Home' Trinidad and Tobago Guardian : May 4th 2014 Contents SBG8 ANALYSIS
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt MAY 4 • 2014
On Thursday, Poverty Reduction
and Economic Management (PREM)
Network vice-presidency of the
World Bank produced Economic
Premise note on the diversification
of the T&T economy.
A lightly edited version of that
note---whose authors are Francisco
Galrao Carneiro, Rohan Longmore,
Marta Riveira Cazorla and Pascal
T&T is an example of suc-
cessful diversification with-
in the oil and gas sector
and the country is now a
global player in the energy
industry. Diversifying its
asset base so that the non-
resource sector can con-
tinue to grow and generate jobs once the coun-
try's oil reserves are depleted is also an important
priority for Trinidadians. With reserves of oil
and gas in T&T expected to be exhausted by
2025--30, the government is focusing more and
more on options for diversification. Although
many countries have grown and improved their
development outcomes while remaining highly
dependent on natural resource rents, the obvious
concern is what will be the sources of growth
for the country when oil and gas run out?
In this context, this note identifies the binding
constraints and potential drivers to further eco-
nomic diversification in T&T.
Why is diversification important?
T&T can be characterised as a dual economy.
With a gross national income (GNI) per capita
of US$14,710 in 2012, the country is a high-
income country, rich in natural resources, with
a well-developed globally competitive oil and
The non-energy sector is relatively under-
developed, attracting little investment and, to
a significant extent, depends on government
subsidies and transfers.
T&T's economy has also been historically
quite volatile and particularly susceptible to
commodity price shocks. As with most natural
resource rich economies, the issue of economic
diversification has been extensively debated in
T&T since the 1950s. This discussion has taken
on a new sense of urgency given recent reve-
lations that the country's largest industry, the
oil and gas industry (45 per cent of GDP), could
disappear within 15 years unless new reserves
In conjunction with exploration efforts, the
government has been aggressively pushing for
answers to the question of how best to diversify
the country's economic base.
There is evidence that vertical diversification
has occurred within the energy sector. Oil pro-
duction has been following a declining trend
since the 1980s, and has been replaced by natural
gas as the dominant activity in the energy sector
(Figure 1). In addition, growth in production of
petrochemicals has mirrored growth in the pro-
duction of natural gas.
T&T has become the world's leading exporter
of ammonia and methanol which, along with
urea, make up the main petrochemical products
in the country.
While vertical diversification is welcome, the
major question that confronts policy makers
relates to the slow pace of horizontal diversi-
fication. More specifically, what could be the
major impediments to further diversification in
the country? Has T&T paid enough attention
to the diversification of its asset base---that is,
its human and physical capital---and its insti-
This note discusses the main determinants
of export concentration in T&T and the sig-
nificance of potential drivers of diversification
away from the resource sector in the context
of a country that has already successfully diver-
sified vertically within the industry.
Literature on diversification
A number of authors have analysed the struc-
ture of the twin-island economy and reported
what they consider to be major impediments
to growth and development as well as to reduc-
tion of the country's industry concentration.
Using a Growth Diagnostic Methodology devel-
oped by Hausmann, Rodrik and Velasco (2005),
Artana et al (2007) found that the most impor-
tant factors limiting growth opportunities in
T&T result from limited human capital, high
macro-economic volatility, inadequate devel-
opment of infrastructure, inadequate access to
foreign markets, rising criminality, lack of inno-
vation, corruption and a burdensome bureau-
Elias and Rojas-Suárez (2007) analysed T&T's
institutions and documented poorer than expect-
ed quality-of-governance indicators. The authors
claim that, in the absence of improvements in
terms of governance, the country might not be
able to achieve sustainable high gross domestic
product (GDP) growth rates.
Other authors, in particular Balgobin and
Omar (2006), found that the development of
the private sector seems to be hindered by weak
and inefficient public sector institutions that
result in administrative delays and unnecessary
How diversified are T&T's exports?
The Herfindahl-Hirschman index (HH index)
is used to measure export diversification and is
one of the most commonly used proxies for the
economy-wide level of diversification. See Box
Table 1 shows the average diversification per-
formance for selected countries during 1980--
2010. T&T appears to have made significant
progress in terms of diversification over the last
three decades (its HH index did contract by
more than 70 per cent).
The twin-island country has also rapidly
transformed in terms of diversification relative
to other countries with similar structural char-
acteristics. There seems to be greater limitations
in terms of diversification for net oil exporters,
as the average HH index for this group of coun-
tries is above the HH average for all other groups.
Since the end of the 1990s, T&T has ranked
below the net oil exporters' average concentration
index. Also, while T&T has become more diver-
sified over the past 30 years, it has remained
less diversified than the average of country
groups with which it shares significant structural
In 2010, the energy sector still accounted for
66 per cent of exports and 44 per cent of GDP,
while it only employed 3.0 per cent of the labour
force. Most of the country's diversification has
indeed happened within the energy sector.
Who are T&T's comparators?
To put the experience of T&T into perspective,
we constructed a group of comparable countries
and developed a consolidated net commodity
exporter category. Countries that fit into this
category are defined as net exporters of fuel,
metals, and ores for at least five years between
2000 and2010. The list of control countries is
restricted to non-OECD (Organisation for Eco-
nomic Co-operation and Development) and
non-European Union member countries because
these countries share particular institutional
Additionally, given the size of T&T's economy,
countries with a total population greater than
10 million are excluded. This results in a list of
15 control group countries located across different
The rationale behind the creation of this com-
parison group is to have a set of countries similar
(i) assess whether commodity-rich countries
share particular characteristics in terms of diver-
(ii) evaluate whether specific policies have a
differentiated impact between commodity
exporters and commodity importers.
The experience of T&T, although starting
from a lower concentration level, appears to be
rather analogous to Qatar and Oman.
Potential diversification drivers
This exercise adopts elements of the frame-
work developed by Al-Kawaz (2008) and Agosin,
Alvarez, and Bravo-Ortega (2012) to determine
the potential drivers of concentration/diversi-
fication in selected oil-producing states.
Using pooled, weighted, least squares regres-
sions over 1991--2001, Al-Kawaz found invest-
ment and higher quality institutions to have a
strong and positive impact on diversification.
Higher inflation discourages the development
of new activities. Finally, openness to trade
seems to foster diversification.
Similarly, Agosin, Alvarez, and Bravo-Ortega
(2012) empirically estimate the determinants of
export diversification using a large data set cov-
ering 161 countries over 1962--2000.
Their results suggest that greater trade open-
ness induces higher specialisation.
Additionally, some of the results suggest real
exchange rate volatility has a positive effect on
concentration, whereas overvaluation has no
significant effect on concentration. Human cap-
ital accumulation is foundto be positively asso-
ciated with diversification. Moreover, while pos-
itive terms of trade shocks tend to increase
export concentration, the effect appears to be
less important for countries endowed with higher
stocks of human capital.
Has foreign direct investment
contributed to greater export
diversification in T&T?
The findings suggest that access to finance,
terms of trade shocks, and foreign direct invest-
ment (FDI) inflows have significant effects on
diversification. Other things being equal, coun-
tries receiving more direct investments tend to
be more diversified. This could be an indication
that foreign investors tend to develop new indus-
tries instead of pooling their resources in sectors
already oriented toward international markets.
Terms of trade shocks appear to be associated
with a concentration of the export base, sug-
gesting that relative price variations are accom-
panied by a reallocation of factors of production
toward the sectors where profitability has
In addition, an interaction term between terms
of trade and human capital included in our
model is significant and negative, suggesting
that the concentrating effect of terms of trade
shocks is less important for those countries with
higher levels of human capital.
The level of financial development has a neg-
ative and significant coefficient. By reducing
liquidity constraints, greater access to credit
may indeed stimulate export activities. Countries
where investors face fewer barriers to credit are
more diversified. Real exchange rate variations
also appear to have a strong impact on diver-
sification patterns. Currency real appreciations
are found to translate into a higher concentration
of the export base. This is consistent with the
argument that a real appreciation reduces invest-
Institutional quality and a commodity exporter
dummy were used to test for a conditional effect
of resource wealth. One may expect that coun-
tries with stronger institutions control rent-
seeking behaviors associated with mineral wealth
better and more effectively reorient resource
rents toward other sectors of the economy.
However, the coefficient estimate turned out
to be insignificant.
To address the concern that, in island coun-
tries, FDI inflows may have a different effect
than in other countries, a dummy for island
nations was interacted with FDI inflows.
While the interacted term is not significant,
all the other dependent variables remained sig-
nificant and kept the same sign, suggesting that
the effect of FDI on diversification does not
differ in island countries.
GMM system estimates with standardised
variables are also applied, which enables ranking
A future without oil?
Diversifying options for T&T
Herfindahl-Hirschman Index = where Si
is the share of industry
i in total exports, and n the number of sec-
tors in the economy. The HH index is the
sum of squared shares of each product in
total export. A country with a perfectly di-
versified export portfolio will have an index
close to zero, whereas a country that ex-
ports only one product will have a value of 1
Continued on Page 9
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