Development: It’s Complicated

Sometimes you come across an article or a post that makes you say, “Huh, now that’s interesting!”  This research from two noted academics made me do exactly that.

In 2007, a developmental economist and a physicist joined forces to try to paint a clearer picture of one of the most complex systems on earth: a nation’s economy.  Albert Einstein once said that “politics is far more complicated than physics.”  So too is economics, it would seem.  Ricardo Hausmann and Cesar Hidalgo created something that they call the “product space” to show how development is bound up in the complex structures of production.  While we intuitively know that complexity matters, it was their research that allowed for it to be measured and mapped.  The result gets to the heart of development.

Adam Smith saw the “wealth of nations” lying in the division of labor, with specialized input and diverse outputs.  A diversified economy is often a highly complex one, and to Smith also wealthier and more developed.   A traditional hunter-gather society may have some 300 distinct products and services available, but in today’s London or New York City the number is more like 10 billion.

How do you show this complexity?  Most economists simply aggregate production totals, judging the “success of an economy by the volume, not the variety, of output per head.”  Instead, Hausmann and Hidalgo looked at the quality of the products made (how unique they are) as well as the quantity, and combined that with an understanding of their proximity.  Proximity is critical to their work, as it shows how the “ability of a country to produce a product depends on its ability to produce other ones.”

What results is a map of a country’s product space, which Hausmann and Hidalgo describe as something resembling a forest.

Think of each product a country produces as a tree.  Within this forest are knots of trees, or sectors of an economy where production is particularly active.  These knots are usually surrounded by more scattered woodland where production is sparse.  The authors imagine firms as primates trying to jump from tree-to-tree to get from the sparse, poorer part of the forest to the denser one.  “In some places, the trees are close together, so it is easy for the monkeys [firms] to move around.  In other places, the trees are far apart – this is where the capabilities that go into making one thing don’t help much in making the next thing.”  This distance is what often prevents countries from leaping forward developmentally.

Comparing the economies of Pakistan and Singapore helps to further illustrate the authors’ point.  If you simply look at how much each country produces, Pakistan and Singapore stand as equals with GDP totaling exactly $929bn apiece.  Yet, Singapore is clearly the more developed country.  When the complexity of their respective economies is mapped out, you see that “Singapore uses far more capabilities and makes more unique products than Pakistan.”  Highly developed countries export a large amount of unique products, and their product space thus reveals “large clusters around capital-intensive goods, such as machinery and chemicals,” that are vitally linked to other productive areas in their economy.

So what does all of this mean?  First, Hausmann and Hidalgo’s work allows us to more fully see how the wealth of nations is not based on simply producing more of something, but accumulating more complex sets of capabilities and figuring out the incentives to put those capabilities to use.

Second, we can now measure complexity in order to gain a broader and deeper understanding of development.  Interestingly enough, measurements of a country’s complexity correlate strongly with its per capita income.  If per capita income is below what an economy’s complexity suggests it should be, it almost inevitably catches up within roughly 20 years, as was ultimately evidenced by India, China, South Korea, and Ukraine.  What’s more, mapping a country’s economic structure is roughly predictive of future exports, so you can see now the direction that a country can most productively develop in the future.

Third, the difficulties of development are given shape.  Developing more advanced capabilities really depends a lot on what a country is capable of producing right now and, quite simply, “it is easier to graduate from assembling toys to assembling televisions than to jump from textiles to laptops.”

Finally, Hausmann and Hidalgo’s research suggests that an effective approach to development would “leverage an existing matrix of capabilities” rather than simply “adding a new capability in a country that has few to begin with.”   How to do this?  This gets us right back to the start, to Adam Smith’s division of labor.  Productivity and income rises when a country has the free market institutions that allow for specialization and diversification.  Now, thanks to these two researchers, we have a map of that path to prosperity.

Published Date: July 23, 2010