Is economic growth more like accumulating masses of putty, or assembling many hundreds of different lego pieces? This was the question that Professor Cesar Hidalgo of MIT put to a World Bank audience yesterday on the topic of Networks and the Emergence of Economic Development. Professor Hidalgo was using this analogy to question the conventional way economists think about GDP.
Typically, GDP is seen as a function of just a few inputs (i.e. different types of putty). These are capital, labor, and, for those who favor a Romer-type approach, some kind of technology input. The types of labor and the types of capital are more or less interchangeable (just as putty is). Of course, economists know this is a massive simplification of the world, but it is useful in helping describe an extremely complex reality.
Professor Hidalgo has proposed a new approach (see his paper on the topic) that will help take into account a bit more of the complexity that's out there in the world. He jokingly calls it the "lego" theory of development. Simplifying a bit, if we look at those countries that are wealthy, we see that they produce products that require many, many different types of inputs or 'legos' (e.g. fighter planes require highly specialized labor skills, highly developed legal systems, advanced R&D, etc.). Further, wealthy countries don't specialize in one or two products (in contradiction to a simplistic interpretation of comparative advantage) -- they export many different types of goods.
Fine -- but rich countries may have lots of legos simply because they are rich. How do we know it is the complexity of an economy that helps create wealth? Professor Hidalgo also produced a regression analysis that looked at the number of legos each economy had back in 1985, and this produced a pretty decent prediction of GDP growth over subsequent decades.
Hidalgo then added one more wrinkle into all of this. There is no straight line in accumulating additional lego pieces. If you want to create a lego helicopter, you can't simply repurpose the pieces you would use for something simpler, say, a bicycle. And if you are an individual businessman in a developing country with only a few lego parts, you don't personally have the incentive to accumulate all the lego parts. Each of the lego parts has 'complementarity' with other lego parts. The result is that some countries get caught in a coordination trap -- the products a country currently produces (say, watermelon or cotton) require only a few lego pieces, and market incentives alone are insufficient for society to simultaneously obtain all the different lego pieces required to produce more complicated products.
The story Professor Hidalgo told is convincing. But there are at least two problems with it, both touched on in different ways during the Q&A. First, the creation of global supply chains means that it is possible to outsource very narrow pieces of a production process, which means countries don't necessarily have to accumulate many different lego pieces all at once to participate in the production of complex products.
Second, although Hidalgo didn't get very far into this question, his model points to the need for an active government to help solve this coordination problem. But this assumes a benevolent government that (1) is able to identify, if not a winner, at least a general group of products that a country could successfully manufacture; and, (2) actually cares about advancing economic development, rather than enriching those in positions of power. Unfortunately, both (1) and (2) are likely to be in short supply in countries with the least legos.
(Photo credit: idealisms)