Economic theorists have long realized that the linkages between different products are critical to prosperity. But until recently, the data and statistical methods didn’t allow a detailed mapping of the structure of economic specialization around the world. The result is new empirical approaches to academic economic research.
Ricardo Hausmann of Harvard’s Kennedy School and Cesar Hidalgo of Massachusetts Institute of Technology and their research team have a theory that the more different products a country makes, the better positioned it is to grow. This idea runs counter to the conventional wisdom that countries should hyperspecialize.
They recently put out a report predicting that China’s growth will slow over the next decade, while India’s will remain rapid. Obviously, more than just economic complexity matters here — population growth is also important, as is a country’s initial level of income (richer countries have less room to grow). But if Hausmann and Hidalgo are right, investors should be also look at Indonesia and Vietnam.
Another group of researchers from the World Bank, World Trade Organization and elsewhere, led by David Dollar, has taken a different approach. This group has mapped out global value chains — the sequences of trade where raw materials are turned into components, then into finished products and finally into retail sales.
Dollar’s team has identified something it calls the smile curve. This is the tendency of countries in the middle of the production chain to get a smaller share of a product’s final value. The countries and companies that make the complex components in a phone or a computer tend to earn high profits, as do those that handle the research, design, marketing and retailing. But the countries in the middle, that assemble components into finished products and then ship them off to be sold, tend to get a thinner slice of the pie.
China is located precisely at the most unfavorable middle part of the curve, stuck doing low-value assembly instead of the more lucrative component manufacturing, research, design, marketing and sales. That’s good news if you want to count jobs but not if you are counting Chinese company profits. Unless China moves into higher value-added activities, this model also predicts that its growth may slow just as Hausmann and Hidalgo’s.
The development of these new models is good news for the economics profession.
Smith is a Bloomberg View columnist.