1. Diversification: why and how?
Ricardo Hausmann
Harvard Kennedy School &
Center for International Development at
Harvard University

2. A reinterpretation of the sources of growth

3. Why are some countries rich and others poor?
The traditional explanation

4. Why are some countries poor and others rich?
The traditional answer emphasizes factor accumulation and “aggregate” productivity
Countries are rich because they work with more:
Physical Capital (accumulated through investment)
Human Capital (years of schooling)
…and have more “total factor productivity”
…which lets them get more output per capita
Policy implications:
More education and health
More savings to finance investment (and micro-finance)
More property rights to assure investors
More “productivity”

5. The neo-classical dead-end
Assume the world is made out of four things
Output
Physical capital
Human capital
Labor
85% of growth is explained by non-of-the-above
Total Factor Productivity = a measure of our ignorance (Abramovits, 1958)
Maybe it is not that good a way to parse what the world is made out of

6. Rich countries do not just produce more per capita
They produce different products

9. An alternative view
Countries differ in the variety of the capabilities they have
Rich countries make more kinds of products and more complex products that require many capabilities
Poor countries make simple products that reflect the few capabilities they have

10. The hidden structure in the comparative advantage of nations

11. The hidden structure in the comparative advantage of nations

12. It does not matter what level of aggregation you use

13. Countries
Products

14. Countries
Capabilities
Products

15. Intuition Countries have capabilities Products require capabilities
Countries that have more capabilities will be able to make more products
They would be more diversified
Products that require more capabilities will be made by fewer countries
Products will be less ubiquitous

16. Intuition (cont’d)
Countries that have more capabilities will be able to make products that are less ubiquitous
Hence, countries that have more capabilities will be more diversified but will make less ubiquitous products
Diversification of countries and ubiquity of products are negatively correlated
They are indirect measures of the capability set of countries

17. Method of Reflections: k-k1 diagram
Average ubiquity of products
Hidalgo CA, Hausmann R Proc. Natl. Acad Sci. (2009) 106(26):

18. Diversification correlates with income per capita
Log GDP per capita
Diversification

19. Hidalgo CA, Hausmann R Proc. Natl. Acad Sci. (2009) 106(26):10570-10575

20. Complexity in 1985, controlling for initial GDP per capita
Hidalgo CA, Hausmann R Proc. Natl. Acad Sci. (2009) 106(26):

21. What makes growth difficult?
The chicken and egg problem
You cannot make new products because you lack the capabilities
You don’t want to accumulate the capabilities because the products that need them are not being made
Because of other missing capabilities
How does the world deal with this?
By moving towards “nearby” products

27. Step 1: Maximum Spanning Tree
Our Approach:
Distance measured by probability that, if a country is good in one product, it’s also good in another product.
What is the shape of a forest?
Homogenous or Heterogeneous?
What does it look like?

28. Step 2: Overlay Strong Links
0.4 >
0.4 – 0.55
0.55 – 0.65
0.65 <

29. Using Feenstra et al. Trade Data:
132 Countries
1006 Products
SITC-4 ( )
CA Hidalgo, B Klinger, A-L Barabasi, R Hausmann. Science (2007)

30. How do monkeys jump?

31. Malaysia 1975

32. Malaysia 1980

33. Malaysia 1985

34. Malaysia 1990

35. Malaysia 1995

36. Malaysia 2000

37. Key Implications Monkeys jump short distances
So, where you are now in the product space determines where you can jump
In the case of Malaysia, they moved to and dominated the electronics cluster
How are the ECA countries placed in this space?

38. Poland (2000): very well connected & diversified (although no presence in electronics)

39. Russia (2000): Highly peripheral, concentrated in hydrocarbons and raw materials

40. The Ukraine (2000): somewhere in between- more connected than Russia, not as well connected as Poland

41. Summarizing this ‘connectedness’ with one number: Open Forest
Open forest: option value of jumping to other trees
Income per capita

42. Countries in Eastern Europe and Central Asia face very different opportunities
Open forest: option value of jumping to other trees
Income per capita

43. Countries with a better-connected export basket did not suffer as deep an output collapse during transition
Open forest in 1992
Depth of Transition Recession (% of 1990 GDP per capita reached at trough)

44. ..and tend to be those closer to the west.
Open forest in 1992
Distance to Dusseldorf
But proximity to the West has no effect on transition beyond its impact on the export mix: open forest trumps distance to Dusseldorf in a cross-country regression

45. Some implications
Why do many poor countries not catch up to rich countries?
Because there is no “stairway to heaven” or sequence of nearby trees that can get them to the denser parts of the product space
What causes the “resource curse” (bad performance by resource rich countries)?
Poor connectedness of the resource intensive sectors
Add value to your raw materials?
Forward supply linkages vs capabilities
Finland
Why do countries fall into protracted slumps?
Because their existing export products get into trouble when they are in a part of the forest where there are no nearby trees
Is innovation the solution?
It is about finding profitable excuses to accumulate capabilities that will be used for some other purpose down the road

46. Strategic approaches Ease to jump to new products: open forest
Let it be
It ain’t broke
Ample space to move
in all directions
Stairway to heaven
Parsimonious industrial policy
Help jump short distances to other products
High
Ease to jump to new products: open forest
Hey Jude: make it better
Competitiveness policy
Improve the quality of what already exists
Bridge over troubled waters
Strategic bets
Little space to improve quality and few nearby trees
Low
Low
High
Space to grow in existing products

47. Where are the countries?

48. Where are the countries?

49. Countries face different opportunities to jump to other trees

50. Countries with closer nearby trees grow faster
Average growth
Open Forest 1985

51. Implications
Development is about a stepping stone process to solve the chicken and egg problem
Much of oil and mining is too disconnected to help trigger a transformation process
Dedicated rail and ports
Few forward and backward linkages
But there are some spillovers
The Steam Engine
Medellin gold mining and universities
You need not jump from there
Adding value to your natural resource endowment is not what Norway, Australia or Chile do
They have other unrelated sectors

52. Implications A commitment to diversification is key
It implies a commitment to protect the level and stability of the real exchange rate matters
Fiscal stabilization
But also a role for monetary policy
But also a willingness of the government to address chicken and egg problems
Especially those related to the provision of public inputs