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On economic diversification as a pathway to economic prosperity and a greater economic resilience against the impacts of climate change and response measures to climate change

Implementing the Paris Climate accord and transformative 2030 Agenda requires a series of fundamental socio-economic and technological transformations aimed at the transition to sustainable, people-centered and climate-resilient economies. Economic diversification is an important tool of such transformations. It is one component of economic resilience (i) against the impacts of climate change (increasing water scarcity, increasing frequency of extreme weather events, loss in biodiversity, etc.) and (ii) against response measures undertaken by developed countries to mitigate climate change, which produce adverse impacts on the economies of developing countries (art.4.8. UNFCCC, 2.3 and 3.14 of the Kyoto Protocol). Economic diversification is also a key component of sustainable development (UNDP, 2019). It is called to assist reducing poverty by achieving higher levels of productivity, diversified and higher-value-added activities (targets 8.2., 9.b.).

Traditionally, economic diversification was used as a strategy to encourage positive economic growth through shifting the economy away from a single income source toward multiple sources, and growing presence and economic performance in different sectors and markets. In the context of sustainable development and global climate accord, economic diversification can be understood as an essential shift of an economy from vulnerable and unsustainable products, markets, and jobs towards more sustainable and climate-resilient ones (UNFCCC,2019) Both developed and developing countries face the need to diversify their economies and climate-sensitive sectors such as tourism, agriculture, fisheries, forestry, and energy production either by expanding climate-sensitive sectors or by promoting adaptation measures that increase resilience within the sector. (UNDP., 2019) In the context of response measures to climate change, the most vulnerable economies are those for which: a significant percentage of their total exports is concentrated on only a few products or services and demand for those few products or services is likely to drop as a result of climate change mitigation measures in other countries. (UNFCCC, 2016)

Indeed, diversification of the economy and broad-based economic development are critical for the long-term sustainability of developing countries. The rationale for economic diversification (addressing the impacts of climate change, mitigating the impacts of the response measures to climate change undertaken by other states, achieving the SDGs) defines the character of diversification strategies.

Resource-rich developing countries that have the extractive economic model and depend on a few exports face the need to diversify their economies in order to address the potential impacts of the response measures and achieve the SDGs. In the context of sustainable development, the extractive model of resource-rich countries has several significant limitations and vulnerabilities such as (i) exposure to commodity price fluctuations, (ii) weak links to the rest of the economy, and, as a rule, (iii) limited or no positive societal impact on employment, education, improving living standards. From the long-term sustainability view, further investments and expanding such extractive sectors would have a low impact on the growth and productivity of other industries, lead to a high concentration of GDP and a low impact on job creation. (World Bank, 2014) From the climate policy perspective, the global implementation of climate mitigation measures, such as carbon emissions reduction targets, have major actual and potential implications for economic growth and prosperity of the countries with extractive model, particularly, in fossils exporting countries such as Russia, Gulf states, Venezuela due to the effects such measures may produce on the demand and prices in hydrocarbon markets, fossil fuel exports, and, ultimately, GDP growth. Furthermore, constraints on the use of fossil fuel energy (e.g., fossil fuel taxes and carbon pricing) could produce the impact on other countries in the result of the increase in production costs and hence prices of goods and services. In this context, it is imperative for all countries to run a number of smart economic reforms including subsidy reforms, fiscal reforms, economic diversification policies to build economic resilience and ensure long-term sustainability.

At the same time, the economic diversification of non-diversified economies has proven to be a challenging task that may take decades to shape established economic, cultural and political patterns, regulatory frameworks and institutions. It may affect the social contract and reshape traditional redistributive welfare models. Resource-dependent countries, face a number of the unique challenges in achieving economic diversification. It is particularly true for the countries with strong primary exports such as oil and gas, which played a crucial role in shaping political economies and development patterns, led to concentration and control over the resources in hangs of the government or business elites with political influences. Any pressure related to shifting from the established pattern of the non-diversified economy may create political and economic instability both in the country itself and on the regional or global markets. World Bank associates challenges with economic and financial underpinnings such as fast growth in export revenues from resource extraction, that is invariably accompanied by exchange rate appreciation pressures or the so-called Dutch Disease (World Bank, 2010). Such pressures reduce the competitiveness of other traded sectors of the economy. (World Bank, 2014) To counteract the Dutch Disease, World Bank suggests countries to increase productivity and promote investment in non-extractive sectors to spur their growth.

Conducive policy environment is key to successful economic diversification. Effective economics and investment policies have their role to play in (i) attracting private capital in non-extractive sectors with smaller revenues, (ii) providing better access to finance, and (iii) supporting entrepreneurship and skill development. Many governments have also attempted a proactive industrial policy through a system of targeted subsidies and incentives. According to the World Bank, the efficacy of such measures has generally not proven to be high.

Macro-legal parameters of economic diversification such as eliminating non-trade domestic barriers to economic diversification, international trade barriers, foreign investment in non-traditional sectors, assistance, in the form of technology transfer, technical assistance and financial support, international economic policies, and international cooperation play a significant role in supporting economic diversification.

By Katsiaryna Serada

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