economics

February 11, 2010

Some developing economies are rich but crude, while others are poor but sophisticated

Feb 4th 2010 | From The Economist print edition

Illustration by Jac Depczyk

ONCE a sleepy fishing port, the industrial city of Yanbu, on Saudi Arabia’s Red Sea coast, is now a monument to the country’s efforts to diversify its economy. Its petrochemical plant is a sprawling palace of pipes. Propane tanks and cracking towers shimmer in the heat like domes and minarets. The facility’s engineers live with their families nearby in a leafy enclave, their shady balconies reminiscent of the traditional rowshan windows of old Jeddah. At the local mall, shoppers can buy any flavour of Holsten Pils they like (strawberry, apple, pomegranate), so long as it is non-alcoholic.

Like many developing countries, Saudi Arabia has long struggled to wean itself off its dependence on a handful of commodities, in this case oil. Yanbu was built by a royal commission, set up in 1975 as part of a concerted effort to move the Saudi economy beyond crude into downstream industries, such as refined petroleum and petrochemicals. The policy has enjoyed some success: Saudi petrochemical exports exceeded $14 billion in 2008. The kingdom is more ambivalent about some of its other forays. It is, for example, now phasing out efforts to grow wheat in the desert.

Saudi Arabia’s obsession with its industrial mix is not shared by most development economists. They traditionally judge the success of an economy by the volume, not the variety, of output per head. Two exceptions are Ricardo Hausmann of Harvard and his colleague, Cesar Hidalgo, a physicist. In a series of papers with various collaborators, they have explored the composition, as well as the quantity, of production, and have taken into account what countries produce, as well as how much.

Just as economies differ in size, the two authors show, they also vary in complexity. Some are eclectic, making a wide range of products. Others are esoteric, producing idiosyncratic goods that few other countries can make. The authors have created a measure of the sophistication of an economy based on two criteria. How many products does a country export successfully? And how many other countries also export those products? Sophisticated economies, by the pair’s definition, export a large variety of “exclusive” products that few other countries can make.

Income and sophistication tend to rise in tandem, as you would expect. But some economies are surprisingly sophisticated, given their level of income. They tend to grow quickly, perhaps because they have mastered industries that are mostly the preserve of richer, and therefore costlier, rivals. Other economies, by contrast, are surprisingly crude, given their prosperity. Saudi Arabia, for example, ranks below the Philippines and Indonesia in sophistication, despite having a higher income per head.

In its recent efforts to diversify, Saudi Arabia has placed less faith in royal commissions and more in entrepreneurs. It is busy cutting red tape and streamlining procedures in a bid to become one of the world’s ten most “competitive” economies by 2010, as ranked by the World Economic Forum and the World Bank’s “Doing Business” league tables. Saudi Arabia hopes that the private sector, newly unencumbered, will sniff out fresh opportunities, diversifying the economy in response to market signals rather than royal decrees. The work of Messrs Hausmann and Hidalgo, however, suggests that the kingdom’s entrepreneurs have their work cut out for them. As they point out, economies find it easier to master new products that are similar to ones they already make. It is easier to graduate from assembling toys to assembling televisions than to jump from textiles to laptops.

The two authors measure the proximity of one product to another based on the probability that a country makes both. In other words, if an economy that makes T-shirts is also likely to make bedsheets, the authors infer that T-shirts and bedsheets are closely related. They have displayed their results on an ingenious map of the industrial landscape, in which similar products cluster tightly together and unrelated products stand apart.

The territory their map reveals is far from uniform. It resembles a woodland, in which isolated knots of trees surround a few dense thickets of forest. An economy that already exports a few products in the thickest clusters can diversify quickly, hopping from one closely related product to the next. Saudi Arabia, by contrast, is stranded on one of those lonely clumps of products that seem only distantly related to anything else.

To cross these gaps, entrepreneurs need help. But royal commissions are not the answer. In work with Dani Rodrik of Harvard and Charles Sabel of Columbia University, Mr Hausmann argues that governments should emulate venture funds, backing new enterprises in the hope that one will make the leap into a more densely forested area. They should spread their bets widely, monitor progress closely, and cut losses promptly.

Do something different

Two hours’ drive down the coast from Yanbu, Saudi Arabia’s latest experiment in diversification is in progress. The King Abdullah Economic City (KAEC) was conceived by the Saudi government. But it is supposed to be built, run and paid for by the private sector. Taking the lead is Emaar.E.C, the local offshoot of a big Dubai developer, which raised 2.55 billion riyals ($680m) on the Saudi stockmarket in 2006.

In addition to a port, Emaar.E.C plans resorts, residences, schools and a financial centre. But it has left vast tracts of the site empty for other companies to fill, in the hope of attracting a cluster of light industries. Progress is slow. According to Reuters, Emaar.E.C received a loan of about 5 billion riyals from the government last month to stop it falling further behind on the project. What distinguishes a good diversification strategy, Messrs Hausmann, Rodrik and Sabel argue, is not the ability to pick winners; it is the guts to let losers go. But it is not easy to remain aloof from a city that bears the king’s name.

China’s rise good news for everyone
Posted: February 10, 2010, 12:58 PM by NP Editor

By Daniel J. Ikenson and Alec van Gelder

T

o protectionists and Sinophobes, China surpassing Germany in 2009 to become the world’s largest exporter heralds a new, unwelcome world order, with the United States in third place.

But more than a reflection of China’s growing economic might, this development is testament to the erosion of economic, political, physical and technological barriers to production.

China’s success is due to multilateral trade with the rest of the world, despite what the anti-China lobbies in Brussels, New Delhi and Washington argue. So when U.S. President Barack Obama and American lawmakers complain about China, they forget that Chinese exports include American exports.

Beginning with the widespread liberalization of trade and investment rules after the Second World War, barriers have been falling and incomes rising around the world.

China’s opening to the West in 1978; the fall of the Berlin Wall in 1989 and of the Soviet Union two years later; the collapse of communism as a model for developing countries; and the advent and proliferation of containerized shipping, GPS technology, just-in-time supply and other marvels of the information, transport and communications revolutions have spawned a global division of labor and production that defies traditional analysis. This makes trade-flow accounting highly misleading

Global economics is no longer a competition between “us and them,” between “our” producers and “their” producers. Instead, because of cross-border investment and transnational production and supply chains, the factory has broken down its walls and now spans borders and oceans. Competition is often between international brands or production and supply chains that defy national identity

So what does all of this have to do with China’s status as the world’s biggest exporter?

The vast majority of Chinese exports are hugely dependent on imports from the rest of the world: iron ore from Australia; microchips from Taiwan, South Korea or Singapore; software from teams in Redmond (in the state of Washington) and Bangalore (India); new designs from Cambridge (whether Massachusetts or England) and Toulouse (France); investments raised from consortiums based in New York City, São Paulo or Johannesburg.

China has become the world’s largest exporter primarily because of the global division of labour that has helped reduce poverty and create wealth: China provides lower-value-added production. The components of Apple’s iPods and iPhones are put together in China, but their designers in California are worth more to the company’s bottom line. Denmark’s Ecco has shoe factories across Asia, but its most valuable footwear is still designed and manufactured in Europe, where the quality is guaranteed and the workforce highly trained — and higher paid.

China has not become a key figure in global trade by accident. It has capitalized on the new reality of global production and supply chains: Since 1983, it has unilaterally removed barriers to trade, realizing they were primarily harming China.

True, China’s trade policies remain far from perfect. But they have liberalized quickly and considerably, which helps explain the country’s prominent role in global production and supply.

Calculating who earns the biggest amount from exports remains a problem. Intermediate goods are shipped to China from countries such as Japan, Taiwan, Singapore, Australia and the United States, snapped together (or perhaps a slightly higher-value-added operation) in China and then exported. As those goods leave the ports of Shanghai, Tianjin or Guangdong for export, simple trade accounting rules attribute the entire value of those exports to China, even when the Chinese value embedded in those goods accounts for a small fraction of the total.

That accounting method helps explain why China’s exports have surged over the decades, as the division of labour evolved and manufacturing chains proliferated.

A recent study by economists at the University of California concluded that the Chinese-added value embedded in a 30G Apple iPod accounts for only $4 of the total $150 cost, yet the entire amount is chalked up as a Chinese export. Other studies estimate overall Chinese value added in all products exported from China to average somewhere between 35% and 50%, a large proportion but a lot less than gross export figures imply.

Indeed, “if China grows, this pushes the world’s economy – and that’s good for export-oriented Germany as well,” a German Chamber of Industry and Commerce economist, Volker Treier, said recently.

As we consider China’s new status as global export leader, it is important to understand what it means. This data speaks much more convincingly of the virtues of economic interdependence than of China’s stand-alone export prowess: Such figures present opportunities for everyone to join the global economy, including a strategically placed historic trading nation such as Turkey.

Daniel Ikenson is associate director of the Cato Institute’s Center for Trade Policy Studies and author of No Longer Us vs. Them. Alec van Gelder is a project director at the International Policy Network.

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