The wealth of nations explained?

August 30, 2007 at 3:00 am 2 comments

Greece -fenceScience (317: 482-487 (2007) has published a really interesting article on the secret life of economics. Economies grow by upgrading the products they produce and export. To conjure up a product requires a number of things – technology; skills; capital; infrastructure – and the more closely-related the product lines, the easier it is for economies to progress and attain wealth. The Science article looks at the theory of product-relatedness (aka ‘product space’).

Relatedness occurs when you have similarity of inputs such as technology, skills and so on. Nations create wealth based on how transportable the product line is to other products. So for example if a country exports technology-based products like software or computers, then the technology and skills required could be redeployed to other products that require technology input (mobile phones, plasma TVs, iPods etc) But if your country is busy exporting llamas, then it would be more difficult to redeploy the capabilities and skills to other products. Raising llamas no doubt requires a whole lot of capability around agriculture and animal husbandry (not to mention the ability to avoid the llama’s spit, which they only do to fellow llamas I hear) but it’s a narrower skill-set that may not be so easily redeployed and the related products might not be so easily definable. So it’s about relatedness and distance – llamas are more distant from technology; software and computers are more related and closer to other products that use micro-chips, software programs etc.

From a complexity perspective, countries grow wealth and progress by climbing uphill in the fitness landscape. The closer the peaks in the fitness landscape, the easier it is to jump to the next highest peak. But if the fitness landscape is flat or irregular with peaks far apart and and if you’re stuck on the periphery of the landscape, then the leap you’d have to make to a peak might be quite a long one. Network theory has been applied to try to understand why it is that poorer countries don’t seem to produce more competitive exports, whereas richer countries, in terms of the fitness landscape, seem to be located in a densely-connected core.

So if a map were to be produced: what industries or products might appear at the core? This is what the Science article is about. The article is entitled “The Product Space Conditions the Development of Nations” by Hidalgo, Klinger, Barabasi and Hausmann. Albert-Lazlo Barabasi authored a book I really like – Linked: How Everything is Connected to Everything Else and What it Means. As for their research, Hidalgo et. al produced a map of the relationships between different products in economic space. You can see the map below or go here to see fuller detail.

What I think we can see from this map is that the centre or heart is occupied mainly by machinery/vehicles, chemicals and products made from metal. A number of clusters appear: garments, electronics and textiles. And then we seem to have a lot of disconnected stuff: oil out there on its own at the top of the map and disconnected from the core; cereals and tropical agriculture. So if you’re involved in exporting oil-related products, it might be harder to move towards the core; but if you’re in textiles or garments, you’re more closely connected to the densely populated centre.

Getting back to the llamas: animal agriculture is somewhat disconnected from the central cluster. So if a country is specialising in animal agriculture, they will have a harder time moving from this specialisation to another like chemicals, which is not related to llamas. But if you’re already specialising in products that populate the core (and China would be a good example of a country clustering around machinery/electronics), then you can jump around the fitness landscape with more agility. So where you are in the product space determines economic growth and progress.

Clearly, there are some key insights from this research. If a country is specialising in say mining, oil, animal agriculture, cereals (sound a tad like Australia?), then the capabilities, infrastructure and technology that supports these industries and products is quite specific and may not be easily redeployed to other industries or products.

The Science article is subscription only, but if you go here you can download a pdf version from Cesar Hidalgo’s website. I’ve only just finished reading the article, so some of my assumptions may be incorrect but I do think that using network theory to try to explain why some countries are not as wealthy as others gives us a deeper understanding of what’s going on.

You can also check out Country Maps here – Australia’s is interesting. And the site that accompanies the Science article is here.

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Entry filed under: Complexity, Economics, Network theory, Useful resources.

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