What are The Benefits of Economic Diversification?

As the saying goes, “Don’t put all of your eggs in one basket”. This mindset is also frequently embraced by economists in the form of economic diversification — the process of shifting an economy away from a single income source toward multiple sources from a growing range of sectors and markets.

Most associated with lower and middle-income countries looking to scale up their economies, a number of nations have embarked on economic diversification strategies in recent times. These include Malaysia and Dominica, with both diversifying away from agriculture to industries like rubber production and tourism — the latter even has a dedicated Economic Diversification Fund as part of its citizenship by investment programme.

But what are the main benefits of economic diversification?

Increased economic growth

Economic growth is defined as “an increase in the production of economic goods and services in one period of time compared with a previous period”. Measured using estimates such as gross domestic product (GDP), it can provide a number of benefits to citizens, including higher income, reduced poverty, and a better quality of life.

Economic diversification is a fantastic way of generating economic growth, as the higher the number of thriving industries in a country, the more opportunities there are to produce goods and services and create jobs.

Take the example of Chile, which, as part of its diversification strategy, transformed its previously local-only salmon industry to become the world’s second-largest exporter of fish. The sector has been hailed as ”one of the main engines of progress and opportunities in [Chile’s southern] regions of Los Lagos, Aysén, and Magallanes”, according to Chilean Salmon Council Executive Director Joanna Davidovich.

Reduced economic volatility

Undiversified economies are much more susceptible to volatility. For example, those heavily dependent on agriculture could be seriously affected by extreme weather events. 

The Covid-19 pandemic is another prime example, where the economies of tourism-dependent countries were hit hard by travel restrictions. International tourist arrivals declined globally by 73 percent in 2020, leading to a collapse in exports of travel services (money spent by nonresident visitors in a country) and a decline in exports of transport services (such as airline revenues from tickets sold to non-residents).

Diversified economies are much more resilient to such shocks, with several industries on hand to share the economic burden. If one industry falls victim to unexpected events, others are available to fall back on.

Greater productivity

Economic diversification typically involves transitioning away from reliance on industries with low productivity growth (like agriculture), to sectors with high productivity growth (such as industrial and service industries). 

China is probably the most notable example of a country that has done this, going from being a predominantly agrarian economy to a global superpower in a matter of decades by expanding its manufacturing and services sectors.

Productivity is one of the biggest determinants of a population’s standard of living. Raising it enables people to get what they want quicker, or obtain more of it in the same amount of time. Supply increases with productivity, which reduces real prices and boosts real wages. Therefore, economic diversification can again be shown to have a tangible impact on improving people’s lives.