Economic diversification: The road to sustainable development (page 1 of 4)

Economic diversity across a wide range of profitable sectors and sustainability are intrinsically linked, and are key to a sustainable economy - found a new study by Booz & Company.

Economic diversification can also reduce a nation's economic volatility and increase its real activity performance.

Studying Sustainable Development: Can Diversification Drive Sustainability?

Many Gulf Cooperation Council (GCC) countries are "transforming" their economies from being based on a single commodity to being robust, diversified ones.

"Hydrocarbon rich GCC countries, with economies heavily dependent on oil and gas, face sizeable challenges in diversifying. It is therefore very important to highlight the need to create sustainable economies," explained Rabih Abouchakra, a Principal with Booz & Company.

In evaluating economic diversification and subsequent sustainability, the study compared GCC economies, G7 economies, and transformation economies (Hong Kong, Ireland, New Zealand, Norway, Singapore, and South Korea).

Evaluating Economic Diversification

Three key findings were established during the analysis of economic diversification.

1. Gross Domestic Product (GDP) should be distributed across sectors
Economic concentration and diversification was assessed by analyzing whether GDP was distributed across a wide variety of economic sectors - or across a few.

This evaluation determines a "concentration ratio" and a "diversification quotient." Concentration ratio measures a nation's concentration in a given sector, while the diversification quotient is the inverse of the concentration ratio, providing an innovative metric that policymakers can use to gauge economic diversity. The lower the concentration ratio and the higher the diversification quotient, the more diversified a nation's economy.

"GCC countries have the high¬est concentrations in terms of sector contribution to GDP and thus the lowest diversification quotients due to the historic dominance by the oil and gas sector," Abouchakra said.

Growth in non-oil sectors reflects spillover effects from increased oil receipts and subsequent record-high inflows of capital.

These cannot be considered inherently sustainable because of dependency on the dominant sector's fortunes in the marketplace.

"GCC countries' non-oil sectors have not fully matured and still have pervasive structural gaps," commented Richard Shediac, a Vice President with Booz & Company.

This suggests revenues from oil and gas are not being reinvested effectively in GCC countries, but instead are being used to fund nations' internal (i.e. local) economies, rather than external ones.

An economy therefore with a strong foundation in export helps insulate against unexpected changes in the domestic economy and insulates against volatility of oil and gas prices and the subsequent knock-on effects.

2. Concentration is not inevitable in hydrocarbon-rich economies
Many GCC economies, especially larger ones, have been susceptible to such changes in oil prices.