Economic Diversification

Economic diversification is the process associated with the shift of a nation's economic focus from one sector to a variety of sectors. This is a method of encouraging economic development and growth in a positive direction. It also increases the income earned in a country.

Diversification is a critical element of economic development because it enables the spread of production and trade structure to various sectors of the economy. It reduces economic vulnerability and external shocks that undermine the development process. The diversification process helps in the reallocation of resources, reduces poverty, increases well-being, and balances growth in all aspects.

Economic diversification is the process of expanding the sources of income of a nation from a single area into different sectors. It involves the development of new products and industries, the introduction of services, and moving away from traditional sources of income. It is closely linked to structural transformation and reallocation of resources across and within various sectors of the economy.

There are various methods through which a country's economy can be diversified. This may be discovering new industries or integrating two different sectors to form a new sector or product. It is also applicable to the service industry. It all depends on scaling the existing levels to a different new level to support successive improvements.

Diversification can help in various aspects. It prevents a country's economy from crashing down in an economic shock. This happens when there are fluctuations in global demand and prices. It enhances economic stability as different industries respond differently to different market conditions. This reduces the overall risk faced by the economy. It can stimulate innovation, help train people with new skills, and improve their employability.

The process can help the country lead a balanced, more resilient economy with multiple sources of income. This leads to higher standards of living, better educational and medical facilities, and a better political, social, and economic environment.

It can be generalized and divided into two categories:

1. Product Diversification: Domestic production and the diversification associated with it are the result of the shift in domestic output across varied sectors, firms, and even industries. When different domestic sectors, firms, and industries produce a variety of products, they help capture the dynamics of structural transformation. This pushes the shift of activities from those resulting in low productivity to those in high productivity.
2. Trade Diversification: This type of diversification can happen in three ways. This could be done through the export or import of new services or products. The second is the export or import of existing services and products to new markets. Third, it is the upgrading of the quality of exported or imported products. Trade diversification helps facilitate the easy integration of the world economy. It reduces trade shocks and results in stable export revenues.

Let us look into a few examples that can help us understand the concept better.

Example #1

Suppose country A is a country that exports Oil. For decades, it has exported Oil; however, after learning that it can be depleted and that other countries can move away from this due to high prices, it decided to diversify into making renewable energy, concentrating on its artisans, and developing its craft sectors. This helps them access both renewable and non-renewable energy markets and improves their traditional crafts. This will reduce and diversify dependability on one single source.

Example #2

Chile and Zambia are two countries that possess significant copper deposits. Given below is a brief glimpse of what diversification can do to a country's economy. Chile opted for diversification and reduced its reliance on copper exports, and Zambia remained heavily dependent on it. Chile increased its value addition within the copper industry and diversified its economic activities by concentrating on new industries such as fisheries and agriculture. It also set up mechanisms to invest the rent received from rent from mineral extraction through structural fiscal surplus rule and its sovereign wealth funds. It helps the country withstand its spending when copper fluctuates; it saves the surplus amount and uses it to train its people on advanced skills. This will create more domestic employment opportunities that will lead to further development. 

On the other hand, Zambia needed help with translating its resources into broad-based economic development, resulting in uneven growth. It benefited those who were above the poverty line than people in need. Zambia was landlocked and hence had to pay high transportation costs, too, hindering its diversification efforts. This means it could be difficult for the country to diversify even if it had plans to diversify.

Given below are some of the advantages and disadvantages of the diversification of economies:

Advantages

• It pushes structural transformation through the shift of economic activities from agricultural to non-agricultural sectors, which improves the scope of development.
• Development across various fields leads to increased employment opportunities and the national income of the country.
• It eases global stagnation and increases the number and quality of jobs in the country, thus elevating the status of the countries in terms of development.
• It fosters economic innovation and pushes technological advancements to reach greater heights. This further brings in more opportunities for development.
• Diversification improves economic stability and growth.
• It reduces the impact of external shocks as risk is now diversified across many areas. Hence, it reduces risk and increases resilience.
• It helps a country mark its place in the global market.

Disadvantages

• Investment is a significant hindrance, especially for economic diversification in developing countries. This is because funds will be required to manage critical areas for people's welfare.
• There can be challenges in discovering and developing the necessary infrastructure. An economic diversification strategy shall be implemented in such a manner that the resourceful areas are covered.
• If this strategy is not well planned, the process becomes complex and complicated. The management of diverse sectorial improvements can be complex as a result. Evaluations from the economic diversification index can help navigate it.
• There may be resistance from established industries.
• Improper planning can lead to uneven development, which requires time and effort, especially in developing countries.