Diversification: why and how?

Ricardo Hausmann

Harvard Kennedy School &

Center for International Development at

Harvard University

A reinterpretation of the sources of growth

Why are some countries rich and others poor?

The traditional explanation

Why are some countries poor and others rich?

The traditional answer emphasizes factor accumulation and “aggregate” productivity

Countries are rich because they work with more: Physical Capital (accumulated through investment) Human Capital (years of schooling)

…and have more “total factor productivity” …which lets them get more output per capita Policy implications:

More education and health More savings to finance investment (and micro-finance) More property rights to assure investors More “productivity”

The neo-classical dead-end

Assume the world is made out of four things Output Physical capital Human capital Labor

85% of growth is explained by non-of-the-above Total Factor Productivity = a measure of our

ignorance (Abramovits, 1958) Maybe it is not that good a way to parse what

the world is made out of

Rich countries do not just produce more per capita

They produce different products

An alternative view

Countries differ in the variety of the capabilities they have

Rich countries make more kinds of products and more complex products that require many capabilities

Poor countries make simple products that reflect the few capabilities they have

The hidden structure in the comparative advantage of nations

The hidden structure in the comparative advantage of nations

It does not matter what level of aggregation you use

Countries Products

Countries Capabilities Products

Intuition

Countries have capabilities Products require capabilities Countries that have more capabilities will be

able to make more products They would be more diversified

Products that require more capabilities will be made by fewer countries Products will be less ubiquitous

Intuition (cont’d)

Countries that have more capabilities will be able to make products that are less ubiquitous

Hence, countries that have more capabilities will be more diversified but will make less ubiquitous products

Diversification of countries and ubiquity of products are negatively correlated They are indirect measures of the capability set of

countries

Method of Reflections: k-k1 diagramAv

erag

e ub

iqui

ty o

f pro

duct

s

Hidalgo CA, Hausmann R Proc. Natl. Acad Sci. (2009) 106(26):10570-10575

Diversification correlates with income per capita

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67

89

1011

0 100 200 300 400k

LYPPPK Fitted values

Diversification

Log

GD

P pe

r cap

ita

Hidalgo CA, Hausmann R Proc. Natl. Acad Sci. (2009) 106(26):10570-10575

Hidalgo CA, Hausmann R Proc. Natl. Acad Sci. (2009) 106(26):10570-10575

Complexity in 1985, controlling for initial GDP per capita

What makes growth difficult?

The chicken and egg problem You cannot make new products because you

lack the capabilities You don’t want to accumulate the capabilities

because the products that need them are not being made Because of other missing capabilities

How does the world deal with this? By moving towards “nearby” products

Step 1: Maximum Spanning TreeOur Approach: Distance measured by

probability that, if a country is good in one product, it’s also good in another product.

What is the shape of a forest? Homogenous or

Heterogeneous? What does it look like?

Step 2: Overlay Strong Links

0.4 >

0.4 – 0.55

0.55 – 0.65

0.65 <

CA Hidalgo, B Klinger, A-L Barabasi, R Hausmann.Science (2007)

Using Feenstra et al. Trade Data:

132 Countries1006 Products

SITC-4(1975-2000)

How do monkeys jump?

Malaysia 1975

Malaysia 1980

Malaysia 1985

Malaysia 1990

Malaysia 1995

Malaysia 2000

Key Implications

Monkeys jump short distances So, where you are now in the product space

determines where you can jump In the case of Malaysia, they moved to and

dominated the electronics cluster How are the ECA countries placed in this

space?

Poland (2000): very well connected & diversified (although no presence in electronics)

Russia (2000): Highly peripheral, concentrated in hydrocarbons and raw materials

The Ukraine (2000): somewhere in between- more connected than Russia, not as well connected as Poland

Summarizing this ‘connectedness’ with one number: Open Forest

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Countries in Eastern Europe and Central Asia face very different opportunities

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.2 .4 .6 .8 1troughDepth of Transition Recession (% of 1990 GDP per capita reached at trough)

Op

en f

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st i

n 1

992

Countries with a better-connected export basket did not suffer as deep an output collapse during transition

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0 1000 2000 3000 4000 5000distance

..and tend to be those closer to the west.

But proximity to the West has no effect on transition beyond its impact on the export mix: open forest trumps distance to Dusseldorf in a cross-country regression

Distance to Dusseldorf

Op

en f

ore

st i

n 1

992

Some implications

Why do many poor countries not catch up to rich countries? Because there is no “stairway to heaven” or sequence of nearby

trees that can get them to the denser parts of the product space What causes the “resource curse” (bad performance by

resource rich countries)? Poor connectedness of the resource intensive sectors

Add value to your raw materials? Forward supply linkages vs capabilities Finland

Why do countries fall into protracted slumps? Because their existing export products get into trouble when they are

in a part of the forest where there are no nearby trees Is innovation the solution?

It is about finding profitable excuses to accumulate capabilities that will be used for some other purpose down the road

Space to grow in existing products

Ease t

o ju

mp

to n

ew

p

rod

ucts

: op

en

fore

st

Low High

Low

High

Bridge over troubled waters

Strategic betsLittle space to improve quality and few nearby trees

Stairway to heaven

Parsimonious industrial policyHelp jump short distances to other products

Let it be

It ain’t brokeAmple space to move in all directions

Hey Jude: make it better Competitiveness policyImprove the quality of what already exists

Strategic approaches

Countries in the Policy Plane

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Where are the countries?

EBRD Members in the Policy Plane

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Where are the countries?

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4 6 8 10 12GDP per capita (log)

Countries face different opportunities to jump to other trees

Countries with closer nearby trees grow faster

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coef = -.00122659, se = .00153985, t = -.8

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Open Forest 1985

Aver

age

grow

th 1

985-

2005

Implications

Development is about a stepping stone process to solve the chicken and egg problem

Much of oil and mining is too disconnected to help trigger a transformation process Dedicated rail and ports Few forward and backward linkages

But there are some spillovers The Steam Engine Medellin gold mining and universities

You need not jump from there Adding value to your natural resource endowment is not what

Norway, Australia or Chile do They have other unrelated sectors

Implications

A commitment to diversification is key It implies a commitment to protect the level

and stability of the real exchange rate matters Fiscal stabilization But also a role for monetary policy

But also a willingness of the government to address chicken and egg problems

Especially those related to the provision of public inputs