Models for growth

2nd October, 2010

Is the world like Play-Doh or like Lego? That might seem like an odd question for an economist, but there were some provocative characters present at a recent “Growth Week” at the London School of Economics, organised by a new joint venture between Oxford, LSE and the Department for International Development.

Growth Week assembled policymakers from developing countries alongside development economists, and my attention was grabbed by Paul Romer, Ricardo Hausmann and John Sutton, all three of them, in different ways, economic iconoclasts.

Romer created endogenous growth theory – thus memorably giving Michael Heseltine the chance to remark that the idea “wasn’t Brown’s – it was Balls!” He quit academia, founded a successful online education company, and now travels the world campaigning for the foundation of “charter cities”, modern versions of Hong Kong. More of him in a future column.

It was Hausmann – once a Venezuelan minister, now a professor at Harvard – who was asking about Play-Doh and Lego. Hausmann, in joint work with the physicist Cesar Hidalgo (I’ve written about their work before), has been trying to puzzle out the relationship between the sophistication of a country’s economy and the kinds of products it makes.

Economists have tended to view the economy as a Play-Doh affair: products are produced by a few undifferentiated inputs of “stuff”, which we call capital and labour. More sophisticated accounts might introduce land, education (“human capital”) and institutions (“social capital”). Even then, that’s just five types of stuff, and economic growth just means getting more stuff and using it more efficiently.

Hausmann argues, convincingly, that this isn’t a helpful way to think about the capabilities needed to produce a sophisticated product or service. Amazon, for instance, offers a service that requires widespread access to the internet, credit cards, physical addresses and a trustworthy post office. An orchid business would require the right kind of land, water and electricity, along with appropriate customs regulations to allow shipping. Some countries might have the preconditions to allow internet shopping; others might be fertile territory for orchid production. What’s needed is not “more human capital” but some rather specific, and sometimes subtle, requirements: different Lego bricks, not lumps of Play-Doh.

Hausmann’s Lego analogy is probably too optimistic. In fact, these elusive economic capabilities are probably more like the components of your computer: the keyboard, mouse, screen, internet connection, processor. You can assemble them in various ways, but you don’t have to remove many components before your computer is far less useful, and some components, such as the processor, are indispensable. Hausmann worries about the fact that until a country has a critical mass of capabilities, there’s little point in acquiring more. There is no point in going to the trouble of getting a keyboard for your computer if you have no software.

The LSE’s John Sutton has been trying to figure out how companies acquire the capabilities that they have. His research reveals that in Ethiopia, for instance, many of the key manufacturing companies start not as small manufacturers but as traders. They have the know-how to run an organisation of 50 people and real expertise about the market. One unfortunate matchbox manufacturer was undercut by Chinese imports at one-fifth of the price, including shipping. A wilier company with a background in trading went into steel wire because it understood the Chinese supply chain and knew how to compete.

Sutton and Hausmann have very different research strategies, but a shared question: if “capabilities” are the Lego bricks of economic growth, where do they come from and how can we make more?

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