The Caribbean Product Space: Development Strategies and Institutions Ricardo Hausmann Center for International Development Harvard University (based on a joint paper with Bailey Klinger)

Agenda  A different view of the development process  A different assessment of the Caribbean  Policy implications

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 (Real cumulative investment) Human Capital (years of schooling)  …and have more “total factor productivity”  …which lets them get more output per capita  Policy implications: More education More savings to finance investment More property rights to assure investors More “productivity”

…but rich countries do not just produce more per capita They produce different products

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

How do countries grow rich?  By going from simple products requiring few capabilities and inputs  …to more complicated products requiring more capabilities  Developing new products is difficult because the requisite capabilities may not be there  Developing new capabilities is difficult, because there may be no demand for them if the other complementary capabilities are not there  This creates an important “chicken and egg” problem between products and capabilities that requires coordination

Sophistication of exports is measured as the income per capita of countries with a comparative advantage in the country’s export basket Rich Countries Produce Rich Country Goods Relationship between per-capita GDP and EXPY, 2005 Rich countries do not just produce more of the same They produce different goods To grow rich, countries need to change what they produce and export

Sophistication in 1992 Growth in , controlling for initial income Sophistication Today Determines Tomorrow’s Growth: Countries become what they export Strong evidence that countries converge to the level of income of the countries they compete with.

Many Caribbean countries are poorly positioned in the product space  EXPY vs. GDP per capita (logs), 2005

It is not just because the countries have a big tourism sector

How To Advance? Monkeys & Trees Our metaphor: Products are like trees Firms are like monkeys Structural transformation: process whereby monkeys move from the poor part to the rich part of the forest Easier for monkeys to jump short distance (i.e. to change to products that use similar capabilities)

Moving to new products is difficult New products face a chicken and egg problem: Why create inputs for an industry that does not exist? How can the industry exist, if the inputs are not there? In practice, new products use inputs that have been accumulated to serve other “nearby” products This creates very strong path dependence

Nodes sized according to World Exports, darker links are stronger (red is strongest) The Product Space

Malaysia:

Malaysia 1975

Malaysia 1980

Malaysia 1985

Malaysia 1990

Malaysia 1995

Malaysia 2000

Where does the Caribbean have its comparative advantage today?

Bahamas, 2000

Belize, 2000

Guyana, 2000

Jamaica, 2000

St. Kitts & Nevis, 2000

Trinidad & Tobago, 2000

Guatemala, 2000

Cyprus, 2000

How well positioned are countries in the product space?  Open forest vs. GDP per capita (logs), 2005

The Caribbean is poorly positioned  Open forest vs. GDP per capita (logs), 2005

Current level of export sophistication Ease to jump to new products: open forest LowHigh Low High Bridge over troubled waters Strategic bets Little space to improve quality and few nearby trees Stairway to heaven Parsimonious industrial policy Help jump short distances to other products Let it be It ain’t broke Ample space to move in all directions Hey Jude: make it better Competitiveness policy Improve the conditions of the sectors that already exist The strategic setting

Regional integration What if CARICOM were a single country exporting to row?

If Caricom was integrated, it would be more sophisticated  EXPY vs. GDP per capita, logs, 2005

…and better positioned in the product space  Open forest vs. GDP per capita, logs, 2005

Using the data to find your way in the forest Jamaica and Belize

Belize and Jamaica’s Efficient Frontier: Sophistication vs. Distance Distance vs. sophistication

Belize and Jamaica’s Efficient Frontier: Strategic Value vs. Distance Distance vs. strategic value

The policy problem  Production requires two classes of highly specific and complementary inputs Private inputs provided by markets Public inputs provided by the government or non-market entities  Complements are like coffee and sugar, substitutes are like coffee and tea. With complements, the more you have of one, the more you want of the other  Private inputs have prices These provide information about costs and willingness to pay  They are provided by profit-motivated firms they respond to those prices  Financial markets respond to profits They move resources towards profitable activities

The problem continued  So very often, markets are able to work well and efficiently  Exceptions are related to coordination failures, such as the chicken and egg problem  There are also what we have called self- discovery or cost discovery externalities You don’t know the cost of making a new product in the country because it is hard to know ex ante whether the requisite inputs are present Imitators can free ride

The problem continued  Governments are in a very different situation than markets  The inputs they provide have no price and hence no ready information about what is needed and possible Hence no information about costs and willingness to pay  …no obvious incentive to provide, even if informed  No source of automatic cash to respond to the need

The predicament  How can the government organize itself to provide the inputs required by current activities?  ….given that it cannot rely on the market for information, incentives and resource mobilization?  Even more difficult: how does it organize itself to provide the inputs to the activities that could have existed but do not, because

1- Organizing for dialogue  Allow an open window Let them come to you  Let promoters self-organize Do not try to parse the world into arbitrary buckets Let the buckets form themselves as a function of shared interest in public inputs  Require co-financing Willingness to pay is correlated with the social returns to the public input, so it is informative Eliminates rent-seeking, but also creates incentives not to free-ride  Require transparency: public information Again to prevent rent-seeking What you request in private is different than if it becomes public knowledge  Restrict actions to the the supply of public inputs Infrastructure, regulation, training, certification, market access, property rights, not subsidies  How to guarantee government responsiveness?

2- Google-like search engines  Need institutions to search the space of possibilities and the related obstacles  Two examples Development banks Industrial parks

Development banks Traditionally conceived as motivated by a financial market distortion or failure Instead, provide the finance to attract interest …but use the interaction to learn about the space of possibilities and obstacles …and use it to provide the requisite public inputs This requires a completely different set of goals and targets  Key Performance Indicators KPI KPIs: not volume of lending but activities crowded in whether financed by the institution or not  Example: Industrial Development Corporation – South Africa

Business zones  Usually created to provide either good infrastructure or tax privileges  Really about identifying the space of possibilities  Three anecdotes ZonAmerica – Uruguay: from manufacturing to back offices, software and call centers Couga – South Africa: from aluminum to a broad search Tangier – Morocco: discovering new opportunities and missing public inputs

Take away  Each Caribbean country faces a dearth of local capabilities  These could be expanded if they could be more easily accessed through regional integration  Given their position in the product space, countries will need to consider strategic bets  Organizing the provision of the requisite public inputs is key  Open architecture, non-hierarchical structures may be better  Keeping the process legitimate vis a vis the rest of society and credibly limiting the rapacity of the state are key  Development banks and economic zones could have an important role to play

Appendix

We can measure the complexity of countries  K6 vs. GDP per capita (logs), 2000

Even if we control for the small size of the economy  Open Forest vs. GDP per capita, logs, 2005, controlling for population

…and the Caribbean looks problematic  K6 vs. GDP per capita (logs), 2000

El Salvador, 2000

Costa Rica, 2000

Singapore, 2000

(tourism comparators)

Malta, 2000

Belize- Low Hanging Fruit, 2005

Jamaica- Low Hanging Fruit, 2004

Belize  As we move from the low-hanging fruit listed above, the ‘best’ activities continue to be in agriculture, but increasingly sophisticated and more intensive in valuable and diverse capabilities: non-traditional agriculture forest products processed foods mariculture  Allowing for longer jumps adds some manufacturing sectors, namely apparel and electronics. As can be seen above, these sectors (the light-blue dots) are quite distant, but they represent the best mix of high wages and stimulation of subsequent structural transformation at that distance, making them sensible considerations.

Jamaica  Both the very nearby products and those slightly up the efficient frontier are agricultural goods, such as dairy products, canned vegetables, and processed fish products.  There are also activities in the garments cluster, however these have a significantly lower PRODY meaning they typically support only low wages.  Allowing for further jumps, other manufactures enter the efficient frontier, such as simple plastic manufactures, as well as many goods in the medicaments and cosmetics industry, such as creams and soaps, non-soap surface-active agents, and hair products.