Is ‘complexity’ the key to economic growth?

at 03:00 PM ET, 10/26/2011

Two economists, Ricardo Hausmann of Harvard and Cesar Hidalgo of MIT, have just released their 364-page “Atlas of Economic Complexity,” which claims to be the best model yet for predicting how much nations will grow in the future. So what’s the secret?

As it turns out, the authors argue, the best way to tell how rich a country will get isn’t by looking at things like political institutions, or the rule of law, or even education levels. Nope, it’s far better to look at what they call a country’s “collective knowledge.” That means looking, primarily, at how many different products a country creates — and particularly how many unique products a country makes, things that no other countries are making (say, medical-imaging devices). For example, the authors note that Pakistan and Singapore both export a similar number of types of products. But Singapore’s exports tend to be relatively rarer on the world stage than Pakistan’s, and the country’s much richer as a result.

That all sounds obvious, but a couple of interesting corollaries fall out of this. For one, the authors note, formal education alone won’t necessarily bridge the gap between poor and rich countries. Training more teachers and building more schools isn’t enough. Instead, poorer countries need to focus on boosting their “productive knowledge” — knowing how to do things like run a business and make less-generic products — the sort of know-how that is “tacit and hard to transmit and acquire.” The countries that fare best, they write, tend to start by making products they already know how to make and then slowly expand outward and diversify.

Hausmann and Hidalgo also (inadvertently) pitch in on the recent debate over small business vs. big business, explaining why economies that rely on large, well-connected firms tend to do better. “Most modern products require more knowledge than what a single person can hold,” they write. “Nobody in this world, not even the savviest geek nor the most knowledgeable entrepreneur knows how to make a computer. He has to rely on others who know about battery technology, liquid crystals, microprocessor design, software development, metallurgy, milling, lean manufacturing and human resource management, among many other skills. That is why the average worker in a rich country works in a firm that is much larger and more connected than firms in poor countries.”

Meanwhile, if Hausmann and Hidalgo’s theory is actually right, then the future looks relatively limp for the United States. The authors note that the best way to predict a country’s future growth is to look at the gap between economic complexity and current earnings. On this score, China, India and Thailand have the highest expected growth in the years ahead. The United States, by contrast, ranks 91st. Economies that have already taken full advantage of their existing complexity, like the United States, have few remaining opportunities to move up further. This sounds unduly pessimistic, though it jibes pretty well with Tyler Cowen’s “great stagnation” thesis.

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