Determinants of Vertical and Horizontal Export Diversification: Evidences from Sub-Saharan Africa and East Asia

Abstract

This paper analyzes the main determinants of vertical and horizontal export diversification based on a balanced panel data for 41 countries from SSA and East Asia over the period 1975-2004; using FGLS estimation methods with corrected heteroskedasticity and autocorrelation. The results reveal that education, health, and income per capita, population size, infrastructural development and openness are crucial factors to induce vertical as well as horizontal export diversification. FDI was found to be a key factor to speed-up vertical and horizontal export diversification in East Asia, but only for vertical diversification in SSA. The elasticity’s of human capital and FDI were much higher in East Asia than SSA. The intuition is that East Asian countries have devoted significant amount of investment on education, health, infrastructure and these in turn created a better conducive atmosphere for FDI inflow. The study also reveals domestic investment plays an important role to enhance vertical as well as horizontal export diversification for East Asia, while it only induces horizontal diversification for SSA. While ‘arable land’ resource has a positive and significant effect on vertical and horizontal diversification, ‘oil’ wealth was found to be negatively associated with export diversification. This implies that not all types of natural resource endowment have a ‘Dutch disease’ effect. While inflation, exchange rate, and foreign aid variables have a mixed effect on vertical and horizontal export diversification, political instability however has a strong adverse effect on export diversification; especially for SSA. The key lesson from East Asia to SSA is that investment on human capital and physical infrastructure through foreign investment as well as domestic capital formation are key ingredients, as are stable macro-economic and political environment, a stable and flexible exchange rate, and a fair and an open trading framework in order to accelerate vertical and horizontal export diversification and ultimately promote structural change on the economy. In line with this, SSA countries should follow a dual strategy of vertical and horizontal export diversification, mainly by supporting backward and forward linkages into higher value-added resource-based industries and gradually shift production and exports from customary products to more dynamic ones by developing competitive advantage in the world market.