Title: Shooting High or Low: Do Countries Benefit from Entering Unrelated Activities
Author Flávio L. Pinheiro, Aamena Alshamsi, Dominik Hartmann, Ron Boschma, and César A. Hidalgo
Scope: 3 stars
Readability: 2 stars
My personal rating: 4 stars
See more on my book rating system.
Topic of Book
The researchers examine how countries add new sectors to their economy.
- Almost all instances of when a nation starts producing new products for export, they do so in a field that is closely related to another product that they already produce (for example from hats to pants, instead of hats to medical devices).
- Nations rarely make big jumps into a sector of the economy that is completely unrelated to what they already produce (for example from hats to medical devices)
Important Quotes from Book
We analyze the economic diversification paths of 93 countries between 1965 and 2014 and find that countries enter unrelated products in only about 7.2% of all observations. We find that countries enter more unrelated products when they are at an intermediate level of economic development, and when they have higher levels of human capital… countries that enter more unrelated activities experience a small but significant increase in future economic growth, compared to countries with a similar level of income, human capital, capital stock per worker, and economic complexity.
We find that in 92.8% of the observed cases countries enter the export of products that are more related than the average product in their option set.
In fact, the level of relatedness of new economic activities follows a U-shaped curve, with countries at both low and high levels of development entering primarily related activities, and countries with an intermediate level of economic development entering more unrelated activities.
Knowledge production is often conceived as a process of recombining existing ideas (Romer, 1994; Weitzman, 1998). To compete, organizations explore different parts of the knowledge space (Breschi, Lissoni, & Malerba, 2003), searching for new knowledge while being constrained by the limits of bounded rationality (Simon, 1972). Since organizations have limited access to information, and do not have a perfect capacity to absorb, process, and respond to new information (Cohen & Levinthal, 1990), they experience a cost of diversification that decreases with the level of relatedness of activities (Atkinson & Stiglitz, 1969; Chatterjee & Wernerfelt, 1991).
Countries, on average, shoot for related products with a sophistication that is slightly lower than the average in their option set.
When countries enter more unrelated activities (deviating more from relatedness), they also enter more sophisticated (higher complexity) activities.
Countries closer to the least complex products tend to occupy the peripheral region of the Product Space, in contrast, countries closer to the most complex products occupy the central region of the Product Space. Countries in between these two limiting scenarios to occupy products that intermediate the central and peripheral region.
Countries, such as Ireland, Singapore and Thailand, underwent a similar transition as South Korea between 1970 and 2010. However, most countries kept a stable profile, like, for instance, Japan and Chile. Some countries fail to fully transit from ‘being close to simple products’ to ‘being close to complex products’, such as Brazil and Spain.
Accordingly, we can divide the diversification opportunities of countries into three stages: i) countries with low complexity: their option set is characterized by a strong negative correlation, bounding these countries to develop towards related and simple products; ii) countries in a rapid transition phase: they benefit from being close to both simple and complex products, which is captured by the lack of correlation between relatedness and complexity of the products in their option set; and iii) countries with highly complex economies: their option set shows a strong positive correlation, making these counties being close to the most complex products. Most countries are close to simple products (stage 1), while some countries—like Japan, Sweden, and the USA— are close to complex products (stage 3), and others–South Korea, Spain and Ireland—underwent a transient scenario and were/are close to both complex and simple products (stage 2).
Related Books and Articles
- “Atlas of Economic Complexity: Mapping Paths to Prosperity” by Hausmann, Hidalgo et al
- Observatory of Economic Complexity (this is a free online website displaying data related to economic complexity)
- “The Product Space Conditions the Development of Nations” by many
- “Dynamic of Economic Complexity over a 42 Year Period” by Cesar Hidalgo
- “Economic Development as Self-Discovery” by Hausmann and Rodrik
- “Discovering Southern and East Africa’s Industrial Opportunities” by Cesar Hidalgo
- “Linking Economic Complexity, Institutions and Income Inequality” by Hartmann, Hidalgo et al