Article Summary: “Dynamic of Economic Complexity over a 42 Year Period” by Cesar Hidalgo

Title: Dynamic of Economic Complexity over a 42 Year Period
Author: Cesar Hidalgo
Scope: 3 stars
Readability: 2.5 stars
My personal rating: 5 stars
See more on my book rating system.

Topic of Book

Hidalgo applies his theory of economic complexity to understand how nations get richer. He focuses on Brazil, Indonesia, Turkey, Malaysia, Thailand, Korea, Singapore and China.

Key Take-aways

  • 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.
  • Countries become what they make.
  • Countries that can produce products requiring a relatively large number of capabilities have economies that are more adaptable than countries producing less complex products.
  • A few nations (see list above) have been able to gradually ratchet themselves up from producing simple product to producing complex products.

Important Quotes from Book

How does the productive structure of countries’ changes over time? In this paper we explore this question by combining techniques of networks science with 42 years of trade data and find that, while the Product Space remains relatively stable during this period, the dynamics of countries’ productive structures is characterized by a few highly dynamic economies. In particular we identify Brazil, Indonesia, Turkey, Malaysia, Thailand, Korea, Singapore and China, as countries that transformed their productive structures considerably during these four decades, albeit following different trajectories.

One important observation of this research is that what a country produces matters more than how much value it extracts from its products. This is because not all products are equally sophisticated and therefore, 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. Countries become what they make.

The theory proposes that the productive structure of countries is determined by the local availability of highly specific inputs, or capabilities, which can be thought of as specific building blocks of production. Capabilities could be tangible inputs, such as bridges, ports and highways, or intangibles, such as norms, institutions, skills or the existence of particular social networks. In this theory, at any given point in time, countries are endowed with a set of capabilities, whereas products require specific capabilities. The sophistication of a product is related to the number of capabilities that the product requires; whereas the complexity of a country’s economy is related to the set of capabilities it has locally available.

If countries can only produce the products for which they have all the required capabilities, and if capabilities are hard to accumulate, then the current mix of capabilities available in a country will not only determine the products that the country can make today, but also the products that it will be able to make in the future. This is because countries will bias their future production towards products that use many of the capabilities that are already available. Countries that can produce products requiring a relatively large number of capabilities, therefore, should have economies that are more adaptable than countries producing less complex products. Given their large capability endowment, these countries will have more potential uses for any new capability that comes along. Ultimately, this will make development easier for countries with more complex productive structures, explaining why what you export matters, as equal revenues from products of different levels of complexity do not translate into equal future possibilities.

In broad terms, the position of countries in the complexity ranking is relatively stable, albeit with some notable exceptions.

The “great transformers” of this period [1963-2005] were Indonesia (IDN), Brazil (BRA), Turkey (TUR), Thailand (THA), Malaysia (MYS), China (CHN), Korea (KOR) and Singapore (SGP). Figure 2b, however, shows some differences in their stories. For instance, Indonesia, Brazil and Turkey started this 42 year period with primitive productive structures, which occupied spots in the bottom third of the ranking, whereas China, Korea and Singapore’s progress took place within the top positions of the ranking. Our indicators suggest that even in the 1960’s the productive structure of China, Korea and Singapore were quite complex and that we should have expected the income of these countries to catch up, eventually, with the complexity of their economies. Korea and Singapore grew significantly during this entire period, supporting this theory. China’s growth, however, came after a series of reforms started by Xiaoping Deng in the late 1970’s. Our analysis allows us to add to the story of China’s miracle by suggesting that what these reforms did was to unleash an economic power that was already latent in China. Figure 2 suggests that the productive structure of China had been relatively sophisticated all along and that the economic hardships that China suffered between the 50’s and 70’s resulted more from a poor incentive structure than from a lack of capabilities. This also explains why we would not expect these reforms to have the same effects in other countries with productive structures that are not as sophisticated as that of China.

Most products remain close to the line, indicating that the level of sophistication of products remains relatively stable during this 20-year period. Indeed, the correlation between these two series is ρ=0.8047 (p<10-176).

The connectivity of products in the Product Space does not change substantially during this 42-year period, yet the connectivity of countries in the “Country Space” does. This suggests that while the structure of the Product Space remains quite stable during this period, due to the relatively slow changes in technology that alter the sophistication of products, the relationships between the productive structures of countries did not. Changes in the structure of Mcp , therefore, are mostly driven by the structural transformation of some countries in a world where products evolve slowly.

During the entire study period products such as vehicles and machinery (in light blue) populated the more densely connected part of the network. Oil and some of its derivate products (in crimson), in contrast, are always located in a weakly connected “twig” on the periphery of the network, demonstrating that oil remained a peripheral product that required specific capabilities that did not foster development, despite the large revenues that oil generated. Agricultural products (in light green) and raw materials (in red) are also consistently located in the periphery of the space during the entire study period.

These observations are relevant because the development advice that usually emerges from economic research deals primarily with questions of incentives and institutions. The data presented here, however, highlights another important aspect of development that is rarely considered, which is capability-building. Traditional economic theory assumes that the production of goods and services is trivial, and that therefore their availability depends only on the demand for them and the costs of the few abstract factors that are required to produce them.

The theory and empirical analysis that we presented in this paper help differentiate cases such as Singapore, Korea and China, from other countries. The narrative the analysis proposes is that these growth miracles did not only occur because of appropriate incentive structures, but also because of a complex economic structure that had been dormant for decades, even if it was present only in a small fraction of the urban population. One question that emerges then is how much of the miracle of small, fast- growing states such as Singapore and Hong Kong is due to the European institutions that were exported into these countries by colonial powers, or was due to the latent potential in the collective evolutionary process that already existed in these societies? The fact that other European colonies failed to transform the way East Asian miracles did would suggest that the evolution of economic complexity could play an important role in development. This hypothesis has yet to be tested and should be explored more rigorously.

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