It’s Sophistication, Stupid

Economic Complexity SpainSince Adam Smith we know that division of labour is the secret sauce to the wealth of nations: as people and firms specialize in different activities, economic efficiency increases. David Ricardo developed later the theory of comparative advantage to explain why countries engage in international trade. Hence, classical economic theory prescribe specialization of countries industrial production.

International trade data tells a different story. Successful countries are extremely diversified, in a closer analogy with biological systems evolving in a competitive dynamical environment. A complex market dynamics suggests that flexibility and adaptability are more important for competitiveness than specialization, which would be an optimal strategy only in a static situation.

A first attempt to define competitiveness in terms of diversification was made by César Hidalgo and Ricardo Hausmann in “The building blocks of economic complexity”(1). They develop a view of economic growth and development that gives a central role to the complexity of a country’s economy. The complexity of an economy is related to the multiplicity of useful knowledge embedded in it. Tacit knowledge is what constrains the process of growth and development. This knowledge is costly to acquire and transfer, and is modularized into chunks they call capabilities.

journal.pone.0070726.g003Hidalgo and Hausmann show that it is possible to quantify the complexity of a country’s economy by interpreting trade data as a bipartite network in which countries are connected to the products they export, and characterizing the structure of this network. They show that countries whose economic complexity is greater than what would be expected given their level of income, tend to grow faster than those that are “too rich” for their current level of economic complexity. In this sense, economic complexity is not just a symptom or an expression of prosperity: it is a driver. This suggests that development efforts should focus on generating the conditions that allow the required complexity to generate sustained growth and prosperity.

In a more recent paper, “A New Metrics for Countries’ Fitness and Products’ Complexity”(2), another team of physicists propose a new, data driven, non-monetary and non-income based algorithm to capture the intrinsic link between the export basket of countries and their industrial competitiveness. They think that their method is better able to correctly grasp the economic essence of trade bipartite network which characterizes the non-monetary competitive advantage of diversification. Data clearly shows that, contrary to mainstream theories, countries tend to produce all the possible products they can, given their level of technology. As a result the shape of country-product matrix is approximately triangular.

Triangular Trade Matrix

Now, in another related paper, the same method is used to characterize also “The Scientific Competitiveness of Nations”(3). Technological leading nations have the largest production of scientific papers and collect the largest number of citations. They also have the highest fraction of research and development expense with respect to their GDP: indeed only nations that spend close to 3% of their GDP in R&D compete most successfully. This new analysis points diversification out again as the key element for nations to achieve a successful and competitive research system, suggesting that excellence comes out as a natural side effect of a complex, very heterogeneous system.

The more complex disciplines are not necessarily those of high technological requirements. Instead, they are disciplines (such as environmental conservation, medical caretaking and treatment research, or socio-economic studies) addressing needs of a more developed society that are not directly related to “basic” nor economically-driven research. Only very competitive and advanced nations develop a strong activity in these sophisticated domains. In turn, these domains play the role of good “markers” for the scientific fitness of a nation.

I can feel Paul Krugman’s head spinning like Linda Blair’s in the Exorcist. Krugman won the Nobel Memorial Prize in Economic Sciences for his contributions to New Trade Theory in 2008. I am pretty sure he knows all about trade better that anyone else, and very likely he thinks this physicist’s inroad in economics is bullshit:

The general rule to remember is that if some discipline seems less developed than your own, it’s probably not because the researchers aren’t as smart as you are, it’s because the subject is harder. (Paul Krugman, “Limits to growth and related stuff”)

But images are great, aren’t they?

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(1) César A. Hidalgo, and Ricardo Hausmann. “The Building Blocks of Economic Complexity.” Proceedings of the National Academy of Sciences 106, no. 26 (June 30, 2009): 10570–75. doi:10.1073/pnas.0900943106.

(2) Andrea Tacchella, Matthieu Cristelli, Guido Caldarelli, Andrea Gabrielli, and Luciano Pietronero. “A New Metrics for Countries’ Fitness and Products’ Complexity.” Scientific Reports 2 (October 10, 2012). doi:10.1038/srep00723.

(3) Cimini, Giulio, Andrea Gabrielli, and Francesco Sylos Labini. “The Scientific Competitiveness of Nations.” arXiv:1409.5698 [physics], September 19, 2014. http://arxiv.org/abs/1409.5698.

Featured Image: Hidalgo, Hausmman et. al. “The Atlas of Economics Complexity”, Spain Economic Complexity index 2008. You can see more information here

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