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Economic progress occurs because countries upgrade what they produce. In doing so they move from their current products to other, usually more sophisticated, related products. The more closely related the product lines, the easier it is for countries to make progress.
This theory of product-relatedness, also termed “product space,” is the subject of a new research report, co-authored by Kennedy School Professor Ricardo Hausmann, director of Harvard’s Center for International Development. The research is published in a new article in Science Magazine.
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Q: Please explain “product space,” and how it relates to economic growth.
Hausmann: Product space is a term we use to describe the network of relatedness between products. Relatedness is associated with the similarity in the inputs required by a certain activity including everything from particular skills, institutional and infrastructural requirements, technological similarity and the like.
I will cite an example from two relatively successful countries, Malaysia and Chile. Malaysia exports microwave ovens and Chile exports salmon. Salmon is a farm animal. It requires a lot of knowledge of biology and animal health. A microwave oven is a technological product, an electronic product. It’s difficult to say which one is more advanced or sophisticated, which one will lead to greater economic advancements. But, the central point we’re making is that if for some reason the microwave oven market got into trouble or if you simply wanted to advance to other product lines, it’s relatively easy to redeploy your capabilities from microwave ovens into many other electronic products, while it’s much more difficult to redeploy your capabilities utilized in salmon farming to many other products. It’s not impossible, but it’s much more difficult because there are fewer closely related product lines. So what we have created is, in some sense, a metaphor of how this process of moving from one product to another product works in the real world.
Think of each product as a tree in the forest. Any pair of products is akin to any pair of trees in the forest; they are at a certain distance from each other. Now think of firms as animals living on the tree, like monkeys living off the tree, exploiting a certain product. Following our metaphor – in order for countries to progress, they have to move from poorer trees to richer, more fruitful trees, and they do so by jumping to nearby trees. If all trees were each five yards apart, it wouldn’t really matter where the monkeys are in this forest because every leap would be the same distance. But if this forest is irregular, like economic structures can be – with dense patches of trees in some parts and barren patches in others – then a country that is poorly placed in the forest will have trouble moving ahead economically. This is where I think the salmon and microwave oven cases serve as illustrative examples.
Working in conjunction with Prof. Barabási from Notre Dame University, his student C.A. Hidalgo, and my student Bailey Klinger, we were able to use network theory to analyze this product space and map out the areas where the good trees are, where the poorer trees are and how densely connected they are. So now we can put countries in the forest and determine where they are economically in the forest, how easy it would be for them to move and grow, what the nearest trees are, and so on. And this opens up some very interesting possibilities, both to explain why the world is as it is and to help countries think about the road ahead.
Q: Can you cite some other “real-world” examples of “product space” limitations and opportunities in developing countries?
Hausmann: The product space shows a very peculiar structure. It has a central dense core composed mainly of machinery, metal products, chemicals and capital intensive goods. To one side lies an electronics cluster; to another side there is an apparel cluster. Disconnected from it and closer to the central cluster is the textile cluster. The rest of the product space is quite barren. Oil is off to one corner, very far from anything, and tropical agriculture is fairly disconnected. Forest products and paper are a bit more connected to the central core.
So if you look, for example, at where is Africa on this map, where is the Middle East on this map, they’re in a very disconnected part of the product space. So for them to move from their current area of specialization to other areas of specialization involves very, very long jumps. It’s not obvious that what you learn from doing what you’re currently doing doesn’t necessarily prepare you to do a bunch of other things.
Meanwhile the countries that have specialized – maybe for serendipitous reasons – in a more central part of the product space, suddenly can observe these explosive growths because they have many, many trees nearby. And for example when we look in our statistics at which are the best connected countries in the product space, then you suddenly find the Chinas, the Indias, the Eastern Europes and so on that have been the fast growers over the last period, while the countries that are in a poorly connected part of the product space have a lot more trouble making progress.
Q. Does this economic progress tie in closely with access to natural resources?
Hausmann: Natural resources tend to trap an economy in a very disconnected part of the product space. In the case of mining for example, essentially you learn how to make holes in the ground. You develop a logistics system that typically takes the raw material from the mine to the port, but doesn’t necessarily leave you with a network of transportation systems that can trigger other economic activities.
Sometimes you do get clusters of natural resource-intensive activities – say for example, non-traditional agriculture that is based on the capacity to certify and transport quickly fresh produce. With the transport of fresh produce, a cold storage logistics system is needed. And a cold storage logistics system is a pretty sophisticated thing – you have sanitary regulations to abide by, you have food safety standards, it has to be quick, it has to get there fresh. Well, that’s a system that could be used to transport peaches, to transport fish, to transport asparagus. So there’s suddenly a bunch of other activities that might be crowded in because the economy has now developed infrastructure and institutions that can support many other activities. Getting back to our metaphor, that becomes a part of the product space that is densely populated by trees and monkeys can move around more swiftly.
Q: What are the most salient policy implications from this research?
Hausmann: One key concept that I would like to stress is the concept of specificity. The development thinking of the last 20-30 years or so has been dominated by the idea that an economy must concentrate on a few very aggregate capabilities, like education, health, reducing child mortality, rule of law, and generalized infrastructure. So we have been thinking in these very general categories, and the idea was that if you showed improvement in these general areas, that would translate into more production, higher productivity, greater incomes.
What we are finding is that many countries have made enormous progress in education, health and institutional quality and have little to show for their efforts. This is often due to the fact that the ancillary support systems that economic activities actually need are quite specific to that activity and in their absence, very little takes place. When some of them are put in place, they might crowd in other activities that require very similar kinds of support, but will not necessarily extend out and incite a lot of other activities. It depends on where you are in the product space.
So an economy that prioritizes manufacturing will have an industrial zone and urban transport and a good logistics system and a good legal framework to hire labor and to bring products and materials in and out, and that could crowd in many other activities that utilize those same kinds of support mechanisms. But if the economy is dominated by oil, agriculture, mining, or forestry, the support mechanisms are quite specific and do not tend to spawn other economic activities.
Another takeaway from this research is that governments must establish an effective dialogue with the private sector, a dialogue that must take place at a much higher “information bandwidth,” so to speak. Policymakers, economists, and business leaders will have to work harder to try to understand which and what mix of specific legal frameworks, regulatory rules, labor training services, market access rules and infrastructure can significantly promote different types of economic activities. This, in turn, implies that the paradigm of a government at arm’s length from the private sector does not work. Instead, we need a government that is able to cooperate with the private sector much more intensely, but in a way that is legitimate vis-à-vis the rest of society, so that that cooperation is not seen as a social program for the rich, but as a way of advancing the capabilities of society as a whole.
Watch video clip.
Interviewed by Doug Gavel.