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Exports Diversification Economic Growth Economics Essay

Export plays a very important role in the economic growth of a country. However, export can be influenced by many factors. Therefore, it is important for policy makers/business executives to understand the driving factors behind this process. The process of economic development (i.e. economic growth) is a process of structural transformation where countries shift from producing “poor-country goods” to “rich country goods” (Hesse, 2008). A precondition for this transformation process is often the existence of strong demand for countries’ exports in world markets therefore countries are able to take advantage of global markets without fearing negative terms of trade effects.

In many developing countries including China, there is often a very weak domestic demand so exports remain of the few channels that in the longer run significantly contribute to higher income per capita growth rates of a country. One of the major reasons behind export diversification is “export instability”, which is analogous to the portfolio effect in finance. Commodity products are often subject to very volatile market prices so that countries that are dependent on these commodities may suffer from export instability.

This would be followed by provision of case studies that discuss the factual evidence of exports driven economies which is China that has been relying heavily on its exports products to other countries, and subsequent growth that they have reaped as a result of this activity.

Introduction

The process of economic development (i.e. economic growth) is a process of structural transformation where countries shift from producing “poor-country goods” to “rich country goods” (Hesse, 2008). A precondition for this transformation process is often the existence of strong demand for countries’ exports in world markets therefore countries are able to take advantage of global markets without fearing negative terms of trade effects.

In many developing countries including China, there is often a very weak domestic demand so exports remain of the few channels that in the longer run significantly contribute to higher income per capita growth rates of a country. Many countries that are highly dependent on their commodity exports such as Brazil or Australia often exhibit a narrow export basket suffer from export instability arising from weak demand of exports.

Therefore, having a solid export diversification system is one way used to alleviate these particular constraints. Another issue relating to the competitiveness of a country’s exports since globalisation and accelerating cross-border trade exposes countries’ exports to global competition. Therefore, in order for the country to be successful in export diversification, countries’ exports need to be globally competitive to take advantage of leveraging global markets.

Next question is why do countries diversify their exports and does it benefit countries’ economic growth? Also, how an increase of economic growth would lead to an increase in exports? Often countries may experience export led growth. For example, China’s strong rate of growth is primarily caused by the strength of the Chinese manufacturing sector. In this case it is exports that are increasing economic growth, rather than the other way around.

On the other hand, economic growth could also increase exports. In a period of economic growth, firms have more money to invest. This investment could increase the long run productivity of the economy and therefore, could help boost exports. In a recession, firms will be more reluctant to invest and therefore, there will be a slower growth in exports.

Therefore, in theory it is also possible economic growth could harm exports. This is because high growth could cause inflationary pressures making exports less competitive. Also higher growth may lead to higher interest rates. Higher interest rates could cause an appreciation in the exchange rate which makes exports less competitive.

To understand why countries diversify their exports to promote economic growth, it is important to explore the theory called ‘structural model of economic development’ that states that countries should diversify from primary exports into manufactured exports in order to achieve sustainable growth (Chenery, 1979; Syrquin, 1989). It has been argued that vertical export diversification could according to the Prebisch-Singer thesis reduce declining terms of trade for commodity-dependent countries.

One of the major reasons behind export diversification is “export instability”, which is analogous to the portfolio effect in finance. Commodity products are often subject to very volatile market prices so that countries that are dependent on these commodities may suffer from export instability.

This could potentially discourage necessary investments in the economy by risk-averse investors, increase macroeconomic uncertainty, and be detrimental to longer-term economic growth. Export diversification could therefore assist the exports-driven countries to stabilise earnings in the longer run (Ghosh and Ostry, 1994; Bleaney and Greenaway, 2001).

Endogenous growth models such as Matsuyama (1992) emphasize the importance of learning-by-doing in the manufacturing sector for sustained growth. Related to export diversification, there could be knowledge spill overs from new techniques of production, new management, or marketing practices, potentially benefiting other industries.

Producing an expanding set of export products can be seen as a dynamic effect of export diversification on economic growth where countries below the technological frontier widen their comparative advantage by imitating and adapting existing products. Furthermore, it is often the case where countries diversify export products through imitating and exporting products from cheap labour countries such as China or India.

Another literature that discusses the relationship between export diversification and economic growth is a literature by Hausmann and Rodrik (2003), which analyses the benefits of export diversification and exports in general for economic growth, both empirically and theoretically. Within their framework, economic growth is not driven by comparative advantage but by countries’ diversification of their investments into new activities.

An essential role is played by the entrepreneurial cost-discovery process. According to the model of Hausmann and Rodrik (2003), entrepreneurs face significant cost uncertainties in the production of new goods. If they succeed in developing new goods, the gains will be socialised (i.e. information spillovers) but the losses from failure end up being private.

This in fact leads to an under provision of investments into new activities and a suboptimal level of innovation. The bottom line is that according to Hausmann and Rodrik (2003), the government should play an important role in economic growth and structural transformation by promoting entrepreneurship to improve the exports driven sectors of the economy.

Hausman, Hwang and Rodrik (2006) develop an economic indicator that measures the productivity level associated with a country’s export basket. This measure is significantly positively affecting economic growth. In other words, countries that produce high-productivity goods, where it has been argued that the key is the transfer of resources from lower-productivity to higher-productivity foods with the presence of elastic demand of these goods in export markets generates higher economic growth.

As an example, Taiwan's economy grew at an annualised rate of 18% in the last three months of 2009, driven by demand for high-tech products from mainland China (BBC News, 2010). The growth was better than expected, and an increase on the 8.25% expansion between July and October. Also, Thailand's economy also grew sharply in the final quarter of 2009, expanding at an annual rate of 5.8%.

Analysts said Thailand's growth - which saw it exit recession - was also fuelled by increased exports to China. China's economy, which is on course to overtake Japan to be the world's second largest, grew 10.9% in the last three months of 2009. Taiwan's economic growth is measured on an annualised basis - which shows what the annual rate would be if the latest change continued for a whole year.

Using a different measure - comparing the fourth quarter with the same period of 2008 - its economy expanded 9.2%. Despite the strong growth, analysts expect the Taiwanese central bank not to raise interest rates from the current 1.25% low until later in the year, when it gets further evidence of the durability of the economic recovery in the US. Hsu Kuo-an, economist at Capital Securities in Taipei, agreed that this was the best way of going forward.

"Taiwan relies on export growth, and demand from Europe and the US is pretty weak," he said. Therefore, based on experience, the government needs to be a bit cautious."

Xin, J and Miles, T (2010), reports that Growth in China's exports and imports last month blew past expectations, providing fresh evidence of the vigor of the economy and strengthening the case for Beijing to let the Yuan start climbing again.

Exports leapt 17.7 percent from a year earlier, dwarfing the 4.0 percent rise forecast by economists and breaking a 13-month streak of year-on-year declines; imports surged 55.9 percent, much more than the 31.0 percent increase markets had expected. "The strong acceleration in imports may heighten the chances of overheating and put more pressure for the government to tighten policy," said Wang Hu, an economist at Guotai Junan Securities in Beijing.

Based on the trade data, he estimated industrial output in December grew by more than 25 percent from a year earlier and that GDP growth in the fourth quarter exceeded 11 percent.

Despite the leap in exports, the even bigger jump in imports meant China's trade surplus slipped to $18.4 billion in December from $19.1 billion in November and $39.0 billion in December 2008. Economists had expected it to tick up to $19.6 billion.

China was not the only Asian exporter to enjoy a dazzling December. South Korea and Taiwan reported export growth of 46.9 percent and 33.7 percent, respectively. But China is far bigger, overtaking Germany as the world's biggest exporter of goods in 2009.

Its booming investment and consumption are helping to rebalance the world economy even though Beijing has refused to let the yuan rise against the dollar since the global financial crisis began in mid-2008, said Rob Subbaraman, chief Asia economist at Nomura in Hong Kong.

Its imports of crude oil also hit a monthly record, while iron ore shipments were the second highest ever and copper imports beat expectations. Booming Chinese demand will be a boon for commodity exporters like Australia, said Liu Nenghua, an economist with Bank of Communications in Shanghai. "It shows that China will continue to play an important role in driving world economic growth," he said.

Liu said policy would not change in response to one month's figures, but the strong data would further reassure Chinese officials that global demand was not as weak as they had feared. "The government needs some time to see what happens. The really critical period is the first quarter of 2010: if the situation continues to be rosy, then the government may have to change a slew of policies, including its exchange rate policy," he said.

China flagged the possibility of tighter policy settings last week when the central bank nudged up a key money market rate for the first time since August. And on Sunday the cabinet voiced fresh concern over the bubbly property market and vowed not to let speculative inflows heat it up.

Other economists agreed that the Yuan could start to rise around the end of March if exports remain strong. But any appreciation would be moderate, in the order of 3 percent for the whole year, as China strove to protect export jobs, said Lin Songli at Guosen Securities in Beijing. "China is in need of exports to create jobs and to promote economic growth, there's no doubt about that," Lin said.

A new strand of literature investigates whether export growth is predominantly driven by growth at the extensive or intensive margin. Under extensive margin growth, countries export a wider set of goods to existing or new geographical markets whereas under intensive margin growth, an increase of existing goods to current markets occurs. Hummels and Klenow (2005) as well as Pham and Martin (2007) in a cross-sectional analysis find that most of the export growth is driven by growth at the extensive margin.

This stands in contrast to Brenton and Newfarmer (2007), whose results in a panel data-setting from 1995-2004 suggest that exporting larger quantities of existing products matter more than exporting a wider set of products. Also, exporting existing products to new geographical markets carries a higher weight in explaining export growth than discovery of new products.

The conflicting results could be potentially traced back to different levels of disaggregation and types of regression models used so more work needs to be done for a better understanding of the contributions of extensive as well as intensive margin growth to countries’ export performance.

Conclusion

As a conclusion based on theories and evidences discussed in the report, it is to be suggested that export concentration has been favourable to the growth performance of many developing countries including China in the past few years. China's economic growth in 2009 was driven solely by domestic demand instead of exports.

In the first three quarters, the contribution to GDP growth by investment and consumption reached 94.8% and 51.9%. Exports contributed a -46.7%, with its share in GDP falling from 32.4% in 2008 to 24.5%. Apparently, this fits the change of growth reliance from exports to domestic demand and reflects the strong adaptability and potential of the Chinese economy, including the substantial demand for infrastructures and the huge room for growth arisen from divergences in development stages among different regions and sectors.

The stimulating measures have boosted the development of these areas, filling the gap created by the sudden shrinkage of external demand. Nevertheless, whether this development trend can persist is far from certain, as it only takes place passively due to the deterioration of exports.

Specifically, relying on stimulating measures to boost domestic demand would probably be unsustainable and the inner drive for over-reliance on exports may still remain. At least, the 26.8% high growth of fixed investment in manufacturing during the first 11 months of 2009 still signifies the persisting reliance on foreign demand should domestic consumption fail to bolster. Also, it has been proven that the cost-discovery process faced by entrepreneurs and the valuable contribution of government policies to alleviate ensuring problems of coordination and information externalities. This results in a diversification of investments into a new range of activities and higher levels of economic growth.

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