Thorvaldur Gylfason Economic and Political Diversification and How It Relates to Growth Commentary

Excessive diversification does not make sense (World Bank 2012 Golden Growth Report) Diversification in resource-rich countries makes sense: Karl 1997; Ramsay, 2011; Humphreys, 2005 and others. Avoiding declining terms of trade (Chenery, 1979; Syrquin 1989) Avoiding export instability caused by volatility of commodity prices which could discourage investments, destabilize public finances and increase overall uncertainty (Ghosh and Ostry, 1994; Bleaney and Greenaway, 2001). Causing knowledge spillovers from new technologies of production, improved management, or marketing practices potentially benefiting other industries (Matsuyama 1992; De Pineres, Ferrantino, 2000) Improving comparative advantage of economy by imitating and adapting existing products (Agosin 2007).

Earlier research confirms positive effect of economic diversification on growth. Cross-sectional country growth regressions (Al-Marhubi, 2000; Agosin, 2007; Lederman and Maloney 2007). Using Johansen trace test for Chile, a multivariate error-correction model and the dynamic OLS procedure (Herzer, Lehnmann, 2006). Using dynamic panel model of growth which reduces problem of endogeneity, positive impact of diversification on growth still holds (Hesse 2008). U-shaped pattern found earlier. (Imbs and Wacziarg, 2003) countries in their early stages of development diversify production and specialize at higher income levels, with estimated threshold of switching from diversification to specialization around US 9,000 per capita.

Cause and effect. Inverse causality problem? Influence of political regimes and institutions is crucial for economic diversification and growth. (Ahmadov 2012, Dunning, 2005). Cause and effect. Inverse causality problem? Institutional view - political institutions promote economic performance (Lipset 1959, Acemoglu, Johnson, Robinson, 2001) Development view - economic growth stimulates democracy and adoption of better institutions (Hernández-Murillo, Martinek, 2008); accumulation of human capital through education spurs democracies and therefore growth (Glaeser, La Porta, Lopez-de-Silanes, Shleifer, 2004). U-shaped pattern of political diversification? (Barro 1994, Tavares, Wacziarg 2000)