Growth and volatility in resource-rich countries: Does diversification help?

•This paper measures productive diversification using input–output data.•I study whether resource-rich countries are able to offset the volatility-triggering effects of natural resources by diversifying their economies.•While direct effects of natural resources on growth are positive, their adverse indirect effects through volatility could be larger.•Diversification reduces volatility in resource-intensive economies and allows them to reap the benefits of their resource endowment.•Export diversification cannot be helpful, unless the country diversifies its production structure.

This paper studies the “natural resources – volatility – growth” link by evaluating the role of economic diversification. I study whether resource-rich countries are able to offset the volatility triggering effects of natural resources by diversifying their economies. Using input–output data, I construct an indicator that captures diversification of the production structure of the economy and density of inter-industry linkages. The results show that resource abundance exerts negative impact on growth through the volatility channel. While the direct effects of natural resources on growth are positive, their adverse indirect effects through volatility could be larger. I find that productive diversification offsets the volatility impact of natural resources. When diversification is controlled for, the negative growth impact of volatility induced by resource abundance disappears. However, the results do not hold true if export concentration measure is used instead of productive diversification.