On the expenditure side, government spending can both catalyze and constrain the growth in employment and output of economic sectors. An expansion in the number of government expenditure targets can indicate a shift from subsidies to specific economic sectors, such as primary commodities or heavy industries or basic public services.
It can also reflect structural economic changes in production and employment. Through expenditures, governments can free up resources that might otherwise be allocated to suboptimal economic sectors and reallocate them to sectors that provide higher economic and social returns.
Government spending and associated policy to help ease credit constraints can help smooth financial frictions that otherwise distort the allocation of capital and entrepreneurial talent across firms, industries, and sectors.
Some studies suggest that government spending may target certain constituencies as a way to induce tax compliance.
For instance, Jeffrey Timmons found that governments that rely relatively heavily on taxes paid by poor people regressive taxation will tend to motivate these relatively impoverished taxpayers through social spending on public services; and those governments that rely more heavily on taxing the rich progressive taxation will motivate them by providing relatively high levels of protection for property rights.
Historically, governments in developing countries have sought to use the fiscal tools—both revenues and expenditures—at their disposal to spur structural transformation.
Some countries—primarily the Central and Eastern European late-industrializers and the East Asian tigers—succeeded in doing so. In other instances, however, the experience proved disastrous for economic development. In the last two decades, domestic revenue generation has dramatically increased among African countries see figure 4. Furthermore, as Moore and others note, governments in Africa are collecting taxes more effeciently than other governments in some low-income regions and are making consistent, gradual progress in improving their revenue systems.
As a result, they are capturing a higher proportion of national income for public purposes. For instance, development assistance accounts for 20 percent of gross national income in The Gambia, Liberia, Malawi, and Somalia.
Furthermore, overall, Africa is more dependent on ODA than any other region; in , it received about 33 percent of total ODA from donors of the Organisation of Economic Co-operation and Development.
It is preferred partly because, as Olivier Cadot and others explain, it can be broken down between groups of export lines. In computing the Theil Index for Nigeria for , the changes in concentration at its intensive margin, which includes goods such as petroleum and cocoa, and at its extensive margin, which includes maple syrup and snow plows presumably , would both be computed.
Therefore, the index findings would indicate whether diversification in Nigeria came from further diversification in the products it previously exported or from products it did not previously export. That said, its disaggregation component could be used to assess the relative contribution of economic sectors to fiscal revenues.
For example, according to the Budget Review published by the South African National Treasury, Pretoria will collect just over 1, billion rand in the — fiscal year, predominantly from two sources: taxes on income and profits, which include the corporate income tax CIT and the personal income tax PIT , and taxes on goods and services, which include the value-added tax.
For instance, the CIT or PIT could each be disaggregated at the intensive margin of the active contributing economic sectors today such as gold mining or automobile manufacturing and at the extensive margin of inactive sectors that could contribute to taxes in the future such as aircraft manufacturing.
Among development practitioners, a widely used tool with the potential for measuring fiscal diversification is the PEFA framework. It is used to assess and report on the strengths and weaknesses of PFM performance under seven broad pillars. Each pillar is comprised of two to seven indicators, making a total of thirty-one indicators. While PEFA is one of more than forty-five tools that assess PFM systems, it has the greatest potential for evaluating fiscal diversification.
Second, PEFA offers extensive geographic coverage—the formal assessments undertaken by PEFA since cover countries, including nearly all developing countries and all African countries except Libya and Somalia. Finally, PEFA is increasingly being used at the subnational level to assess the PFM performance of state, provincial, regional, and local governments, including districts and municipalities.
However, there are some limitations in using PEFA to assess fiscal diversification. For instance, according to Sierd Hadley and Mark Miller, not all elements of the framework are universally relevant, and indicators do not always capture which systems are deficient or why.
Thus, the ratings inadvertently incentivize reforms that change how systems look but not how they function. Overall, since PEFA is rooted in a multidonor initiative, the framework has a normative and prescriptive bias toward measuring and conforming to so-called best practice processes in finance and other relevant ministries rather than measuring the outcomes of these PFM reforms. To better capture fiscal diversification, the framework would need to factor in government revenues and expenditures to help assess issues like sustainability or potential for economic transformation in relevant sectors.
These dimensions and measures of economic diversification matter because they determine the menu of policy options for a country. Structural differences, such as natural resources wealth and government effectiveness, have implications for the specific challenges of economic diversification in any country.
Many of these structural characteristics are on full display in Africa. According to World Bank data, twenty-three African countries are classified as low-income, thirty are middle-income, and one, Seychelles, is high-income. In terms of natural resource endowments, twenty of the fifty-one African countries that have available data are considered resource-rich with resource rents accounting for 10 percent or more of GDP and thirty-one are considered resource-poor see figure 8.
Finally, the quality and effectiveness of governance vary greatly across the continent, with twenty-eight of the fifty-four countries scoring a 50 or more on the Ibrahim Index of African Governance, which has a maximum value of , and the remaining twenty-six scoring below These structural differences should be considered when measuring and interpreting the economic diversification outcomes of countries, as they have critical policy implications.
Zero reflects an export structure as diversified as that of the world as a whole. A highly diversified country typically scores between 1 and 2 on the index, while a country with little export diversification scores between 5 and 7. As figure 9 demonstrates, African countries have highly varied export diversification levels. While a handful of East African countries the five original members of the East African Federation , Egypt, South Africa, Togo, and Tunisia are highly diversified, resource-dependent countries are not.
Economic diversification is closely correlated with income, and for a long time, economists assumed the relationship was linear. As these old cones die, diversification drops.
Thus, according to this literature, a high level of diversification among middle-income countries is a temporary phenomenon. With regard to African countries, the figure shows that no diversification appears to take place as income levels increase. As the next paragraph explains, this is likely due to the outsized dependence on natural resources of many middle-income African countries.
Equatorial Guinea is the clearest outlier in Figure 10, owing to its small population of 1. It has by far the highest GDP per capita level among African countries and is heavily reliant on oil exports. Therefore, it is unlikely to fit the pattern described by Imbs and Wacziarg and Cadot and others, whereby economic diversification arises from increased productivity and decreased trading costs that accompany economic growth.
Economic diversification levels also vary significantly with resource endowments. A large volume of literature convincingly demonstrates that resource-rich countries tend to be less diversified economically than their resource-poor counterparts.
But governments might be reluctant to reduce dependence on those extractive resources industries in which they have a strong national comparative advantage. This might be due to economic constraints, as the transition can be difficult, costly, and replete with resonating fiscal risks, especially in countries afflicted by the Dutch Disease in other words, uncompetitive economies resulting from overvalued currencies. Therefore, domestic political support for diversification policies is needed.
The global policy consensus may also impede such measures. As Ha-Joon Chang and Amir Lebdoui argue, the global policy consensus for resource-rich countries tilts toward fiscal stabilization and revenue management rather than structural transformation and diversification.
This is consistent with what Nour Alsharif, Sambit Bhattacharyya, and Maurizio Intartaglia found—that a notable negative relationship exists between oil dependence and economic diversification. The data demonstrate a clear positive relationship between the two.
This is unsurprising, given the results presented above and the fact that resource dependence and manufacturing value added are expected to be negatively correlated. Governance is also closely correlated with economic diversification. But while governance is widely accepted to be a key determinant of economic growth, 83 it remains underexplored in the economic diversification literature.
Figure 13 plots government effectiveness and export diversification. Favorable institutional conditions are necessary for economic diversification—but not sufficient. The concept of fiscal diversification as it relates to inducing or supporting structural economic change and transformation remains underexplored in economics literature, and analyses are constrained by data limitations.
Drawing on available data, figures 14—16 show a positive correlation between tax revenue as a percentage of GDP, government spending as a percentage of GDP, and government subsidies as a share of government spending and export diversification.
Various explanations can be provided. The data may be suggesting that African governments are not leveraging their fiscal tools in a way that leads to economic diversification. It could also be suggesting that governments, through taxation and spending, are crowding out economic actors from nondominant sectors. Of course, the impact of depending on natural resources for revenues and crowding out other sectors cannot be excluded. It is also possible that governments shield the dominant sectors of their economy from taxation or support them via government spending, which could reinforce economic concentration.
While exploring how country-specific characteristics are associated with diversification is useful, it does not account for subnational heterogeneity within countries themselves, which can sometimes be stark. It is common for countries to contain islands of relative economic diversification and productivity surrounded by a proverbial sea of low-productivity activity.
This is particularly salient in Africa, which has high levels of interregional inequality at the subnational level. These areas of productivity in African countries are often located along the coast while, further inland, huge swaths of land are used for subsistence farming. Within other countries, economically productive and diversified areas, or growth poles, are clustered around the national capital, while the hinterlands predominantly engage in subsistence agriculture.
This is the case in Ethiopia, Madagascar, and Rwanda. This phenomenon often takes place in countries that are home to special economic zones or export-processing zones, as the special tax-exempt status of such zones can make them more competitive than other areas. Both cross-country analyses and country-level policy recommendations are of limited utility in cases where stark interregional inequalities and corresponding diversification gaps persist.
By looking at national-level measures of diversification like the ones presented in this paper, central governments may conclude that a lack of diversification is a problem at the national level when it may in fact be more predominant at a subnational level and necessitate different policy responses. Together, the two countries produce about two-thirds of global cocoa output. FDI strategies vary by sector, but success stories in recent years illustrate common themes.
In some cases, these government agencies, as well as international organizations and bilateral aid and development agencies, are willing to help investors overcome obstacles by offering sovereign guarantees, political-risk insurance, financing and instruments.
Local partnerships are often useful for land acquisition, which often triggers cultural sensitivities in many sub-Saharan states. Land registries are often incomplete or inaccurate, and non-governmental actors such as the leaders of ethnic groups or communities often wield power. Rather than attempting to buy land, investors have often instead provided a small slice of equity to landowners, which can be private or public entities.
Providing equity to state- or provincial-level governments for land helped Persianas Group develop malls in Nigeria, for example, boosting local support and political will for the projects. Several main value chains have emerged in the two decades since FDI broadened beyond extractives, based on telecommunications, agricultural and energy. That created a virtuous cycle in which foreign entrepreneurs leveraged the payments system and the data it created to do things such as secured lending on a pay-as-you-go basis for home solar-energy kits.
This made-in-Africa model is now spreading elsewhere in the Global South. The gas-to-power narrative is a more complex one than telecommunications, with more counterparties and long-term contracts required to finance the considerable infrastructure required to move gas to power plants. But if more of these long-term projects reach completion, opportunities open up in manufacturing, and the coveted jobs that factories bring. Governance is poised to evolve in other agencies and institutions, such as finance ministries, electricity utilities and tax authorities.
The state says its contracts with private power producers leave it with a surplus it is contractually obligated to pay for, even if not used. Most African governments are open to private investment in power, particularly in building new generation capacity.
Investors like Ghana due to its reputation for good governance and the general peace it has enjoyed over time. Ghana has a judiciary seen as independent of the executive and the legislature and a free press. There is plenty of room for improvements in governance, but the basic building blocks are in place, says Solomon Lartey, who recently resigned as CEO of the insurance company Activa Ghana to found the Africa Sureties and Insurance Advisory Company, which aims to address access-to-finance issues for small businesses.
In many leading African countries, tax authorities were formed in the s, and are now implementing digital systems to boost collections and make the process easier for taxpayers. The group is developing new and open-source solutions for tax collection using new technologies such as blockchain and artificial intelligence.
African countries are now more stable and predictable places to live, work and build businesses. New value chains based on telecommunications platforms, agribusiness, and energy are now developing. EY is a global leader in assurance, consulting, strategy and transactions, and tax services.
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It will also trigger three channels of regional spillovers:. For instance, the governments of East, Central, South, and West African neighborhoods could commit to:. Disclaimer: This blog post reflects the personal views of the author and does not represent the position of the World Bank Group. The working paper can be requested by writing scoulibaly2 worldbank. Future Development. The Future Development blog informs and stimulates debate on key development issues.
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