Is There a Blueprint for Diversification?

Many resource-rich countries are looking to diversify their economies, in anticipation of the day their natural wealth runs out.  Resource extraction is extremely costly and employs only a fraction of the workforce. After the recent turmoil in the Middle East, policy makers have begun focusing more on the need to create jobs, provide for inclusion, and increase public participation in government decision-making. There are several examples of countries that have used their resource wealth to share prosperity, including the United States, Norway, and Australia.

But is there a blueprint for diversification and economic prosperity?

Is Resource Dependence Really a Curse?

There are challenges that are common to resource-rich countries, but they can be overcome. The existence of a resource curse is refuted by history, as several of the current high-income economies relied largely on natural resource exploitation. One example is the United States, which in the years leading up to World War I, was the world’s dominant producer of virtually every major industrial mineral. Similarly, in the late 19^th century, coal and iron ore deposits were the basis for industrial development in Germany and the United Kingdom. Other countries, like Canada and Australia, have highly diversified economies but remain dependent on natural resources for a large share of their exports.

But how did these countries manage to avoid the more deleterious aspects of resource dependence like macroeconomic volatility, an overvalued exchange rate that raises costs to businesses, and problems tied to governance and accountability in rent management?

Possible to Diversify by Decree?

Successful resource-rich countries have pursued diversification not as an end in itself or a policy objective, but as a way to accelerate their economic development. They have developed and strengthened institutions that have helped create the right incentives to developing their non-resource sectors based on market principles. Industrial policies have been used, but they have succeeded only in very special circumstances. For example, if a country is already building ships, as Norway was when the construction of oil platforms started there, then moving to constructing offshore platforms becomes a much smaller step.  

Local content policies have also been tried in many countries, but they also tend to work only when there is enough capacity to make the national industry internationally competitive, as in Norway’s case.

Indonesia and Malaysia moved successfully from economies dominated by commodities, to manufacturing. Both countries used the right macroeconomic policies, in Indonesia’s case by slowing the absorption rate of oil rents, thereby controlling Dutch disease effects. Chile has been able to generate high growth rates by developing a highly dynamic and diversified commodity export sector. It has greatly emphasized improving its business environment, becoming the highest rated Latin American country on the “Doing Business” indicators.

Is There a Blueprint for Diversification?

So, no -- there isn’t a single blueprint for economic diversification. Each experience is unique.

However, there are many factors tied to success. The importance of getting the macroeconomics and business environment right cannot be emphasized more. It is also essential to build up capital that is complementary to natural resources, like highly skilled human and institutional capital. Finally, resource wealth will not be successfully used to promote wealth and shared prosperity if institutional quality is neglected. Remember that the extractive industries, due to their enclave characteristics, can be operated in weak institutional environments. This is not the case for most other industries that require an adequate investment climate to thrive. In these cases, achieving success will depend not only on human capital development, but to a greater extent, on strong enforcement of contracts, laws, and a generally strong business environment.