Economic diversification: The road to sustainable development (page 4 of 4)

For GCC economies, any increase in growth inherently increases economic risk -rather than economic reward.

Diversification is a critical component of a sustainable economy

How can economies that have relied on the export of a single commodity reduce volatility and achieve sustainability? Is economic diversification a key part of accomplishing this?

The study compared GDP growth volatility against economic concentration and GDP reward-to-volatility ratio (i.e. the Sharpe ratio) against the diversification quotient. The results revealed a clear link between economic diversification and sustainable development.

Nations - like those in the GCC with a high concentration ratio - suffer from higher growth volatility than G7 or transformation nations. Nations with a high diversification quotient like Norway, South Korea, and Ireland enjoy a high Sharpe ratio - a high economic return per unit of volatility.

Regression estimators in the analysis are significant. About 30& of variation in GDP growth volatility and reward-to-volatility ratio is captured by single inde¬pendent variables, economic concentration and diver¬sification.

The remaining 70% of the variation not explained by the regression can be explained by other factors - oil prices, inflation, exchange rates, investor and consumer confi¬dence, general asset price shocks, and so forth. Many of these are difficult for policymakers to directly influence, while economic diversification is measurable, monitorable, and a critical component of a sustainable economy.

Effecting Sustainable Development: Summary of Key Findings and Recommendations for Policymakers

• GCC economies are the most concentrated and inadequately diversified. Hydrocarbon-rich nations are not necessarily doomed to poor economic diversification - as shown by the paragon economies of Norway and to a certain extent Canada.

• Employment distribution is balanced in G7 and transformation economies, but skewed toward low-value-added sectors in the GCC economies.

• High economic concentration exposes economies to external or exogenous events like changes in oil prices, which creates economic volatility.

• Overall volatility and subsequent spillover effects can be mitigated with the effective development and diversification of high-value-added exports.

• Volatility minimization and risk-adjusted real activity performance improvement can be achieved with increased economic diversification.

Policymakers must focus on economic diversification when creating development agendas, and must rigorously measure and monitor economic diversity in evaluating the success of their policies. Specifically, policymakers should pursue the following courses:

• Diversify economic bases in terms of output and input distributions. Stakeholders should incentivize injection of labor and capital into productive economic sectors, as well as the development of new knowledge and technology.

• Foster the growth of the external sector by exporting a wide range of high value-added goods and services internationally.

• Enhance productivity and competitive levels of the economic base, through resources and strategic investments, including enhancing human and financial capital, technology and knowledge to entrench innovation. Innovation allows economies to create high economic value from almost nothing as a starting point.

This said, although preparing the ground and establishing the prerequisites and underpinnings of an innovation economy should be initiated at early transformation stages, the effective generation of economic output out of innovation sectors should come as a natural phase in an economy's transformation path.

"A premature reliance on innovation sectors is likely to minimize chances of success and expose a not-yet-immunized economy to harmful and disruptive competition" Moujaes commented.

• Use the metrics of economic concentration and diversification, as well as economic sustainability and uncertainty, as targets when determining policy.

• Monitor and devise clear diversification strategies and mechanisms to mitigate economic volatility and spillover effects, uncertainty, and perturbed business cycle transitions.

These steps will help policymakers create long-term, sustainable growth in their economies - to help ensure stability and a high standard of living for their nations.