii) pie-eyed quality and standard requirements, iii) stringent rules of origin, iv) labour and environmental standards. Environmental condit ionalities are a kind of new protectionism which can hamper market access. Tariff and non-tariff barriers also obstruct market access.Lack of strength in the public institutionsThe World Bank noted that the lack of strength in the public institutions hinder private sector activities. There is the alter of sound policy-making and public management, frustration of private entrepreneurship, prevention of competition and rising of corruption due to heavy regulatory and judicial systems and loss-making state-owned enterprise. Private investment can be deterred due because of poorly regulate and undercapitalized commercial banks, problem of telecommunications, infrastructure and law and order problem.Dearth of Skilled ManpowerOther constraints include domestic resource scarcity, shortage of trained labour, and lack of professionalism. There may be lack of skilled manpower in some sectors. Lack of skilled manpower has resulted in under utilization of potential export of services through manpower export as they are catering to only unequal to(p) and semi-skilled needs.Economic growthEconomic growth is a long run concept. It is usually defined as an increase in real gross domestic product (gross domestic product), that is, GDP adjusted for pompousness. In other words, it is as an increase in the real value of goods and services produced in the economy. For comparing one countrys economic growth to another, GDP or GNP per capita should be used as these take into account commonwealth differences between countries. Economic growth can be shown by an outward shift of the Production incident Curve (PPC). Economists see dissimilarity between potential and actual growth rates. Potential economic growth represents maximum efficiency with resources. It is determined by the factors of production that a country has as its command. However, actual growth represents resource utilization in practice and shows the result. This is determined by how effectively factors of product ion available to a nation are developed and combined. There are many factors which determine economic growth in a country.Determinants of economic growthNatural ResourcesCountries which are gifted with natural resources are expected to have rapid economic growth, assuming that these resources are employed for the production of goods and services. However a large add up of natural resources is not adequate to guarantee economic growth. There are a number of less-developed countries which have high natural resources, but still due to various reasons, they have not been successful in exploiting them. To benefit from economic growth, these natural resources must be converted to useful forms, which will need batch to be equipped with appropriate skills.Human CapitalHuman capital and reading are considered to be necessary conditions for economic growth. Lucas (1988) focused on the impact of human capital on long-run growth. The rise in productivity needed for economic growth can be ach ieved by increasing domestic human resources through education and training. Skills acquisition and the ability to keep on learning throughout the lifecycle are needed to develop individuals. Developing human resources through education and training is considered to be a long term process which will upgrade the innovative capacity of an economy. Apart from affecting factor of production, education and human capital can also have impact on factors such as somatic capital and natural resources (Bravo-Ortega and De Gregorio 2002. Azariadis and Drazen (1990) proposed that an economy can experience long-run economic growth if the government designs policies toward the promotion of education and human capital. Lucas (1993) pointed out, the appeal of human capital specially, knowledge is a name factor in explaining the growth experiences of countries.Capital AccumulationCapital accumulation refers to buildings, machinery, infrastructure and the amount of tools available to the economy . A necessary prerequisite for economic growth is a large capital stock. Developed countries do spend a significant amount on capital formation. For example, in UK in the year 1998 and 1999, 12% of annual GDP was spent on fixed capital. Capital is a major factor affecting growth. The more an economy has as capital, the more it can produce and the higher will be real income. If there are few machines available, a nation will be able to make fewer goods and services. More machines will mean more income can be generated. Therefore, the larger the capital stock, the larger is the potential income. In short, we can say that investment in capital should increase the productive potential of an economy. Young (1994) plunge that Asian tigers success resulted from rapid accumulation of capital (through high investment). The Solow model predicts that investment rate is a key determinant of whether a country is rich or poor. Fingleton (1999) found capital accumulation as being the determinant of europiuman region productivity growth.TechnologyThe most important determinant for an economy to grow is associated to its pace of technological progress. This is because with technology, we can obtain more output from same amount of input as before. Neoclassical economists regarded technological progress as a critical source of economic growth. Romer (1990), Aghion and Howitt (1992), Grossman and Helpman (1994) and Basu and Weil (1998), among others, concentrated on the role of innovation and technological progress on long-run growth. Economies must invest in knowledge just as they must invest in fixed capital. The productivity of capital can be increase if machinery is updated so that firms use the latest technologies available. Technological advances are encouraged when there is investment in research and development. De Long and Summers (1993) has shown that the only variable that have a significant positive effect on growth of less-developed economies is the investment in e quipment Technological progress, along with accumulation of human and capital, is essential in find out a nations rate of growth. For example, the large growth in the U.S. economy during the introduction of the Internet and the technology that it brought to U.S. industry as a whole. The Solow-Swan Growth Model which entailed a series of equations shows the concept of growth as an increase stock of capital goods. According to this view, the role of technological change became crucial, even more important than the accumulation of capital.(e) OpennessOpenness to international trade accelerates productivity and promotes export as well as economic growth. Romer (1989) stressed on the issue that growth in the volume of trade is positively correlated with the growth of output for a country. Edwards (1993) and Rodriguez and Rodrik (2001) also carried an extensive review of the empirical literature on the growth make of openness. Increasing importance is being attributed to the opening up of the world economy. Globalization is seen to be good for the Worlds economy. slender studies suggest that there is a positive correlation between trade liberalization and an increase in per capita income. In other words, the more an economy is open, the higher is rate of growth. Development in Eastern Europe and the World Trade Organization highlight that during the last twenty years, more and more areas of the world economy have been brought into the competitive market-place. Such openness to trade, investment and competition are clearly important determinants to productivity growth. For example until 1858 Japan was inaccessible to world trade. The Japanese Government banished the trade restrictions which allowed trading with the rest of the world. then this had lead to a 65% rise in real national income (Huber, 1971 Husted and Melvin, 2007).FDI InflowThere are various channels through which FDI can positively affect economic growth technological transfer, capital accumulation, access to international markets, managerial and marketing practices and employment (Lall 2000, Te Velde 2001, Borensztein 1998). FDI can increase competition which will eventually make domestic companies more efficient and encourage diversification. FDI benefits economic growth at large as it contributes to the domestic accumulation of resources. Many studies have been carried out which demonstrated a positive physical contact between FDI an economic growth. Campos and Kinoshita (2002) take ind the effects of FDI on growth for 25 Central and Eastern European and fountain Soviet Union economies and found a positive relationship between them. However there are certain studies which are undertaken that do show any influence of FDI on economic growth for example, Carkovic and Levine (2002), Bacha (1974), Saltz (1992) and Alfaro et al. (2002). largenessThere are many evidence which suggest that sustained high rate of puffiness can be detrimental to real economic growth even in the lo ng run. Fisher (1993) found proscribe links between inflation and growth in pooled cross-section, time series turnabouts for a large set of countries. Investors may face uncertainty about future profitability of investment projects. Barro (1995) put off that inflation diminishes the propensity to investment which eventually decreases growth. Inflation may also have a negative impact on the balance of payments as it reduces a countrys international competitiveness by making export dearer. Inflation can affect growth by altering borrowing and lending decisions. However whether inflation is good or bad for economic growth depends on its degree. That is, at lower rates of inflation, the relationship is not significant or even positive but at higher rates, inflation has a significantly negative effect on growth. In their analysis, Bruno and Easterly (1998) showed that some countries did not go through adverse consequences even if they were experiencing sustained inflations of 20% to 30%. On the other hand, once the rate of inflation go beyond certain critical level (which Bruno and Easterly estimated to be about 40 %), this causes negative effect to growth.However besides the factors mention above, there are also other factors that affect growth. Non-economic factors such as political and social factors too play an important role. The geographic location of a country may also affect economic growth. Government also can adopt both demand and supply-side measures in order to stimulate economic growth. Factors such as population growth, rapid growth of manufactured exports, stable macroeconomic and institutional environment creating confidence in policy makers, exchange rate, and labour force can affect growth in an economy.Link between economic growth and export diversificationPolicy-makers have tended to emphasize the potential benefits that export diversification can bring to the host economy. One of the main advantages which has been put forward by economists is that export diversification tends to increase economic growth in the host economy. There has been little empirical research on the relationships between export diversification and economic growth. There are two essential questions that the literature on this matter has tried to answer Does export diversification affect long run economic growth? Can a country improve its economic performance by exporting different types of goods? (Gutirrez-de-Pieres and Ferrantino, 2000). The primary questions are why do countries diversify their exports and does it incessantly benefit countries economic growth? Export instability can adversely affect growth in an economy. Countries which are dependent on a limited amount of commodities may suffer from export niggardness. This is because commodity products are often subject to volatility in market prices leading to swings in foreign exchange revenues. Volatility and instability can thus discourage investment in an economy by risk adverse firms, reduce import capacity, increase macroeconomic uncertainty and thus be detrimental to longer-economic growth.There are several channels through which diversification may influence growth. It is therefore essential to make a difference between horizontal and vertical diversification. Both of them are positively related to economic growth. Horizontal diversification means the alteration of the primary export mix in order to cop the volatility of global commodity prices. Horizontal export diversification benefits an economy in such a way that it diminishes dependence on a narrow range of commodities that are subject to major price and volume fluctuations. Dawe 1996, Bleaney Greenaway (2001) discovered that horizontal export diversification may present considerable development benefits as this may lead to well-directed economic planning and also contribute towards investment. Vertical export diversification on the other hand refers to contrive further uses of existing and new innovativ e commodities using value-added venture such as processing and marketing. The Prebish-Singer thesis is of the view that a tendency towards declining terms of trade of primary products (Athukurola 2000) may make vertical diversification into manufactures more useful. By highlighting the role of increasing returns to scale and active spillover effects (Amin Gutirrez de Pieres and Ferrantino 2000), the endogenous growth theory suggested that it can be assumed that export diversification affects long-run growth.Export may benefit economic growth through generating positive externalities on non-exports (Feder, 1982), increased scale economies, improved allocative efficiency and better ability to produce dynamic comparative advantage (Sharma and Panagiotidis, 2004). Esfahani (1991) cogitate that export enables developing countries to alleviate the import shortage they may face up to. Speaking differently, revenue from exports can fill the foreign exchange gap which is identified as barr ier to growth.A number of empirical studies have shown that export diversification is contributing to higher per capita income growth. The main theory is that, compared to nations with concentrated export structures, those countries with more diverse economic structures have greater possibilities to sustain periods of high economic growth. Love (1986) suggest that a country should avoid heavy dependence on limited products as it diminishes a countrys potential of partially offsetting fluctuations in some export sectors with sectors in which stability prevails. In his study, Al-Marhubi (2000) put forward that market investment becomes riskier because instability in export earnings is a main cause of economic uncertainty in many commodity-exporting nations. In other words, this may adversely affect investments and in turn negatively impact economic growth. Using a cross-country sample of 91 countries for the period of 1961-88, Al Marhubi conclude that there is a positive and strong r elationship between export diversification and economic growth. His regression was undertaken by adding different variables affecting export concentration to the basic growth equation. Regressions on cross-sections of countries (Sachs and Warner 1995, or more recently Gylfason 2004) and panels (de Ferranti et al. 2002) proposed that export concentration is certainly statistically related with slow growth, mostly when export concentration reflects the high proportion of primary products. A broad literature review on export diversification and economic growth was offered by Hesse (2008), where he estimated a simple augmented Solow growth model to examine the connection between export diversification and income per capita growth. There was strong support in Hesses findings that export concentration, mensural by a Herfindahl index, is harmful to economic growth in developing countries. The relationship between a countrys productivity and sectoral export variety was studied by Feenstra and Kee (2004). From an estimation of a translog GDP function system for a sample of 34 countries going from 1984 to 1997, they found that a 10 percent boost in export variety of all industries leads to a 1.3 percent increase a countrys productivity.Moreover another model of export diversification and economic growth was developed by Agosin (2007) where countries which lack technology, expand their comparative advantage by learning from and adapting to existing products. The cross-sectional regression of Agosin (2007) found that export diversification strongly affect economic growth. In addition, models in the product life cycle literature (Vernon, 1966 Krugman, 1979 Grossman and Helpman, 1991) gained variety of export products by advancement made by the North and consequently the South adopting and exporting the products from countries where labour cost are low. In his cross-country panel model, Lederman and Maloney (2007) concluded that one cause of diminution in growth prospects is the concentrations in export earnings. The advantages of export diversification for economic growth have been examined both empirically and theoretically in a new literature by Hausmann and Rodrik (2003), Hausmann, Hwang, and Rodrik (2006), and Hausmann and Klinger (2006). Their studies demonstrated that comparative advantage do not lead to economic growth. Instead, growth is achieved when countries diversify their investments into new or a range of activities. The model of Hausmann and Rodrik (2003) explained that there are various uncertainties related to cost in the production of new goods. They believed that the government should help in industrial growth and structural transformation by encouraging entrepreneurship and providing incentives to motivate entrepreneurs to invest in a new range of activities. Hausmann, Hwang, and Rodrik (2006) developed an indicator (EXPY) that determines the productivity level related with a countrys export basket. This measure is significantly affecting economic growth. Faster growth is achieved by countries that produce high-productivity goods than countries with poorer productivity growth. Economic growth is experienced when a country shift its resources from lower-productivity to higher productivity goods with elastic demand of these goo