Friday, September 13, 2013

Charts of economic development: a fantastic journey

Venezuelan economist Ricardo Hausmann and Chilean physicist César Hidalgo, in a joint effort of Harvard University and the Massachutes Institute of Technology MIT, draw a new world map of economic adventure, and suggest the Earth may not be flat.

by Andrés Schäfer
A shorter version of this article appeared in El Mundo Economía y Negocios, in Caracas. It lacks graphic ressources.

According to classical economics, the road to development for producers of raw materials would be to achieve growth by adding value "downstream" in the chain of production. "If you have trees, try to export furniture instead of wood," would be the mantra, as formulated by Ricado Hausmann to MIT's Technology Review. This approach aggregates very dissimilar things within big magnitudes, such as GDP, or "capital goods". But to Hausmann, the physician César Hidalgo, and their colleagues at The Observatory of Economic Complexity at Harvard/MIT things don't work like that. The world is full of economies with different degrees of complexity. As Hidalgo likes to put it: the world is unequal in its diversity.  Some countries produce a few simple goods, while others manufacture many different and complex ones. Every single product carries specific knowledge embedded -or "capabilities". The interplay of capabilities can bring about combinations that prompt, rather, cell phone manufacturing from tree felling, as was the proverbial case of Nokia. To get behind this magic, Hausmann and his coworkers created the model of Product Space and the Economic Complexity Index: based on trade data and complexity theory a graphic representation was produced, akin a neuronal web, to reflect the productive knowledge of each country. The aim is no other than to chart the paths to development. Hausmann explains:

Global Product Space. The size of the nodes corresponds to their share in world trade. Hausmann and Hidalgo like to compare it to a forest, where nodes would be trees, inhabited by apes, trying to jump from one to another, to picture the process of economic development. But The Product Space strikingly resembles the maze of a big city, or conurbation: in the center, bustling and active, are located the most complex, diverse and interconnected products. Several "towns" can be spotted: the blue town of machinery, the purple of chemicals and health industry, the turqoise of electronics, red of construction and green of shoes and textiles. Here the interactions are consistent, creative, and produce surprising results. In contrast, the "suburbs" are populated by less interconnected goods, which are often (not always) the simplest. Oil lives in a dead end. Big profits make it the proud owner of a MacMansion with tennis court and pool. But the neighborhood is boring and nothing is really going on around there.
Infographic: Observatory of Economic Complexity, Emen, Andres Schaefer

Q: How does economic development happen?
A: The basis of economic development is the increase in a country's productive knowledge. Underdeveloped countries only produce a few things and especially things that many other countries can do. Developed countries, however, can do many things, and among them complex ones that few others can do. In order to develop, an economy must accumulate knowledge and use it to make a greater variety of more complex products. That means not only, or even primarily, a population with more years of schooling, but with a greater diversity of "know-how". It is the difference between what we call "explicit knowledge," which can be taught at school, and "tacit knowledge," which is acquired in practice, the "know-how" of procedures and experience. It's the difference between learning by heart the traffic rules or learning to speak another language. So it's not about producing geniuses who know everything, but to have teams of people who provide different complementary skills. The more diverse that knowledge, more complex the things you can do. A movie can earn up 18 Oscars, if we count  acting, directing, screenplay, cinematography, music, editing, sound, special effects, set design, costumes, casting, etc. The film unites all these into one final product.

Education is not a panacea
A notable example is the comparison between Ghana and Thailand. In 1970 both had similar levels of schooling. Ghana started a major investment in education surpassing Thailand, while Thailand began a massive increase in economic complexity. The result was that Thailand's economy diversified and its income soared. But Ghana stagnated.

Economic Complexity INdex/Time

GDP evolution in Time
Graphics: The Atlas of Economic Complexity

Q: What is the Product Space about? How do you build it?
A: The Product Space is very heterogeneous. Some products are very connected to other products, like clothing, machinery, chemicals and electronics, and some others are much more isolated, such as oil, mining and tropical agriculture. There are 700 products, which means about 245.000 distances between products. The visualization of this space is based on showing only the strongest links, about 1500.
The more connected the products, the easier it becomes to diversify from them. Countries do not go from planting corn to manufacturing airplanes in one fell swoop; they rather move from things they can do right now, to things that can be done by gradually increasing "know-how". The Product Space is like a forest: each product is a tree, and the distance between them indicates how similar they are in terms of "know-how". Entrepreneurs can know where their country is located in the Product Space and move from products the country can do, to increasingly complex products that are "close", and therefore more feasible. In the Atlas of Economic Complexity, 128 countries can explore their possibilities.

Q: Can it be used as a roadmap for development?
A: The idea is to use the tools we have developed to explore what might be called "possible adjacencies," the neighborhood of productive knowledge. To help better understand the possible stairways to heaven. I had the opportunity to work on these issues in dozens of countries, starting in Colombia and South Africa, and continuing with Brazil, Chile, Mexico, Peru, Pakistan, Kazakhstan, Algeria, Morocco, Egypt, Uganda, Nigeria and even Saudi Arabia and the Netherlands, among others. 

To downtown, from the suburbs:
As can be seen in the following sequence of visualizations, the economy of Ghana chose to stay in the suburbs of the Product Space, while Thailand actively colonized the interconnected centers. Colored notes indicate export capacity. Scroll the computer's mouse over the nodes to get additional information.
By clicking on the products, readers can see with what others they are connected, their closeness, the export capacity (an RCA above 1 indicates export capacity), the world market and the country's output. This way, the advantages of "living downtown" in the Product Space center become clear.
                                                                      Ghana 1975

                                                                     Ghana 2012

                                                                     Thailand 1975

                                                                     Thailand 2012

Q: This approach to economic development is relatively recent. What aspects are yet to be elaborated?
A: Many. We need to deepen our research on the nature of "know-how", what its elements are, how it accumulates, how does it relate to education, job training, immigration, multinational companies, etc. We need to understand on what depends the assimilation of new technologies and what can be done to speed up this process. Fortunately, there is still a lot to be done.

            The big conglomerates and the statistical shadow.
The Atlas of Economic Complexity is based on trade data because this is the most reliable set. Goods that are not exported are not part of the study: the model assumes that a country shows no competitive advantage in goods not exported. The data also excludes non-tradable services and activities. The PDF book of the Atlas acknowledges these limitations, but argues that global trade statistics are in any case an eloquent approach to the level of complexity of economies. In an article for Project Syndicate, Hausmann speaks about the role of conglomerates in economic growth, suggesting, without naming it, the weight of what is still in the statistical shadow of his work. These national groups, the conglomerates, can be decisive to conquer industries with high entry barriers, either by their nature or by a difficult economic environment. They can use their management skills, their structure and their not-so-negligible capital. It was the case of the chaebols in South Korea, where Samsung went from being a trading company to what it is today. "But, in many developing countries," says Hausmann, "conglomerates have not played an equivalent role. They have focused on non-tradable goods and services - those that cannot be imported or exported - and have eschewed international competition. They have focused on banking, construction, distribution, retail, and television broadcasting." Instead of becoming motors of change they hinder it, he contends. And while they might have some capabilities crucial to initiate growth, these cannot (by now) be included in the model since they don't show in export data.

Q: Is the Economic Complexity Index resulting from your analysis more accurate as a diagnosis and prediction tool than other variables?
A: The Economic Complexity Index measures how much productive knowledge a country has. The Complexity Outlook Index measures how well a country is located in the Product Space, in the sense of just how easily it can gain productive knowledge. All this means that countries differ not only in what they do, but in the opportunities they have to learn how to do other things. Both indicators have a strong ability to predict the economic growth of countries for the next 10 years.

ECI Ranking from1st to 20th. This last position is occupied by México.
From The Atlas of Economic Complexity

Q: Is there effectively a "curse of natural resources"?
A: Natural resources are a mixed fate. On the one hand they generate to countries possibilities for accumulation of knowledge and productive capabilities. Remember, the steam engine was invented to pump water from coal mines in Britain. But the fact is that oil and mining require productive capabilities that have few alternative uses in other activities. They are dead ends, so that countries will have more difficulty to move to other parts of the forest. You see, Venezuela's Margarita Island is much more beautiful than Aruba, but its per capita income is less than half, although Aruba has no oil.

Economic Complexity Index by Product Communities, ordered according to overall market volume. The community of machinery is the most complex one, and the community of oil is the penultimate in the list. Yet crude oil is the least complex among the 773 products in the SITC4 classification of the UNO.
Graphics: The Atlas of Economic Complexity

Q: What would be the status and perspective of Latin America, a region rich in natural resources, but not strong in labor?
Q: The world is changing, in the sense that the value chain of manufacturing is going global and the boundaries between manufacturing, agriculture and services are blurring. This opens new avenues for development. But many countries in Latin America think of themselves as being rich in natural resources, not because they have so many, but because it is the only capability they have. For example, Venezuela believes it is rich in oil, but exports now six times less barrels per capita than when I was born, and seven times less than Norway. And Norway exports 35 times more non-oil products per capita than we do.

Q: How has the Venezuelan economy performed since the sixties, when the statistical series of the Index begins?
A: Venezuela had a moderate diversification period until the 90's, but it has lost more productive knowledge in the last 12 years than almost any other country in the world. We used to be good in cement, paper, automobiles, rice, chemicals and engineering, not to mention (the state-run oil company) PDVSA. These capabilities have been devastated.

One country, one product: 
In Latin America, Venezuela is the country with the lowest Index of Economic Complexity. It underwent a moderate process of diversification until 1998, when it started to reverse. There is a temporal correlation with the recovery in oil prices that preceded the commodity boom in the 2000s. At the other end, Mexico has today the most complex economy in Latin America. The following Tree Maps express these assertions. Again, web surfers can discover additional information by scrolling the mouse.
From: The Atlas of Economic Complexity

                                                              Venezuela 1998

                                                              Venezuela 2012

                                                                 México 2012

Economic Complexity in Latin America: the curse of natural resources?
This table represents the change in Economic Complexity in different Latin American countries within two periods: 1964-2008 and 1998-2008.
Venezuela is at the bottom of the table in the period 1964-2008, as in 1998-2008 (second to last worldwide among 125 countries for this period). Then follows an alleged "model student": Chile, second-worst, also in both periods. Another "model student", Brazil, is the third-worst performer in the decade from 1998 to 2008. Uruguay, Bolivia, Peru and Argentina, in that order, follow them on the bottom of the ranking in 1998 to 2008. Notable is the case of Brazil: after increasing its ECI from -0.74 in 1964 to a high of 0.727 in 2000, it dropped to 0.24 in 2008. These tendencies have some temporal correlation with the commodity boom in the 2000s. Despite this, Brazil managed to improve the most in the total period of 1964 to 2008. In turn, Venezuela has the lowest ECI in Latin America with -1,109 in 2008, and the lowest growth projections in GDP per capita to 2020 in the region, with 1.23% year on year, according to this methodology. This is consistent with most oil producing countries, including Norway (who stands 96th globally in the ranking of variation in ECI, losing -0.75).

The left column shows the position occupied in the world, followed by the regional position for the period 1964-2008. The column to the far right shows the regional position for the period 1998-2008, followed by the global position at the left. I apologize for the clumsy artisan crafting of this table: as can be inferred, it consists of pieces from a bigger table in the Atlas of Economic Complexity.

An economic iconoclast
Ricardo Hausmann, former Minister of Planning (1992-93) in Venezuela, currently heads the Center for International Development in Harvard University. Economic concepts like Original Sin (the burden of foreign currency debt in developing countries), Self-Discovery (how to discover the feasibility of new products to an economy), Growth Diagnostics (methodology to detect obstacles to growth), reflect the passage of this "economic iconoclast" (so Tim Harford in the Financial Times) by public policies as well as his origins in a developing country. The logical consequence of this line of work are the Economic Complexity Index and the Product Space, developed in the Atlas of Economic Complexity together with the MIT Media Lab.

 The site of the Observatory is the master thesis of Alexander Simoes at the MIT Media Lab. The project can forked at You can also access the IPA. The license is a Creative Commons Attribution-ShareAlike 3.0 Unported License.

AJG Simoes, CA Hidalgo. The Economic Complexity Observatory: An Analytical Tool for Understanding the Dynamics of Economic Development. Workshops at the Twenty-Fifth AAAI Conference on Artificial Intelligence. (2011)

R Hausmann, CA Hidalgo, S Bustos, M Coscia, S Chung, J Jimenez, A Simoes, M Yildirim. The Atlas of Economic Complexity. Puritan Press. Cambridge MA. (2011)