Economic diversification in the history of economic thought

From the classical authors to the present, a central theme of economic research has been the way economic systems grow and transform. This section briefly reviews the role of some main contributions on economic diversification in the history of economic thought. Several lines of research can be traced back to Adam Smith, Karl Marx and Joseph Schumpeter, giving different explanations for why econo-mies grow and diversify their economic activities over time. While the term has not always been used, diversity has been an important concept in economics, at least since Adam Smith (1776), who identified the division of labour as a driving force of economic development. Specialization of activities at a lower level of aggregation (e.g. in a company or a region) often leads to the diversification of activities and outcomes at a higher level of aggregation (e.g. in the national econ-omy). Increasing specialization and hence also diversification can be found at all levels of the economic production processes and activities on the regional, national and international levels. The division of labour led to an enormous number of new professions and skills, the saving of time, more output and technical progress.

In his theory of economic development, Joseph Schumpeter (1912) saw economic development as a structural transformation process in which innovation leads to the emergence of new sectors and the obsolescence of some old sec-tors. He coined the term ‘creative destruction’ to describe this process. Creative destruction processes lead to qualitative changes in the composition of sectors, job opportunities, skill requirements and demands, consumption possibilities and standards of life. In the long term, economic systems diversify, but in the short term many jobs and competences may become obsolete. Structural transformation processes and the direction of economic specialization and diversification deeply affect people’s learning processes, their choices and functionings.

Based on ideas of Schumpeter, Marx and Keynes, several schools in development economics have traditionally put strong emphasis on structural change and

economic diversification. Early approaches focused on: (a) how developing countries can transform their activities from agricultural production into higher value added industrialized activities (Rosenstein-Rodan 1943; Nurkse 1953;

Lewis 1954; Hirschman 1958); and (b) how the embeddedness of developing countries in the global production system can produce structural dependency and underdevelopment due to specific types of productive specialization and diversi-fication (Prebisch 1949, 1959; Furtado 1961). LASA viewed the periphery of the world economy as serving to meet the dynamic centres of development’s demand for primary products. Whereas the centre continuously innovates and increases the diversity of its products and services, the periphery is deemed to specialize in the provision of basic primary goods which show a low income elasticity of demand. This means that when the income of people rises they do not equally consume more coffee or sugar produced in the periphery of the world economy, but rather spend their money on industrialized products (such as mobile phones or cars) made by the centre of the world economy. The result is a dependent develop-ment of the periphery whose products continuously lose their relative importance in the global consumption basket.

The policy implication of this phenomenon was that governments of the devel-oping countries in Latin America and elsewhere closed their markets and tried to diversify their economies through industrialization policies driven by import substitution. In some cases, this has been successful and has provided the basis for current competitive sectors, for example some industrial sectors in Brazil, or the economic success story of several East-Asian Tiger states. But it led also to economic inefficiency, high debt rates, inflation and even economic collapse in several countries that did not have sufficiently large internal markets and did not combine the import substitution model with an export oriented strategy.

The field of urban studies and economic geography has also put emphasis on economic diversity. Examining growth in cities, Jane Jacobs (1969) identified the variety of activities, ideas and resources as a source of creativity, recombina-tion, innovation and growth. Work from the field of economic geography also highlights the crucial role of proactive specialization and geographic agglomera-tion of related activities and companies (Becattini 1979; Pyke et al. 1990; Porter 1990, 1998; Glaeser et al. 1992). However, even the most famous industrial clusters such as Silicon Valley or Route 128 (Saxenian 1994) are certainly not perfectly homogenous; at lower levels of sectoral disaggregation there is enor-mous complexity and variety of related activities and processes. Furthermore, regional specialization does not necessarily make for a reduction of activities on the national or global level, but can even add to the number of activities and com-plex interactions between them.

Economic diversity and structural transformation is a recurrent key issue in eco-nomics, and especially in development economics. Many influential economists have highlighted economic diversity as a crucial factor and outcome of economic growth.

For instance Kuznets (1971) defined economic growth as the long-term rise in capacity to supply increasingly diverse economic goods. Weitzman (1998) presented development as recombinant growth, where new ideas built upon the recombination

of old ideas. The influential Dixit-Stiglitz (1977) model also puts emphasis on the demand of consumers for variety. Hausmann and Rodrik (2003) view economic development as a self-discovery process, in which companies discover which variety of products they can produce in a cost efficient and effective way.

Increased data availability and modern analysis techniques permit empirical analysis of the theories of the early development pioneers about the role and dynamics of polarization, structural transformation and economic diversification.

Several works have shown that that economic diversification and position in the global productive space are crucial for the economic performance of countries (Hidalgo et al. 2007; Funke and Ruhwedel 2001; Saviotti and Frenken 2008) and regions (Frenken et al. 2007). With the exception of some oil-rich coun-tries, most rich countries can draw upon highly diversified economic structures.

Diversification also requires and draws upon a large variety of productive capa-bilities such as infrastructure, knowledge, institutions etc., within these countries (Hidalgo et al. 2007; Hidalgo and Hausmann 2009). Productive capabilities allow countries to produce high value added and complex products, recombine capa-bilities and further diversify and grow. By using employment and aggregated export data, Imbs and Wacziarg (2003) showed that countries diversify until they have very high levels of income. At around US$7,000–11,000 per capita, depend-ing on the measure and data applied, a tendency towards more specialization is observable. However, in the long term and at lower levels of disaggregation, the economic system has to constantly diversify, producing more and better products, processes and services, to maintain economic development (Pasinetti 1981, 1983;

Saviotti 1996). This is not only true for the global economy, but also for countries and regions, to enable them to maintain flexibility and economic competitiveness (Tödtling and Trippl 2005).

To understand the effects of diversification on socioeconomic development, the abstract term ‘diversification’ needs to be defined and different types and dimensions of the terms ‘diversity’ and ‘economic diversification’ need to be distinguished. Over time, many different dimensions of diversity in general and economic diversification in particular have been discussed. Regarding the meas-urement of diversity in general, Andy Stirling (2007) argues that a comprehensive composite measure of diversity should include variety, disparity and balance as different core aspects of diversity. While variety measures the number of elements (here, sectors), balance measures the quantity of each element and disparity how different the elements are. Indeed, the evolution and measurement of each aspect may have distinct impacts on economic development. For our topic of interest, growth in the variety, balance and disparity of sectors may have different effects on the social choices and required capabilities of people. Economic diversification in terms of the growth of activity in a variety of similar sectors (e.g. in low-paid services) may not necessarily lead to a greater balance in the economic income distribution, significantly new social choices or more creative jobs. On the other hand, economic diversity measured in terms of a high level of balance between the sectors of an economy does not necessarily mean that the economy has a great variety of competitive sectors, providing well-paid and creative jobs.

To differentiate between the effects of different types of economic diversity on regional and national economic growth, Frenken et al. (2007) and Saviotti and Frenken (2008) made a distinction between related and unrelated economic vari-ety, where related variety growth indicates diversification into related economic activities and unrelated variety growth covers the diversification of economic activities into essentially different activities and knowledge bases.

Hidalgo et al. (2007) draw attention to the complexity of the products a country is capable of producing (i.e. whether many other countries are able to produce and export the same types of products). In their analysis based on export data, they obtain highly significant results showing that the combination of the number and complexity of products matter for the past and future economic development of countries, because this indicates their existing and potential future productive capabilities.

In summary, however, in spite of the recent significant advances made in the analysis of economic diversification and its role in economic development, the effects of economic diversification on human development and well-being are still poorly understood.

4.2 The relevance of economic diversification for human