Limited economic diversification – where production is concentrated in sectors characterised by low technology spillovers – can limit productivity growth and expose an economy to the macroeconomic instability of a fate dictated by external events. Moreover, development and diversification appear to be related. Imbs and Wacziarg (2003) show that higher per capita incomes are associated with greater diversification and then with increasing specialisation at higher per capita incomes. Cadot et al (2011) indicate that the pattern Imbs and Wacziarg found between incomes and economic diversification is an inherent feature of the development process. While Lin (2012) argues that governments can guide economic diversification and speed up the structural transformation essential to development, policy makers face the risk that misguided intervention can hurt the process of economic diversification.
Can governments do something about economic diversification? In a recent working paper we explore the hypothesis that volatility is at least partially responsible for Russia’s limited success in diversifying its economy (González et al. 2013). Specifically, we ask the following questions:
- Do new firms emerge; and,
- If so, do they survive the deep, long and frequent ups and down that characterise the dynamics of the Russian manufacturing sector?
Russia's economy is highly concentrated and dependent on activities of extraction and exploitation of natural resources. Trends of the last two decades in this respect are not promising. In fact, growth in Russia has been limited to a few sectors and to a few firms. As a consequence, Russia is much less diversified today than it was during the Soviet Era, both within and across sectors. The bottom quartile of the manufacturing sector, ranked by operating revenue, contributes 0.6% of total manufacturing output while the top quartile contributes 80%. In addition, the average share of output for the bottom quartile of firms (in terms of operating revenue) in the manufacturing sector is 0.06% while the share of the top quartile is 94.7%.
The extraction and exploitation of natural resources depend on specialised inputs, assets and capabilities, which are said to be difficult to redeploy to, say, complex manufacturing products (Hausmann and Klinger 2007). In this context, it is often argued that without state aid, it is unlikely that diversification will occur. But is this true? This assumes that the Russian economy is not dynamic enough to generate activity outside the extractive sectors. Alternatively, we ask whether this assumption is correct, or whether there is emergence of new activities but economic volatility wipes these gains away.
Manufacturing output volatility in Russia is higher than in other emerging markets.
Figure 1 shows that Russian sector-level growth is more volatile than comparable economies. The more extended spread of the box and the whiskers alongside indicate higher variances in growth rates.
Figure 1. Russia manufacturing annual output growth exhibits more volatility (higher variances). Year to year sector-level growth (1993-2009)
Source: Authors' calculations from UNIDO 2011 Industrial Output Data (4-digit ISIC).
Volatility in Russia is a nearly all-encompassing event. When things are booming, the boom is shared by nearly all manufacturing sectors. When things go bust, practically all sectors go bust. The relatively high level of concentration of output across firms and sectors exacerbates the problem. Further, when analysing slumps and surges across time and comparing these to other economies, we find that although surges in Russia have similar looking peaks and last about as long as those in comparator countries, the slumps are deeper (Figure 2) and longer (Figure 3). For slumps of less than 6 years (the horizontal axis), the probability (the vertical axis) of a slump persisting for another period is higher in Russia (the step-like line is above that of the other economies).
Figure 2. Russia slumps are deeper
Figure 3. Russia slumps last longer
It is not about lack of new activities but rather about survival of efficient and young firms
The survival of new, relatively efficient firms (particularly during longer and deeper slumps) is a central weakness and likely key issue limiting economic diversification in Russia. Our analysis shows that during slumps, more productive firms tend to have lower odds of surviving relative to less productive ones than during surges. During long and deep slumps, older firms and firms facing less intense competition are more likely to survive. Unfortunately these firms are often not the champions of change and innovation that form the basis of diversification. In Russia the slumps do in fact wipe away some of the hard fought gains made by new, emerging entrants. So much for the new blood needed for the economy to diversify.
Our analysis suggests that that the emergence of new firms is not the binding constraint on economic diversification in Russia. The constraint is rather the poor odds of survival that these long, deep Russian slumps present for young and efficient firms. The staying power of hardened incumbents – who have survived many of these surges and slumps – do not help the entrants’ odds of survival either, regardless of their efficiency. Inefficient incumbents who weather these slumps hold on to resources that more efficient firms could use if freed up. From a policy perspective, the focus should be on removing barriers to the survival of young firms during output slumps, rather than just promoting emergence of new firms or activities. One thing is clear: more competition would drive out less efficient, older firms, and create space for young and efficient ones to survive and thrive.
Editor's note: The views expressed in this column are those of the authors and do not represent those of the institutions with which they are affiliated.
Cadot, Olivier, Céline Carrère and Vanessa Strauss-Kahn (2011), “Export diversification: What‘s behind the Hump?” Review of Economics and Statistics 93: 590-605. Print.
González, Alvaro, Leonardo Iacovone and Hari Subhash (2013), “Russian volatility: Obstacle to firm survival and diversification”, Policy Research working paper; no. WPS 605. Washington, DC: World Bank.
Hausmann, Ricardo and Bailey Klinger (2007), “The structure of the product space and the evolution of comparative advantage", CID Working Paper No. 128. Cambridge, MA: Harvard University.
Imbs, Jean, and Romain Wacziarg (2003), “Stages of diversification”, The American Economic Review, 93: 63-86. Print.
Lerner, Josh (2009), Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed - and What to Do About It, Princeton University Press, Princeton, N.J.
Lin, Justin Yifu (2012), The Quest for Prosperity: How Developing Economies Can Take Off, Princeton, New Jersey: Princeton University Press.