How Rich Countries Became Rich and Why Poor Countries Remain Poor: The Role of Sophisticated and Well-Connected Products
In a new paper, Felipe et al. (2010) provide empirical support for the idea that countries that are unable to upgrade and diversify their exports may end up being caught in a middle-income trap. They classify 779 products according to their sophistication and connectivity to other products and use this information to categorize countries. They find that 120 out of 154 countries are in a “bad product” trap, as they mostly export unsophisticated and unconnected products. They conclude that escaping this trap will require policy interventions aimed at addressing the market failures that are pervasive in many developing countries.
Broadly speaking, the world can be divided into three groups of countries: (i) the high income economies, with income per capita above $12,000; (ii) the low income economies, with income per capita below $1,000; and (iii) the middle income economies, with an income that ranges between $1,000 and $12,000. Most countries that belong to this latter group grow at a moderate rate but are still far from graduating to the club of rich countries. They thus appear to be trapped in a “middle income” stage.
A key challenge that many middle income countries face is how to upgrade and diversify their export baskets. Many countries have been able to exploit their low-wage advantage to attract foreign direct investment into many industries. However, the challenges to deepen industrial capabilities, upgrade the skills of the local labor force, set up and build innovation, research and development capacity in the domestic economy, and move to high-value added and more sophisticated products remain significant.
Development is about the transformation of the productive structure towards greater diversification, sophistication, and accumulation of capabilities. Economic development is a process in which new activities emerge and old activities disappear (Kuznets, 1966, Kaldor (1967, or Chenery et al., 1986). In recent research, Hidalgo et al. (2007) and Hausmann et al. (2007) recognize the central role that structural transformation plays in development. They argue that not all activities have the same consequences for a country’s growth prospects (see also Sutton 2001, 2005). The growth stories of Asian countries such as South Korea and Singapore suggest that these countries succeeded because they managed to change the productive structure of their economies.
Countries that have failed are the ones that have not been able to engineer this process and are stuck in the production and export of a relatively narrow range of goods that are unsophisticated. Increasing the sophistication of the export basket is not an easy task. Export diversification and upgrading require venturing into new activities that may involve information and coordination externalities. Hausmann and Klinger (2006) investigate the process by which countries are able to diversify their export mix. They argue that a country’s ability to foray into new products depends on whether the set of existing capabilities can be easily redeployed for the production and export of new products. In other words, development is path-dependent.
In a recent paper (Felipe et al., 2010), we classify countries according to the sophistication and connectivity of their exports and examine the kind and the degree of policy interventions that can promote faster structural transformation. In particular, we classify 779 exported commodities according to two dimensions: (i) sophistication (measured by the income content of the products exported); and (ii) connectivity to other products (a well connected export basket is one that allows an easy jump to other potential exports). We identify 352 “good” products and 427 “bad” products.
Next, we split all countries into two groups according to the share of core commodities (chemicals, machinery, and metals) exported with revealed comparative advantage (RCA) in the total number of commodities exported with RCA. “High core” countries are those where the share of core commodities exported with RCA in the total number of commodities exported with RCA is above 30%. “Low core” countries are those where the share is less than 30%. “Core commodities” are, on average, more sophisticated and have a higher connectivity. Countries that export a significant share of core commodities with RCA face very different prospect from those of countries with a low presence in the core. Then, we calculate for each country the share of products exported with revealed comparative advantage (as percentage of the country’s total number of products exported with revealed comparative advantage). We assign each country to the cell with the largest share. Tables 1 and 2 show the results.
The above classification of products and countries allows us to categorize 154 countries into four groups. We find 34 countries that have an export basket which contains a significant share of “good” products. We also find 28 countries in a “middle product trap.” These are countries with an export basket that contains a significant share of products that are in the middle of the sophistication and connectivity spectra. We then find 17 countries that are in a “middle-low” product trap, and 75 countries that are in a “low product trap.” These are countries with export baskets that contain a significant share of unsophisticated products that are poorly connected to other products.
We conclude that 120 countries in the world are in a “bad product” trap, as they mostly export unsophisticated and unconnected products. We argue that escaping this trap is neither straightforward nor automatic and that it will require policy interventions aimed at addressing market failures, many of which are specific to developing countries.
The actions required to escape the “bad product” trap demand a swift shift from soft, parsimonious industrial policies to aggressive policies tailored to accumulating relevant capabilities, as well as strategic bets with significant government intervention. As history has shown, it is impossible to become a rich country without creating industrial and service-oriented sectors and relatively complex and sophisticated products/services. No country has been able to do this without explicit government interventions amounting to industrial policy in different shapes and forms.
Disclaimer: This column represents the views of the authors and not necessarily those of the Asian Development Bank, its Executive Directors, or those of the countries that they represent.
Bibliography
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