Why getting complicated increases the wealth of nations

4th July, 2009

One of the defining characteristics of the modern economy is that it’s awfully complicated. Even a fairly humble product such as a shirt might incorporate cotton from west Africa, oil from Indonesia to make the polyester in the button (manufactured in China), and designs sketched out by an Italian using American computer software. Then there is the sheer number of products: Eric Beinhocker, author of The Origin of Wealth, reckons there are probably 10 billion distinct products and services available in a modern economic environment such as London, Tokyo or New York. It’s a guess, but a fairly educated one. Beinhocker also estimates that for a traditional hunter-gatherer society, the number is closer to 300.

This would probably not have surprised Adam Smith, who emphasised the importance of specialisation as a source of the wealth of nations. Specialisation and complexity are closely linked: an economy with more specialists is one that requires more teamwork and more distinct interactions between individual activities.

Leaving aside a few complexity theorists such as Beinhocker, this is not the way that most economists think about what makes countries rich. It is not that they disagree, simply that they tend to focus on more easily measurable aggregates, such as the total stock of capital and labour.

Actually trying to measure economic complexity is a tricky business, but it is not impossible. César Hidalgo, a young physicist specialising in the mapping of networks, and Ricardo Hausmann, a development economist, are both researchers at Harvard’s Center for International Development, where they have been grappling with the problem. One obvious measure of complexity is how many types of product a country exports in significant quantities, from a list of more than 770 categories. Exports are a meaningful indicator because if you export a product it means someone else is willing to pay for it. A further measure of complexity is whether a country’s exports are uncommon (many countries export T-shirts; few export aircraft parts).

Hidalgo and Hausmann discovered a striking pattern: countries that export only a few products tend to export fairly commonplace stuff, while those that export a large range also make the kind of specialised products that few others produce.

It is possible to zoom in further. Malaysia and Pakistan seem, at first glance, equally complex, each exporting 104 product types. But many of Malaysia’s exports are also exported by mighty Japan, whereas Pakistan’s exports have very little in common with those of Japan. In general, Malaysia tends to export some of the products that very complex, diversified countries export, suggesting that it has a more complex economy than Pakistan. A mathematical application of such methods produces the top six most complex economies: Japan, Germany, Sweden, the UK, Finland and the US. Malawi, Cameroon and Western Samoa bring up the rear. Intriguingly, it seems that economies that are more complex than their level of income would suggest have a tendency to catch up with a spurt of fast growth; the complexity may indicate potential that is easily unlocked. Hidalgo cites South Korea as an example.

Development economists may find themselves paying more attention to such issues in future. We know very little about how to encourage an economy to become more complex and acquire new product capabilities. That may explain why we still have so much to learn about how to make poor countries rich.

Also published at ft.com.

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