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Wednesday, 27 March 2013

What Next for Diversification in Zambia?

By Chola Mukanga

Economic diversification is the holy grail of Zambia’s economic policy making. And yet despite successive budgets placing it at the centre there has been minimal public debate on what it means for Zambia’s economic development. As a result the ideas and goals remain opaque. 

What do we mean by economic diversification? At its basic level, diversification is about expanding the diversity of existing products that are consumed at home and exported abroad. But it may also mean expansion in the range of markets into which existing products or services are sold. More common however is its traditional usage where diversification is seen as moving from mineral dependence to low value manufacturing products. In recent times equal emphasis has also been placed on understanding diversification as a process of moving from traditional areas into trade in services or ICT.

These distinctions are quite important because each diversification model is different. Critically, some of the processes may be more natural than others. Some forms of diversification may occur naturally as the economy grows. In other instances diversification would simply not occur even in the presence of growth. It is therefore crucial to understand the nature of the diversification processes and their relative importance, in order to develop appropriate enabling economic policies.

Regardless of the preferred model what is clear is that diversification matters to Zambia. 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 by exploiting its resources and engaging in trade with the outside world. That calls for increased competitiveness in every sector in order to attract foreign direct investment (FDI) and boost national productivity.

Economic diversification is widely seen as a positive trade objective in sustaining economic growth. It makes countries less vulnerable to adverse terms of trade shocks by stabilizing export revenues. It also fosters knowledge spillovers and increases returns to scale, which in turn creates learning opportunities that lead to new forms of comparative advantage. Empirical evidence shows that greater diversification is correlated with more rapid growth of per capita income. Therefore the issue is not whether diversification is beneficial but rather what diversification process is worth pursuing.

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. If we focus purely on the structural composition of GDP, Zambia’s sources of Zambia's growth are broad based, with mining contribution to the growth in GDP around 10%. The diversity of products exported abroad have also increased. In 1980 the largest exports accounted for 96% of exports, these now make around 80% of exports. Though mining products continue to dominate exports, over the last two decades years agriculture exports have become more prominent. The process of diversification appears to have spread within mining itself with increasing signs that Zambia has begun diversifying away from copper into other base metals and precious stones.

The challenge for Zambia is that the pace of diversification has been too slow. It has not made significant progress in the area of manufacturing which still accounts for just around 10% of exports. Although tourism continues to grow, it remains far behind compared to regional competitors such as Kenya, RSA and Zimbabwe. Similarly, in telecommunications and air transport Zambia not made inroads. In general, Zambia’s export diversification relative to other countries remains poor.

A key reason for the slow place of diversification is largely historic. The combination of colonial legacy of colonialism and UNIP’s failed experiment in socialism led to copper dependency. Equally hopeless was the MMD’s poor implementation of the privatisation process which led to the collapse of many sectors and foreign ownership of key assets.

It has been noted that most emerging countries pursuing diversification use "resource wealth" to fund infrastructure and other industries. For example, Chile continues to use its 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. Unfortunately, Zambia has been unable to fully utilise these national resources to secure diversification.

Beyond that that are more industry specific issues. For example, although tourism is growing, its progress is being impeded by poor transport, marketing and hotel infrastructure especially in Luapula and Northern Provinces. Similarly, agricultural diversification continued to suffer from poor physical infrastructure provision, inefficient policy distortions, and poor access to credit, education and research.

It is vital that we overcome these constraints. The key lies in seeing growth as the goal and diversification as the means to get there. Hence there’s need for a holistic framework that involves a sector by sector assessment of the constraints and then finding appropriate solutions for eliminating those constraints. This should be at both the national and local levels. The approach should be complemented with greater effort to get domestic firms to take advantage of FDI flows especially in sectors spearheaded through economic zones (MFEZs).

Government needs to put in place policies that encourage spillovers from new FDI to domestic firms. These spillovers are critical for long-term diversification, but are not inevitable. 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. In particular, it needs to increase momentum in ramping up basic infrastructure, education and training, and above all encourage Zambian firms to 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.

Question: What deliberate policies are needed to encourage diversification in Zambia?

Copyright © Zambian Economist 2013

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