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(originally published by Booz & Company)


A Continuous Quest for Economic Balance

Achieving Balance

It is important to note that policymakers should not attempt to undermine or eliminate the elements that are at the heart of their countries’ success. Large corporate conglomerates played a key role in the growth of South Korea’s economy, the attraction of foreign investment was critical to Ireland’s development, and China’s exports launched its stratospheric growth. Instead of undermining them, policymakers should seek out counterbalances to these dominant influences to ensure they do not play a disproportionate role in the economy.

The fundamental question is whether the key elements of an economy are varied, flexible, and readily applicable to a variety of economic opportunities. The imperative for policymakers is not only to monitor these elements but also to continually seek out potential areas of over-concentration, including those that may not yet be evident.

This effort is an unending quest rather than a single hurdle. As policymakers attempt to address each area, they are reminiscent of a man attempting to hold back a bursting dam: Every time he plugs a leak in one place, another jet of water bursts through elsewhere. Instead of trying to stop the flow, he should be trying to understand how to redirect the rushing river in more productive ways. It’s an enormous task: Seeking out the next potential source of over-concentration requires policymakers’ continuous energy, attention, and action as they attempt to shield their economies from unnecessary risk.

Even as policymakers take a broader approach to diversification, moving beyond their industrial base, they must also take a deeper approach. For each single element of economic diversification, multiple ways to diversify can be found within that arena: If a country has expanded its export base to include a wide array of countries, is it shipping a broad enough selection of products to these countries? If it is exporting a diverse group of products, is it properly balancing its export portfolio among large and small companies? The permutations are very nearly endless.

Although no country has achieved complete diversification, some are farther along the continuum than others. Australia is a good example of a country that emerged relatively unscathed from the economic crisis thanks to its economic balance. Perhaps because of its geographic proximity to China and India, Australia saw the potential of these countries and began trading extensively with them and with other emerging markets prior to the economic crisis. As a result, Australia’s trade portfolio was sufficiently diversified when the crisis began, allowing it to avoid the shock of being undermined by the collapse of a single trade partner. This diversity in its imports and exports had corollary effects on the economy; for instance, it led to diversity in the banking sector as institutions sought opportunities in emerging markets. As a result, Australia’s financial system was spared the worst of the problems that affected banks in North America and Europe.

At the same time, Australia offers a cautionary tale about the need for constant vigilance. The country’s exposure to emerging markets is growing steadily: China now accounts for more than a quarter of Australia’s exports, and that percentage is still on the rise. It is not yet clear whether the growth shown by emerging markets for the last few years is truly sustainable; if those markets were to experience a crisis of their own, Australia would be left exposed. The government must be aware of this risk and must make a constant effort to avert this potential problem.

Comprehensive diversification is not simple to implement, because it requires ongoing calibration of every aspect of the national economy. Policymakers will need to be resolute in their determination to keep these risks under control, because properly managing the risks of over-concentration is critical to sustainable, long-term economic development. The global economic system is overly complex and becoming more so by the day. It may be difficult to begin the process of diversification now — but it could well be impossible in the future.

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