Which nations will advance? Watch their 'Legos.'
Both are small, stable nations that posted strong growth between 1985 and 2005. Singapore is richer; Chile is bigger. Although politics and culture will undoubtedly influence their futures, from a purely economic perspective the key is specialization.
Economists since Adam Smith have pointed out that if businesses concentrate on what they do best, then a network of them will outperform a company that tries to do it all. The same holds true for nations: Those with a complex network of specialized industries will outperform those with less specialized, less diverse networks.
But proving the theory has proved next to impossible because measuring complexity is, well, complex. Last month, two Harvard professors put forward an indirect method of quantifying it.
Think of a national economy as a bucket of Legos or “capabilities”, write César Hidalgo and Ricardo Hausmann of Harvard, in their new study (pdf). Some nations have a huge and varied supply of the plastic building blocks; others have very few. From this perspective, products are specific combinations of these capabilities.
So one way to measure a nation's complexity – the diversity of its capabilities – is to look at the number of products it exports. Countries with a larger variety of building blocks will have what it takes to make more products.
Of course, this is a very crude measure because not all products require the same number of capabilities. To take this into account, the team of researchers measured each product's ubiquity (i.e., the number of countries exporting it). Products that require many capabilities can only be produced in the few countries that have all of them. So a product was rated increasingly complex the less ubiquitous it was (the fewer the countries exporting it).
By looking at nations' exports as a network connecting countries to the products they export, the authors were able to combine diversification with ubiquity and calculate the complexity of each nation's economy. Which brings us to Chile and Singapore.
Each exports about the same number of products. But Chile sells goods made by many other countries (i.e., rather ubiquitous), and these countries happen to have rather average levels of diversification (i.e., an average level number of capabilities). Singapore, by contrast, exports much-less-common products that are also exported by diversified exporters of less commonly exported products.
So Singapore, which starts out at No. 47 out of 129 countries in terms of number of products exported, rises to No. 10 when the authors calculate its complexity, whereas Chile, which started at No. 48 in number of products exported, falls to 53.
Signs of the future
These measures also turn out to be good predictors of future growth, the authors argue, suggesting that countries tend to approach a level of income that is dictated by the complexity of their capability endowment.
For example, take China. It's No. 10 in terms of number of exports but falls to 51 on the complexity table. That means it will take some time to overtake the United States, which is No. 6. Still, its growth potential is huge because of the income gap. "Even though China is below those countries, its income is way below its complexity," said Professor Hidalgo in a telephone interview. American incomes, by contrast, are a little ahead of the US complexity score.
Bigger worries lie ahead for oil-producing nations, like Saudi Arabia and Venezuela, whose incomes are much higher than their relatively low complexity scores, Hidalgo said. Should oil prices fall, "those countries would be in big trouble because they don't have a lot of other industries. Moreover, the capabilities required to produce oil appear to be highly specific, so they could not be easily redeployed to produce alternative product varieties."
Challenge for poor nations
This view of complexity also has important implications for economic development. For example, when a new capability comes along – say, a breakthrough in steelmaking or a new graduate student in chemical engineering – those nations that have many complementary capabilities are likely to incorporate it fairly easily. Poorer countries with fewer capabilities have a harder time making the new building block fit.
So poor nations can't simply concentrate on one sector to develop, according to the study. They have to develop a broad array of industries by building up their capacities.
It's not easy because development is difficult to coordinate. A poor country may have beautiful beaches but unless there's an airport, most tourists won't come, Hidalgo said. But who will build an airport unless there's a hotel? "The accumulation of capabilities is always a chicken and egg problem," he added.
But by knowing what an economy needs to flourish, nations at least have a shot at winning the race.
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