activities. Finally, openness to trade seems to foster diversification. In terms of the variables used, the main difference with our model is that Al-Kawaz uses the square value of per capita income and the square value of investment to represent the effect of the early and later stage of economic growth process on diversification. Instead, this paper uses GDP per capita expressed in logarithm to capture the non-linear impact of economic development. Additionally, this paper uses a much larger dataset covering many countries.

Similarly, Agosin, et al. (2012) empirically estimate the determinants of export diversification using a large dataset covering 161 countries over the period 1962-2000. The authors use the generalized method of moments estimator (GMM) to deal with the endogeneity of some of their explanatory variables. Their results suggest that greater trade openness induces higher specialization. Counter intuitively, financial development is not found to influence export diversification. Real exchange rate volatility and overvaluation do not seem to have a significant effect on diversification. Human capital accumulation is found to be positively associated with diversification. Moreover, while positive 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. Agosin et al. test the robustness of their results with three measures of concentration: the Herfindahl-Hirschman index, the Gini index, and the Theil indicator. In addition to the set of variables we use, the authors look at the effect of economic distance on concentration.

# _<u>3.1 Potential Drivers of Concentration/Diversification</u>_

The literature on the main drivers of diversification is not abundant. The set of potential drivers analyzed here is taken from Agosin et al. and Al-Kawaz, and can be divided in three main categories: economic reforms, structural factors and macroeconomic variables. Table 3.1 provides these variables’ definitions, their expected impact on economic diversification, and their effect on diversification previously found in the related literature. Table A.2 presents summary statistics in Annex 2.

**Table 3.1: Description of explanatory variables in the model, expected impact and literature findings**

## 1. <u>Economic Reforms: Trade openness and access to finance</u>

|_Openness to_<br>_trade_|-<br>Measured as the ratio of exports and imports to GDP. It is taken from the World Economic<br>Outlook (WEO) database of the International Monetary Fund (IMF).<br>-<br>The effect of trade liberalization on diversification is a priori not obvious. Traditional<br>theories of international trade argue that greater openness leads to higher specialization in<br>the sectors where countries have comparative advantages. On the other hand, the removal of<br>barriers to trade can encourage investors to start new or expand export activities.<br>-<br>Agosin, et al. (2012) obtain econometric results indicating that trade openness favors<br>concentration.|
|---|---|
|_Access to_<br>_finance_|-<br>Measured as the share of domestic credit to the private sector in GDP and is extracted from<br>the World Development Indicators database(WDI)of the World Bank.|

9