Economic Diversification Policies in Natural Resource Rich Economies

Sami Mahroum, Yasser Al-Saleh

• Publisher: Taylor & Francis
• Year: 2016
• Print ISBN: 9781138958883
• eBook ISBN: 9781317338741
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Economic diversification remains at the top of the agenda for hundreds of regions around the world. From the single commodity economies of African countries and the Caribbean, to the many single industry regions of Europe and North America, as well as the oil and gas rich but volatile hydrocarbon economies. Economic diversification policies have been around for almost a century with varying degrees of success and failure.

Economic Diversification Policies in Natural Resource Rich Economies takes a special interest in the policy experiences of a set of different countries that have extractive industries representing significant drivers of their economies and subsequently are significant contributors to government revenues. It explores twelve cases including upper-middle to high income economies such as Canada, Australia, Iceland and Norway, emerging economies such as Latin America, the GCC (Saudi and UAE), Kazakhstan, Malaysia and Russia, as well as the developing economy of Uganda. Each chapter provides a review of economic diversification experiences including policy environment, diversification strategies, desired outcomes, the role of government, and a critical evaluation of achievements.

This book is suitable for those who study environmental economics, development economics and resource management.

1	Economic diversification New thinking Sami Mahroum

1.1 Introduction

For decades the topic of economic diversification has been high on the agenda of governments in all natural resource-rich economies. In the past two decades, governments of these economies have been making substantial investments in what one might call diversification clusters of new economic activities. These have included high-tech sectors, energy renewables and creative industries. The investments reflect and support governments’ thinking on how to achieve broader economic diversification, which rests on the assumption that government’s role lies primarily in economic factors on the supply side, such as necessary investments in infrastructure and training.

A bonanza created by natural resources sometimes means that there is little in terms of market incentive to diversify away from this sector, and governments have even thought that a market failure case was there to encourage the diversification effort. We see this thinking in all the eleven cases discussed in this book, with varying degrees of intervention. In this regard, innovation policy has become a main framework for many government interventions, with the expectation that economic diversification will be delivered by high-tech sectors such as aerospace, semi-conductors and renewable energy. The role of government thus lies on the supply side of the intervention spectrum through support of the development of science, technology and innovation systems. This is somewhat different from earlier decades where import-substitution policies and policies pertaining to local content were used as demand-based policy instruments for economic diversification (Edquist et al., 2000; Geroski, 1990).

What we now have is a policy paradigm that sees an active role for government in the creation of high-tech or knowledge-intensive zones, known as clusters, incubators, valleys or any other fancy name that gives out the signal that something new is taking place here. For the majority of these initiatives, an underlying, albeit not always announced goal has been the creation of home-grown Silicon Valley-style unicorn firms such as Apple and Google. In fact, economic diversification policies in natural resource-rich countries are the same as economic development policies in developing countries and regional regeneration policies in advanced economies. What we have is a blend of terms for what is in reality a convergence of policy tools, and therefore sometimes we find cluster policies adopted as a policy tool for all three economic development purposes.

For example, this is evident in the case of diversification policies pursued in the Emirate of Abu Dhabi in the United Arab Emirates. Acting at the subnational level, the Abu Dhabi Government has adopted its own economic diversification strategy known as the Economic Vision 2030, which is entirely geared towards diversification into high-tech and knowledge-intensive sectors through the creation of clusters. However, what is often missing in these broad diversification policies is a clear business model. Future plans for production and employment pertaining to future-oriented industries have no clear portfolio of products and services linked to the investments, and neither do they have a clear client base or market to satisfy. It is not obvious that the massive investments made in future-oriented industries will result in any success whatsoever or produce a positive return on investment. In other words, the link between technology supply and market demand in many such economic development and diversification policies is often sketchy, speculative and based on wishful thinking.

In this chapter, I introduce and discuss an alternative model of economic diversification that has been advanced by Mahroum and Al-Saleh (2013), namely ‘demand-led related diversification’ (DLRD). The DLRD model stipulates that successful economic diversification and industrial renewal strategies have higher chances of success if: (i) they are based on existing or anticipated market demand, either domestically or globally; (ii) they can be – at least partially – supplied by existing domestic capabilities; and (iii) they aim to develop complementary capabilities that are – at least partially – compatible with an existing domestic ones.

1.2 Demand-led diversification

Market demand is essential for any economic growth, as both economic and innovation activities take place specifically to meet and satisfy the demand for goods and services. It is in the competition to meet various types of demand that opportunities for innovation and economic diversification emerge. Thus, many governments in the developing world (and in other parts of the world to various extents) have chosen to use demand power as an important driver of local economic development, for example by pursuing so-called ‘import-substitution’ policies. The latter necessitates that local demand is eventually met by local supply, achieved by using various incentives for local supply as well as levying tariffs on imports (Amsden, 1989; Wade, 1990). However, following the perceived failure of many import substitution policies that were put in place in the 1960s, governments began to discard domestic demand-oriented policies to adopt a global demand-led strategy fostered by market liberalisation policies. The latter saw the removal of most barriers to imports and the adoption of a strategy that fundamentally replaced local demand with global demand as a main driver of economic development and growth. Accordingly, local industries were expected to engage in a worldwide race to meet the greater and wider global demand for goods and services, subsequently resulting in a greater diversification of the domestic economy. To ensure that such a dynamic would ensue, local markets and industries had to be opened up to global competition too (Wade, 1990).

Just how demand (domestic or global) can be used to spur economic development has been an important subject of research among economic development scholars (e.g. see Amsden, 1989; Rodrik, 2007; Wade, 1990). It is often argued, for example, that small economies may be more dependent on global demand and hence on international trade and exports, whereas large economies are often fuelled by domestic demand (Chenery, 1982).

However, the debate about the role of ‘demand’ in economic development takes on a different dimension when it is perceived from the angle of innovation and the creation of new markets. In this context, demand may be classified into three types: (i) existing and satisfied demand; (ii) existing but unsatisfied demand; and finally (iii) dormant non-satisfied demand (Edler, 2007; OECD, 2011). When considering these three types of market demand, it is useful to also think of Hausmann and Rodrik’s notion of countries’ ‘self-discovery’. According to Hausmann and Rodrik (2003), entrepreneurs across different economies are constantly looking for new opportunities to create new value. This is a costly process as it always involves making investments. The first type of demand is where most international trade and competition occurs, as goods and services tend to have their own established consumers and suppliers (i.e. markets). It is here that governments are often expected to play no role, or a very small one. Nonetheless, as Hausmann and Rodrik (2003) argue, even in mature markets where technology production techniques are well established, there will be a cost of learning for any new entrant. However, governments should not promote entrepreneurial activities that involve technology adoption and adaptation through imitation, because the return on investment in such learning activities will be low.

The second type of demand is where entrepreneurial activities are concentrated on the pursuit of radical innovations in the hope of making a market breakthrough. This is often the case when the demand (potential market) for certain goods and services exists, but it is not satisfied due to ‘technology failure’ or ‘market failure’ in general. It is in the context of this type of expected demand that Hausmann and Rodrik (2003), and indeed many governments, suggest that governments should support ex ante investments needed to create domestic capabilities to meet the market that is waiting to be tapped. Governments do so in a variety of forms, including the provision of a supportive physical infrastructure for firms and resources along a certain supply chain to mobilise and agglomerate.

The third type is ‘greenfield’ and ‘blue ocean’ areas, where supply triggers demand. These are goods and services where, once people become aware of their existence, they begin to demand them. For example, at one point there was no demand, and indeed no anticipation of a demand, for personal computers, mobile phones or wifi services. It was only after the introduction of these innovations that consumers for them emerged. Table 1.1 provides a schematic overview of these different categories of market conditions with their corresponding opportunity platforms.

Table 1.1 Type of demand and corresponding platform of related variety

Status of demand, market	Related variety platform
Existing, satisfied market	Opportunities lie in supply-chain variety
Existing, non-satisfied market	Opportunities lie in technological variety
Non-existing, non-satisfied market	Opportunities lie in knowledge variety

The first type, with a satisfied market and existing demand as per Hausmann and Rodrik (2003), arguably does not require a strong government role beyond the provision of broad basic services that are required in a modern economy, such as infrastructure, regulation for ease of business, education and training, and law and order. The third type, with a non-existing non-satisfied market – the blue ocean type of market conditions – is a typical case where government support is required in the provision of support for R&D activities, advanced infrastructure and human resources for science and technology. It is in the second type of market conditions where government actions and policies tend to be multifaceted.

1.3 Demand and supply varieties

These categorisations of demand and related variety platforms bring new dimensions to the debate about the role of demand in economic development and indeed competitiveness, but also the potential role of government. Economies not only compete in the same (but differentiated) product classes (Krugman, 1979), or in different segments of product classes according to their comparative advantage (Ricardo, 1817), but also in prospective markets for unmet existing and non-existing demand. This form of competition for prospective and anticipated markets is analogous to the notion of blue ocean strategy at the firm level (Kim and Mauborgne, 2005). The role of government here goes beyond the old debate about import-substitution, levels of trade liberalisation and industrial subsidies. This is not to say that these are irrelevant policy issues, but rather to indicate that a new dimension of policy becomes very relevant, and that the type of demand and the type of supply are most relevant for the development and growth of a particular economy.

For example, in the case of existing but not satisfied demand (second row in Table 1.1), a government is able to influence the technical standards and platforms for new products coming into the market. It can do this in a way that steers the development of certain innovations along trajectories that favour its potential local suppliers. These can be in the form of environmental standards, energy efficiency or health guidelines, as well as design features (OECD, 2011). These could have the power to alter market structure or affect the funds available for investment (Georghiou, 2007) in a way that helps to evolve what we call ‘related demand’. In addition, governments may use public procurement to increase demand for certain products, or they can act as an articulator of a specific need, where they know their industrial base has related capabilities to generate the supply needed. In fact, in past years, as documented by Edquist et al. (2000), public procurement has been used to accomplish a wide range of objectives such as increasing demand for specific technologies, stimulating economic activities, creating employment, protecting domestic firms from foreign competition and remedying regional disparities. In this regard, one particular government intervention instrument that has been experimented with recently is ‘lead markets’. The concept of a lead market builds on the notion of a lead user (Von Hippel, 2005), which has recently been popularised by several scholars (Beise, 2001; Georghiou, 2007; Jacob et al., 2005). In a lead market, a government decides to combine supply and demand measures to make its market a lead (pioneer) market for the introduction of a new innovation (e.g. electric buses). The support may include the provision of adequate R&D, seed capital and supporting infrastructure as well standard setting, regulations and public procurement to foster the development and take-off of a new class of products. The lead market country is then in an advantageous position to set the parameters for the shape of demand in a blue ocean market. That is what Zerka (2009), among others, called a ‘smart’ use of innovation policies that would entail applying several demand and supply-related mechanisms at the same time, while enabling the occurrence of synergies between these instruments.

1.4 The three roads of diversification

Economic diversification is an undertaking that is both costly and risky, especially when it is geared towards a distant future. Therefore, economic diversification experiences can be thought of in three broad groups. First, there are the countries that have successfully diversified their economies by becoming homes for manufacturing and outsourced services for existing demand. These are countries like China, Indonesia, Mexico and Vietnam, among others, that have aligned their development policies with current and existing market needs where costs and benefits can be calculated with a great level of accuracy. The second group includes countries that have managed to diversify by upgrading their existing industries and introducing new products and services into existing markets. Examples in this group include Brazil, Chile, Malaysia and Norway, who have innovated around their existing industrial legacies such as farming, fishing and forestry to create new industries related to corn, salmon, fisheries and palm oil. The final group adopted a less risky approach to diversification by considering the relatedness of existing infrastructure and natural advantages to new economic activities. These are countries that have adopted a longer-term, futuristic, costlier and riskier approach to economic diversification by pursuing a strategy aimed at the development of products and services that are new to the country and new to world. This group includes countries like Australia, Abu Dhabi, Saudi Arabia and other subnational regions in Europe and elsewhere. This is not to suggest that rich countries like Australia and Abu Dhabi are wrong in choosing to take greater risks in return for higher returns on investment. This strategy may well pay off, but would require a muddling-through approach that continues to guide new economic development activities in relation to emerging market demand.

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Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of figures
• List of tables
• Notes on contributors
• Acknowledgements
• 1 Economic diversification: new thinking
• 2 Industrial diversification and the evolving position of natural resources in the Canadian economy
• 3 Diversification of the Saudi economy: challenges and prospects
• 4 Diversification in Latin American oil exporters: was no intervention a better policy option?
• 5 Economic diversification in Malaysia: timing, path dependence and increasing returns
• 6 Diversification, Dutch disease and economic growth: options for Uganda
• 7 Economic diversification in Australia
• 8 Economic diversification in Russia: nuclear to the rescue?
• 9 Kazakhstan’s diversification strategy: are policies building linkages and promoting competition?
• 10 The role of institutions in economic diversification: the case of the UAE
• 11 Double diversification with an application to Iceland
• 12 Industrial diversification processes and strategies in an oil economy: Norway
• 13 Old and new directions for economic diversification policies
• Index