ABSTRACT
Export expansion can be either through the extensive margin – new products or new markets – or the intensive margin – more of current products. Export diversification is therefore understood as the expansion of exports due to new products or new markets – extensive margin. Amurgo-Pacheco and Pierola (2007) provide a useful narrower definition by discussing a geographic dimension with export diversification via the extensive margin in the export of new products to existing markets, old products to new markets and new products to new markets. Why is export diversification important for Africa? Export diversification – and economic diversification in general – build the resilience of poorer countries to face external economic shocks. Diversification is more relevant today to Africa as the impact of the global financial crisis has affected both rich and poor economies globally. For Africa, with its high dependence on primary commodities and which faces fluctuating world prices on most primary goods, there is a need to pursue developmental strategies which promote export diversification. In addition, Africa requires high and sustained growth to help combat poverty. Export diversification is widely seen as a positive trade objective in sustaining economic growth (Brenton et al., 2007). Delgado (1995) argued that diversifying the agricultural export base and diversifying the economy across sectors are central to the long-run growth strategies in Africa given the high concentration ratio of agricultural exports (food and beverages typically account for well over half of merchandise exports in non-oil exporting African countries). Moreover, there is convergence in the developmental literature that growth requires structural transformation (primary – manufacturing – services trade), hence African economies must diversify their production base into high value-added production in order to achieve sustained economic growth.2 Diversification is sometimes claimed to be important not just for resource-rich countries, but as a pre-requisite for economic growth (UNECA and AUC, 2007). Almost every theory of international trade predicts that a larger economy will export more in absolute terms than a smaller economy. Nevertheless, trade theories differ in predicting how relatively larger economies export more (Hummels and Klenow, 2005). One strand of literature emphasizes export expansion through the intensive margin, based on seminal work by Armington (1969). Brenton et al. (2007) has argued that low income countries focus on greater differentiation of existing products rather than attempting to diversify directly into new export categories. On the other hand, some have argued for the expansion of exports via the extensive margin, based on the influential work of Krugman (1980). However, Hummels and Klenow (2005) argue that neither the intensive margin hypothesis by Armington (1969) nor Krugman’s extensive margin hypothesis fully explain international trade patterns in developing countries, and provided an empirical framework dividing trade expansion into both intensive and extensive. The authors argued that consumer preferences for variety increases as economic development increases, thereby providing an
incentive for export expansion in the extensive margin. Their study found that larger economies export higher volumes of each good (intensive margin), export a higher variety of goods (extensive margin)3 and export higher quality goods. Imbs and Wacziarg (2003) found that the process of diversification follows a two-stage process (U-shape relationship), in which growth in the early stages of development is accompanied by diversification, until a turning point upon which the trend reverses towards increasing specialization once more. Few African economies are at the level of development associated with the turning point towards specialization, suggesting that further growth on the continent can lead to greater diversification. This study adopts a measure of GDP per capita, and there is faint evidence of this relationship in Africa, although oil-exporting economies with relatively large GDPs but with poorly diversified exports are anomalies inconsistent with the two-stage diversification hypothesis. A recent finding (Karingi and Spence, 2011) suggests that many African countries are currently engaged in export activities (export sophistication) not commensurate with their level of development and hence associated with significant opportunity costs. The export sophistication4 (EXPY) measures weighted goods according to the income of the exporting countries (Hausmann et al., 2007) arguing that future growth is significantly influenced by current export sophistication. Countries such as Liberia, Madagascar or Egypt can be thought of as exporting products that are richer than they are, and as such can expect higher growth in the future. Imbs and Wacziarg’s (2003) U-shape relationship was later verified for developing countries by Cadot et al. (2008). The latter study suggests that growth at the income levels of most African economies should prompt diversification. As developing economies grow, consumption patterns change through Engel effects, that is, increased demand for a greater variety of goods as income rises. A rising middle class in Africa is likely to demand a larger variety of goods (AfDB, 2011). UNECA’s work on export diversification has reiterated the justifications for diversification with respect to growth dynamics (UNECA and AUC, 2007, 2011; Karingi and Spence, 2011). Ben Hammouda et al. (2006) offer a richer analysis of the diversification regimes in Africa, and found that there is little economic diversification despite prolonged periods of peace and stability. Some African economies remain poorly diversified, such as Burkina Faso and the Seychelles. Also, some African economies – for instance, Mozambique and Malawi – started the process but have not made any significant breakthrough in diversifying agricultural products and are yet to diversify into the higher value activities. Nonetheless, the authors found that some African economies with deepened diversification are engaging in structural transformation in a sustainable manner. Tunisia’s horizontal diversifications into high value activities and Madagascar’s capture of vertical value chains in clothing and apparels are examples. However, the study also found other African economies that were backsliding in the diversification process. Typically, the reason why African economies have attempted to move into new sectors is due to rising commodity prices which leads to an ever-increasing concentration of exports, enclave economies and Dutch disease effect.5 GuineaBissau and Angola can be categorized by this regime. Lastly, the study found
that countries which went through conflicts see their diversification prospects negatively impacted. Some countries which had undergone instability, such as Liberia, Sierra Leone and the Democratic Republic of the Congo, have had positive diversification outcomes when they became more stable. Export diversification through product differentiation in Africa has not been subject to extensive economic scrutiny. Brenton et al. (2007) articulate a convincing case for low income countries to focus on greater differentiation of existing products, rather than attempting to diversify directly into new export categories. This stems from the observation that export growth at the intensive margin is far more significant for developing countries than that at the extensive margin (i.e. export growth is dominated by intensifying trade in existing products rather than undertaking new export activities – see Amurgo-Pacheco and Pierola, 2007; Brenton and Newfarmer, 2009). This may be linked to the fact that the gains from developing new goods for export are socialized through information spillovers, yet the costs are private, leading to a sub-optimal level of innovation (Hausmann and Rodrik, 2003). Moreover, when developing countries do undertake extensive expansion, the survival rate is very low. With imperfect information firms are ex ante unaware of the profitability of entering foreign markets, and evidence suggests that Africa is particularly poor at sustaining export relationships once they are created. Besedes and Prusa (2007) show that African exports would have had a three percentage points higher growth rate if they had South Korea’s survival compared to a 1.8 percentage points higher growth rate if they had South Korea’s deepening (growth of trade in surviving relationships). For Malawi, just 35 per cent of export flows survive beyond one year (Brenton et al., 2007). Investing in improving the quality of existing products is further warranted on the grounds that rich countries import more from countries that produce higher quality goods (Hallak, 2006). In the policy framework of new structural economics (Lin, 2010) export diversification is best achieved by focusing on existing comparative advantage, where industries are competitive, leading to the capture of economic rents for reinvestment and subsequent upgrading of endowments structures. While this is suggestive of a need to prioritize intensive expansion through greater differentiation, Klinger and Lederman (2006) and Cadot et al. (2008) show that the process of diversification (as opposed to export growth) in low income countries is driven from inside the frontier innovation (emulations) and extensive expansion, suggesting that African countries should undertake new export activities if they are to succeed in diversifying exports, but that they should be in industries in which there is already existing expertise. In practice, the dichotomy between intensive and extensive expansion is of little prescriptive utility as export growth and diversification require the upgrading of production of existing exports and the undertaking of new export activities. This implies that African economies need to explore dynamic comparative advantages6 when promoting diversification. These are potential sectors outside Africa’s main comparative advantage sectors of primary commodities and fuel. The role of developing the manufacturing sector, therefore, is of crucial importance. Structural adjustment is a costly exercise and therefore identifying the potential success sectors is essential.
