Making Sense of Economic Diversification by David Adeoye

In recent months, we have witnessed expressions of both pain and hope on the imperative of diversifying the Nigerian economy. However on close examination, it becomes clear that the general understanding of the supposedly mono-product economy is quite fuzzy. In fact, some of the solutions being suggested magnify our weak understanding of what the problems are.

Economic diversification can be evaluated and pursued along three main dimensions. These are: national output, government revenues, and exports. I’ll address each variable in turn. Output diversification describes how well distributed among various sectors productive activities and employment in a country is. A largely agrarian economy may be as ‘non-diversified’ as a mineral resource rich economy. Both will depend on about the same type of economic activity (extraction) and both will be subject to swings in global commodity prices.

To the extent that a very significant number of Nigerians are employed outside any one major sector except for agriculture, it is safe to say that from an output perspective, the Nigerian economy is diversified. However, further diversification is possible and must be pursued.

Next is diversification of government revenues. It is possible that due to the fiscal arrangements that govern the exploitation of valuable mineral resources, revenues that accrue to a government may become concentrated in the production of a few commodities. Such concentration becomes more pronounced when commodity prices are rising and present serious dangers when the prices at which they are sold are determined outside the domestic economy. We refer to such risks as external shocks.
An economy with a robust productive base, vibrant activity across sectors and in which the government is able to implement a broad-based tax strategy with efficient tax assessment and collection systems is in combination the surest way to address lack of diversification of government revenues. A strong productive base and high employment levels tend to reduce the dependence of governments on commodity-price related revenues.

A third area where diversification is important is a country’s export base. This can be achieved on two dimensions: diversity and complexity. It is possible for a country’s exports to be ‘well diversified’ across various products such as hydrocarbon resources (i.e. crude oil, gas and coal), agricultural produce and solid minerals and yet lack any significant complexity in processing or conversion of these base resources into finished goods. In such a case, the export base can rightly be considered diversified. A consequence of such diversification however is the exposure of the export base to such external shocks as commodity price slumps.

Other unintended consequences of a diversified but low-complexity economies is that the dependence on importation of finished goods and intermediate inputs will remain very high with the exchange rate being under constant pressure. In a related measure, if such a country has a large and growing population, import demand will grow steadily to cater for local consumption. Moreover, combined growth in the volumes and prices of export commodities may be insufficient to cope with the rapidly expanding import bill.

In modern economies, the vital need of most emerging market countries is to upgrade their export base to include an increasing proportion of high-skill manufacturing, and high-technology components. Malaysia, for example increased manufacturing as a proportion of its GDP from 6% in the early 1970s to over 70% by 2014. This was achieved through a focus on certain target industries including high-tech electronics.

Another example is Costa Rica which in 1994 made a deliberate decision to upgrade it’s export base toward high-skilled modern technology sectors. With a long-range strategy, incentives, quality and well-staffed institutions, the Latin American country of 3.5 million people became the place to be for a number of global leaders in technology. By 2008, Intel, the global leader in chip-making announced plans to set up a semi-conductor plants in the country. Within a few years, Microsoft, Cisco and some smaller tech firms followed suit. At various times, Intel accounted for between 5 and 10% of Costa Rica’s GDP and a larger fraction of its export base. While the chip-making plant was closed a few years ago, Intel and other tech firms still maintain very significant operational presence in Costa Rica.
The cases of Malaysia and Costa Rica show clearly that a shift towards agriculture and solid minerals is necessary but gorssly insufficient to reposition our economy and firmly stabilize our currency. Unless such shift is combined with complete transformation of those outputs, Nigeria will continue to produce low-value items that earn limited foreign exchange. On the other hand, less resource- endowed countries that process such ingredients will be the real gainers in a world where knowledge and it’s effective application in industry is an increasingly vital competitive advantage.
As it is, Nigeria is currently a Quadrant 1 economy (marked by low-diversification and low complexity). A mere export diversification strategy, even if successful will only move the country to a Quadrant 2 economy (which is marked by high diversification and low complexity). With the nation’s diversified natural resource-base, large population, and broad demographics, a move to Quadrant 3 (low diversification, high complexity) will be sub-optimal. It will create rapid growth without shared prosperity. Hence, the most reasonable path to true economic development will be a diagonal flight towards a Quadrant 4 (high diversification, high complexity) economy.

The move to Quadrant 4 has important implications (benefits and burdens) for the country’s economy. It will affect our foreign exchange earnings, employment levels, income generation, poverty levels, and economic inequality. A well diversified economy with sizable quantum of complex production will export more output, especially higher value products. It will also import less of finished goods. Such an economy will create a larger opportunities for both semi-skilled and higher skilled jobs in different sectors. As opportunities for employment and advancement increase, poverty levels and economic inequality will experience a natural decrease.

Important burdens of a quadrant 4 economy include the pressure on the country’s educational system to adapt it’s output quality and type to fit the needs of the emerging economy. Specific knowledge and skill development initiatives will become a natural must to sustain rising growth in processing and high-tech industries. Also the pressure on infrastructure and social amenities will be immense. The need to strengthen vital agencies of government responsible for attracting, promoting and retaining critical investment will be immense. Our political leaders will also need to see beyond ‘what’s in it for me?’ syndrome which is a major factor impeding the flow of investments and the ease of doing business around here.

What has been painted here may look like a lofty ideal but is attainable with clarity of vision, political consensus and will-power, the correct strategy and dedication of all Nigerians in their own corners, the civil servants and other professionals in various aspects of the financial and real sectors.
@fritova.

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