The Diversification Challenge in Africa's Resource-Rich Economies

Rowing Against the Current: The Diversification Challenge in Africa's Resource-Rich Economies

John Page, Distinguished Visiting Fellow, Global Economy and Development, The Brookings Institution

Global Working Papers No. 28

For a growing number of countries in Africa the current commodity boom is a huge opportunity. But if the economic history of resource-rich, poor countries—especially in Africa—is any guide, rather than bringing prosperity, the resource boom may drive them into what Paul Collier (2007) in his influential book The Bottom Billion terms the “Natural Resources Trap.” In Africa, countries dependent on oil, gas, and mining have tended to have weaker long-run growth, higher rates of poverty, and higher inequality than non mineral-dependent economies at similar levels of income.

Two recent studies suggest both the potential and the risks of resource extraction. Alekseev and Conrad (2008) show the potential—resource wealth has tended to make countries better off. They find that in the long run resource-rich countries have significantly higher levels of income than other countries. However, Collier and Goderis (2007, 2008) suggest that this may be due only to the income generated by resource rents rather than to the growth of output. In resourcerich economies—unlike those with more diversified economic structures—production and income may diverge substantially. Collier and Goderis ask whether a commodity boom helps an economy to produce more output. They find that for the first few years following an increase in the price of commodity exports output increases relative to what it would otherwise have been, but usually the growth of output is not sustained. After two decades the typical resource extracting economy is producing less than it would have done in the absence of the boom. Collier and Goderis simulate the outcome of the current commodity boom and find that, if history repeats itself, after two decades output for the typical African commodity exporter will be around 25 percent lower than it would have been without the boom. This is the resource curse.

But geology is not destiny. Natural resource wealth can be an effective driver of growth. Chile, which has been the fastest growing Latin American country for the past 15 years, has relied almost entirely on exports of natural resource products. Botswana has been among the world’s fastest growing economies for the last 30 years, and Indonesia and Malaysia have used their natural resource wealth to diversify and grow their economies. From the global evidence Collier and Goderis find that although a decline in production is the norm, it is by no means inevitable. Some societies have succeeded in harnessing commodity booms for sustained increases in production, while others have not. The consequences of resource-riches, they argue, depend upon choices.

This paper is about one important set of choices faced by Africa’s resource-rich economies, whether and how to diversify production beyond the natural resource sector. Following this introduction, Section 2 examines the role of natural resource exports in Africa’s recent growth recovery. Using a new methodology developed by Arbache and Page (2007) it finds that Africa’s growth acceleration after 1995 has been driven mainly by avoiding the policy mistakes that led to sharp economic contractions in the past and by a strong surge in growth in the resource-rich economies. This makes Africa’s long-run growth prospects vulnerable to the natural resource curse.

Section 3 introduces the main theme of the paper: Africa’s resource exporters are rowing against the current as they attempt to diversify their economies. The relative price changes that occur in a resource exporting economy—symptoms of the “Dutch disease”— place Africa’s natural resource-rich countries at a disadvantage with respect to two drivers of industrial change and economic growth. Because Dutch disease discourages the development of new tradable goods producing activities, it inhibits the diversification of the manufacturing sector and limits the potential for increases in the sophistication of manufacturing production and exports. Both diversity and sophistication have been linked in recent literature to higher incomes and faster growth. In addition, research on the impact of agglomeration economies on production costs and international competitiveness strongly suggests that late-comers to industrialization, such as Africa’s natural resource exporters, suffer from a competitive disadvantage linked to the spatial distribution of global industry. It is far easier to expand an existing industrial agglomeration than to start a new one. Not surprisingly, then, the data show that Africa’s mineral rich economies trail both the Africa regional average and the least developed countries in general in key indicators of industrial dynamism.

Section 4 draws on the experience of three successful natural resource exporters—Chile, Indonesia and Malaysia—to make the point that geology is not destiny. Each of these economies had rising income growth accompanied by increasing diversity of their manufacturing and export structure between 1980 and 2000. Successful diversification away from dependence on natural resources was the consequence of different public policies to mitigate the impact of the Dutch disease. In the cases of Indonesia and Malaysia, government policies successfully targeted moving into new more sophisticated manufacturing sectors. In Chile public policy favored the expansion into new, knowledge-intensive natural resource based exports.

Some options for policy choices are set out in section 5. The basic theme of the section is that governments—through improvements in the investment climate and public expenditures—can mitigate the worst consequences of the Dutch disease. Section 6 concludes and offers some ideas for further research.