countries become what they make

César Hidalgo argues, “…in the long run, the income of countries is determined by the variety and sophistication of the products they make, rather than by the traded value of their exports.” In The Dynamics of Economic Complexity and the Product Space over a 42 year period, Hidalgo applies network science techniques to 42 years of trade data in order to better understand the impact of a country’s product space (e.g., oil, pears, chemical, cars) on future income growth and movement into new product markets.

Countries with comparative advantage in pears are more likely to also hold advantage in apples than chemical products, and Hidalgo’s research systematically explores the degree to which products are produced in tandem, allowing him to map the product space. Some products, such as vehicles and machinery, reside in the network core, while others, such as oil, raw materials, and agricultural products are located on the periphery throughout the 40-year period, suggesting that the capabilities required for these products do not lend themselves to the production of many other products.

Hidalgo argues that his product space mapping is a useful tool for the policymaker or entrepreneur, as it communicates which products are likely appropriate matches for a country’s production capabilities given a country’s product mix, as well as estimates the impact of various types of production on greater economic development (e.g., the capabilities developed through oil production won’t do much good outside of oil production).

Hidalgo also provides a more nuanced analysis of recent economic growth. In the 40-year period, Indonesia, Brazil, Turkey, Thailand, Malaysia, China, Korea, and Singapore most significantly expanded their economies. Brazil, Indonesia, and Turkey transformed their economies by expanding their at-first primitive product capabilities. China, Korea and Singapore already had relatively complex economies (judging by Hidalgo’s capability analysis), and their growth can be interpreted as the realization of latent economic potential due to improved governance and incentives. As Hidalgo notes, this distinction is significant for economic policy: it can be inferred that governance/incentive reforms will disproportionately catalyze complex economies with latent income potential like China, while quite possibly having little to no impact in countries with primitive product capabilities.

Brazil, Indonesia and Turkey may provide historical examples of economic development that are more useful to low-income countries without the latent economic potential of post-Mao China. While the importance of governance and incentive structures is widely accepted, the arguably more difficult challenge is to help countries like 1960 Brazil, Indonesia, and Turkey develop new and fruitful production capabilities when social returns dwarf the immediate private returns.

Like Dani Rodrik, Hidalgo advocates for more active industrial policy, “Like chaperones in cell biology, these [government] agencies would help catalyze the private sector’s own self-discovery process by helping to identify and develop capabilities that are necessary to move businesses into increasingly more sophisticated products.”

Whether or not an active industrial policy is sensical depends on whether governments have a comparative advantage (compared to private sector entrepreneurs) in discovering a poor country’s comparative advantage. I think the answer is context-specific, and I’ll leave that for another time.

Filed under: Economic Policy