Question 1 : What do we mean by diversification ?
There are essentially four fundamental ideas that people have when they speak of diversifying the economy through the press:
- The first revolves around the call for the country to expand the diversity of existing products that are consumed at home and exported abroad. For example the JCTR recently noted that “Zambia needs to diversify the production and consumption of its food crop away from heavy dependence on maize if it has to attain food security and we call upon the recently constituted taskforce to critically examine this issue…”. Although this is motivated by the quest to expand exports it’s also been used in agriculture as the basis for securing food security. We have heard similar calls regarding the mining industry, in particular the need for Zambia to expand the portfolio of mining products it exports abroad e.g. expanding the production of manganese in Luapula and enhancing the emeral industry.
- The second involves the expansion in the range of markets into which existing products or services are sold. This has been less common but some have noted that there significant opportunities for existing products to be marketed abroad, this is especially the case with those products where Zambia may be able to develop a niche e.g. specialised agriculture produce, cultural products, etc.
- The third idea involves taking advantage of opportunities to expand exports of services. This is essentially the call from moving into trade in services of which the most prominent in Zambia are: tourism; telecommunications; financial services (banking, insurance and accounting); and, transportation. The call for greater expansion in tourism has been particularly loud culminating in the Budget 2009 spending commitments as well as certain incentives. Others have also noted the possibility for Zambia to expand its air transport sector and take advantage of its geographical position.
- Finally, the idea of moving from copper dependence to low value manufacturing products. This is the “traditional route” of diversification and is what many observers have been calling for a while. The Citizens Economic Empowerment Commission (CEEC) Commissioner last year noted: "Our country exports a number of raw materials that are processed in the developed countries and re-exported back to Zambia as finished goods at exorbitant prices. When we increase the skill levels of labour, we will be increasing value added activities and providing employment opportunities to our own people....."
Question 2 : Why bother with diversification?
There are many reasons why countries diversify generally. Achieving strong economic growth is fundamental to reducing poverty. In order to do that Zambia needs to leverage the demand and resources that are available not just within Zambia but also abroad. That means it needs to fully exploit its resources and engage in trade with the outside world. That calls for increased competitiveness in every sector in order to attract foreign direct investment and boost national productivity. Naturally debate exists here on how this can best be achieved. Its not the focus of this piece to discuss this element but simply to point out trade is crucial (for some of the on-going debate on this see Bad Samaritans, By Ha - Joon Chang (A Review)).
Economic diversification is widely seen as a positive trade objective in sustaining economic growth. Diversification makes countries less vulnerable to adverse terms of trade shocks by stabilizing export revenues, makes it easier to channel positive terms of trade shocks into growth, knowledge spillovers and increasing returns to scale, creates learning opportunities that lead to new forms of comparative advantage.
For many countries the issue is not that exports are concentrated but that they are usually concentrated on homogeneous products with individual exporting countries facing a highly inelastic demand curve such that changes in global supply translates into significant price volatility with many poor income countries such as Zambia often suffering terms of trade shocks that adversely affect investment and even consumption e.g. the recent shock to commodity prices. Violatility in income terms of trade can depress long-term growth. Indeed, though the evidence is not universal, several cross country studies have shown that greater diversification is correlated with more rapid growth of per capita income.
The issue therefore is not so much whether diversification is beneficial but rather what diversification process is worth pursuing and could be realistically achievable with deliberate policies. This is particularly important for Zambia because its quest to diversify has been somewhat mixed, with the extent of “diversification” depending largely on the metric used for measurement.
Question 3 : How much progress has Zambia made in terms of diversification?
The answer here largely depends on the definition adopted. If we focus purely on the structural composition of GDP, it is obvious that the sources of Zambia's growth are broad based, as revealed by the chart below from the latest 2008 Economic Report :
The focus invariably has been on "export diversification" for reasons advanced above.
In terms of the diversity of products exported abroad, there are certainly signs that Zambia is broadening its export base. The diagrams below extracted from a previous blog, helps to paint the picture.
Figure 3: Composition of ExportsWhile in 1980 the largest exports accounted for 96% of exports, in 2004 they made up 80% of exports. Mining products continue to dominate exports, but while in the last 30 years the economy relied exclusively on export of ores and metals, in the last 17 years agriculture exports have become more prominent. Indeed this process of diversification appears to have spread within mining itself with some signs that Zambia has begun diversifying away from copper into other base metals and precious stones. However, in both instances the pace of diversification has been too slow.
More worryingly Zambia has not made significant progress is in the area of manufacturing which still accounts for less than 10% of exports. In addition, although tourism continues to grow off the back of limited competition from Zimbabwe, it remains far behind in terms of the level of tourists compared to regional competitors such as South Africa and Kenya. Similar picture emerges for telecommunication industry where the underperformance of ZAMTEL has restricted the growth of the industry and its ability to become a regional exporter in telecommunication services.
Indeed, Zambia’s performance relative to other countries remains poor in terms of export diversification (see Figure 4). Zambia has one of the highest shares of mineral exports on the African continent, making it extremely vulnerable to base metals shocks as we are current experiencing. More importantly, closer examination of data reveals that nearly all the countries with higher share of mineral and oil exports, Zambia is alone in depending on copper. Many of the high mineral dependent nations rely on oil where the windfall gains are substantially higher, lessening the need for diversification.
Question 4 : What constraints are preventing Zambia from further diversification?
Undoubtedly the historic legacy of colonialism which focused on mineral extraction and UNIP’s failed experiment in socialism are at the heart of the copper dependency. However, equally hopeless was the poor implementation of the privatisation process which led to the collapse of many non-mining sectors. The privatisation process also had another impact, the process led to significant reduction in copper output and associated revenue, eventually forcing the government to transfer these valuable resources into foreign hands.
I have previously noted that most emerging countries pursuing diversification use "resource wealth" to fund infrastructure and other industries. Chile being the most prominent. It continues to use the mineral wealth prudently, not only in terms of keeping the exchange rate in check through a stabilisation fund, but have also used windfall revenues to enhance productivity in other sectors. Indonesia in the 1970s and 80s also stands out as another example. It used its oil revenues to pursue an agriculture-led growth strategy with investment in rural infrastructure, such as irrigation and roads, as well as in input subsidies for fertilisers and pesticides. Unfortunately, Zambiah as been unable to fully utilise these national resources to its advantage and now appears to have missed the windfall gains that would have helped it secure diversification.
Beyond these general points there are specific issues related to the relevant industries. Although the tourism sector has grown significantly, its progress is being impeded by poor transport and hotelling infrastructure especially in Luapula and Northern Provinces where tourism opportunities abound. Similarly with agriculture the country suffers not only from poor physical infrastructure provision, which impedes access to markets, also from artificial constraints such as import and export restrictions as well as poor access to credit and lack of education and research - see A better vision for agriculture for more discussion.
Question 5 : How does Zambia move forward?
In order for Zambia to make rapid progress in diversification and without access to mineral wealth, it is vital that we learn how to overcome these constraints. My view is that rather than seek diversification as the goal we should recognise that growth is the goal and that diversification is the means to get there. We therefore need a holistic framework that involves a sector by sector assessment of the constraints and then finding appropriate solutions for eliminate those constraints.
A crucial aspect of diversification is “market discovery”. There are a number of areas in key sectors were the main constraints facing entrepreneurs appear to be knowledge about market opportunities. There are many good opportunities for income creation in rural and urban areas, but locals are just not aware of the opportunities or they struggle with discovering the profitable markets, this is especially the case in agriculture markets. Although private organisations are doing their bit to unlock the potential that exists, the government can play a more proactive role at the local level working with communities to identify their local assets and solving the coordination and "market discovery" failures that exist. Unlocking these opportunities would make our local areas engines of agriculture growth.
It is also critical that with reduction in mining investment, more is done to take advantage of FDI flows in other sectors especially that which is spearheaded through the MFEZs. In order to take advantage of the increase in foreign direct investment, it is critical that government puts policies in place that encourage spillovers from new FDI to domestic firms. These spillovers are critical for long-term diversification, but are not inevitable. The right conditions need to exist for them to occur. Existing empirical consensus shows that it is difficult for emerging economies, like Zambia, to extract potential benefits of spillovers when a large technological gap exists between domestic and FDI firms. It’s therefore imperative that government places FDI policy within a broader economic policy context, by taking forward necessary steps to invest in basic infrastructure, education and training, and above all encourage Zambian firmsto invest in technological development. These policies will do a great deal in increasing Zambian firms technological capability, and hence make it easier for the nation to benefit from spillovers and enhance diversification.