The economic diversity is vital for any country in order to grow in multiple direction and as well as a good protection from the risk of economic fluctuation. Some countries are highly dependent on the single source of income, and this source of income is usually the natural resources. A good example is oil and gas producing countries, where, they are highly dependent to sustain the economic stability. The oil and gas are commodity and the price of commodities are volatile which has an impact on the economy. The stable economy is where the source of income is diversified, which can be through production, foreign direct investment and farming.
The price of coffee is another example of a commodity where economy of some countries in South America and in Africa are dependent on. According to an article by International Coffee Organization (ICO), the exchange revenue from coffee in 2008 was over 15 billion US dollars which are lower than 2004. However, the article mentions that there has been an increase in the economic diversity by coffee producing countries to reduce dependency on coffee. It was pointed out in United Nations conference on Trade and Development (2012) that it is highly encouraging for countries to diversify which will benefit in the long run for countries that are currently dependent on natural resources, it was also pointed out that diversification will reduce the vulnerability of countries from price volatility of commodity. In recent years the economy of many countries have been different, the fall in the oil and gas price had a negative impact on the economy of natural resources dependent countries. These countries have been facing difficulties in the rise of inflation and recession. These two usually happen when the countries has shortage of foreign currency, for example Nigeria and Venezuela. The increase in the demand for foreign currency will reduce the value of local currency, therefore, there will be an increase in the price of goods.
The first step of increasing the diversity in the economy is by having an independent central bank, where the independent central bank will always make an efficient analysis of the economic forecast. The independent central bank will reduce or increase the interest rate to stabilize the economy. The central bank will increase the interest rate when there is an increase in inflation rate to reduce the spending. Whereas, the central bank will reduce the interest rate during recession to increase the spending. The independent central bank will reduce the interest rate to encourage the people to produce the goods locally, the local production can reduce the demand for foreign currency. The local production can also increase jobs which will reduce the recession.
The second step would be increase the foreign direct investment (FDI), but the countries must be very careful in FDI, because investing in other countries will not necessarily bring a return, therefore, the investment must be made with strategy. If the country invest in another countries to increase the size of the market then that FDI is good investment because it will increase the export and increase the revenue from foreign currency.
The third step would be if the local banks increases the purchase of government bonds from a foreign countries, for example of purchasing US treasury before 2008, because before the global recession the US treasury was trading with high interest rate and high coupon payment. However, after 2008 the interest rate reduced to 0.25%, which gave low yield on the bonds. In recent years the federal reserve rates have been rising steady, however the exchange rate of US dollars have been falling. Therefore, the investment in financial market is risky for the countries but it can be a long term insurance during the fall in the economy of the country. Similar to the Dynamic Stochastic General Equilibrium Model (DSGE).