How Does Export Diversification Impact Economic Growth?

Abstract

The paper uses a mixed method approach to conduct a literature review of existing econometric studies to determine the key drivers of export diversification and economic growth, and to examine whether export diversification propels or hinders economic growth. The paper differs fundamentally from previous studies, as it focuses on identifying the key variables used, the frequency with which they are used and their degree of significance based on econometric studies that focused on measuring export diversification, economic growth and the linkage between diversification and growth in developed and developing countries, while highlighting a key gap in this literature, namely a lack of empirical studies focused on small island states. The paper finds that eight variables were used across all studies at a frequency of 10% or greater – namely, real GDP per capita, education, population, domestic investment, market distance, openness to trade, export concentration and rule of law. Based on the literature review, the key factors which support export diversification are human capital accumulation inclusive of higher education, domestic investment, population, quality of institutions, quality of infrastructure and market access. Conversely the factors that retard export diversification or increase export concentration are economic distance (remoteness from major markets), openness to trade, and declining terms of trade, foreign direct investment, exchange rate volatility and exchange rate overvaluation. Similarly, with regards to economic growth, the literature review suggests that the key factors which promote economic growth are rule of law, investment ratio, favorable movements in the terms of trade, technology, higher education and increased international openness while the factors that inhibit economic growth are fertility rate, the ratio of government consumption to GDP, and the inflation rate. In terms of the key variables used to link export diversification to economic growth, based on the literature, the six main categories of trade integration variables include export composition, trade orientation, export structure, geographic structure and trade strategy. After having reviewed the extant literature on export diversification and its relationship to economic growth, one of the overlooked areas of research is a lack of studies examining export diversification in small island developing states, and how export diversification may or may not contribute to economic growth in those particular contexts.