train depot in Milan, Italy by matteo panara
Milan, Italy. (Image: Matteo Panara via Unsplash)

Are quick wins a good bet for diversification?

Conforming or defying comparative advantage? The current debate on diversification, and reconsidering long jumps in policy advice.

By Nicola D. Coniglio, Davide Vurchio, Nicola Cantore and Michele Clara

Far too many countries have still not climbed the so-called ladder of development and continue to engage in trade in a handful of commodities only123. Diversifying the structure of the economy is a near universal objective4 endorsed by both policymakers and scholars around the globe. This objective builds on evidence that demonstrates that diversification triggers a structural change process, inducing sustained growth, higher levels of income and development5. The figure below illustrates that countries with an economy that is highly reliant on a few products only tend to have a lower level of income than those with a highly diversified economy. 

Economic diversification by income group

Note: The UNCTAD products diversification index. It is based on the Hirschmann–Herfindahl index approach, with lower values representing a higher level of diversification. The income group classification is based on the World Bank’s approach as described on the website.

Source: Authors elaboration.

Moreover, a recent UNIDO report finds that in the face of the pandemic, “countries with stronger manufacturing capabilities and more diversified industrial sectors have weathered both the economic and the health impact of the COVID-19 pandemic better than their peers”6. Which path to follow to achieve ‘structural diversification’, on the other hand, is still the subject of fierce debate.

Cesar Hidalgo and Ricardo Hausmann made a ground-breaking academic contribution to this debate in 2007. According to them: “[..] countries move through the product space by developing goods close to those they currently produce”7. In other words, countries develop a comparative advantage more easily in the production of those goods in which they have pre-existing capabilities: what you produce—and export—today defines what you can produce and export tomorrow (i.e. diversification follows a strong path dependence). The key message to policymakers is therefore to set modest goals, as ‘long jumps’ across the product space have been very rare in the past and may prove difficult to achieve. This theoretical approach calls for policymakers to favour “quick wins”, leveraging available production capacities which have largely determined countries’ comparative advantage as “[i]t is quite difficult for production to shift to products far away in the space, and therefore policies to promote large jumps are more challenging”8.

Despite being based on solid evidence, scepticism about taking long jumps in the product space is not without opposition. These conflicting approaches to the design of industrial and innovation polices were brought to a head in the famous academic debate between Justin Lin and Ha-Joon Chang in 2009. According to Chang, “[i]n practical terms, my difference with Justin lies primarily in the extent to which we think the defiance of comparative advantage is advisable. While Justin believes that the skipping of the rungs in climbing the ladder should be very small (‘comparative-advantage-conforming’ in his words), I believe that it can be, and sometimes has to be, large (‘comparative-advantage-defying’ in his words)”9.

We empirically test whether a trade-off between the scope for diversification and the extent of departure from a country’s current exports really exists.

New evidence on the dynamics of comparative advantage

Our recent article10 in the Journal of International Economics analyses the patterns of specialization of over 200 countries in the period 1995–2015 to measure whether actual data substantiate Hidalgo and Hausmann’s claims and, more specifically, whether diversification has in fact been characterized by a strong level of path dependence.

Our study generally confirms the hypothesis of path dependence, but also finds that a large number of new specialization products were unrelated to initial export baskets. Depending on the stringency of the criterion that defines a new entry as path-dependent, we find that the share of new products in a country’s export basket that defy its initial comparative advantage ranged from a lower value of 39 per cent to the highest value of 67 per cent. Although this finding seems to support Hausmann and Hidalgo’s (2011) hypothesis11 that countries frequently diversify by building on their existing capabilities, the flip side of the coin is that countries also frequently diversify by successfully producing and exporting products that lie far beyond their current know-how.

Average share of path-dependent new entries

Note: The chart refers to the share of path-dependent new entries identified by adopting values that are one standard deviation above the country-time-specific option set means as threshold.

Source: Coniglio et al. (2021).

 

It is not surprising then that the development of industrial countries’ comparative advantage has been less constrained by their initial export baskets since these countries already possessed a broader set of capabilities, skills, know-how and all other relevant conditions that underpinned their “long jumps”. At the opposite end, the study identifies developing economies that rely on natural resources or have export baskets concentrated in specific products. Yet even some of the lower- and middle-income countries—for example Algeria, Angola or Turkmenistan—displayed a considerable share of new exports unrelated to their initial export baskets (around one-fifth over the period studied).

Notable examples of diversification away from current export baskets has been widely discussed in academic and policy circles, from Brazil (aeronautical industry) to the Republic of Korea (several high-tech and capital-intensive industries). Our analysis confirms that the emergence of unrelated specialization is more widespread than commonly believed. Among these path-defying products that have been added to developing economies’ export baskets are ‘parts of other aircraft’, i.e. products that fall under HS12 code 8804 (which includes aircraft propellers, under-carriages, parts n.e.s. and parts of spacecraft balloons) and which are currently being exported by Morocco and Tunisia with a revealed comparative advantage. This group of products was added to Morocco’s export basket with a revealed comparative advantage in 2009 and to Tunisia’s in 2011. Tunisia has furthermore also added ‘medical instruments’ (HS code 9018, i.e. products that are usually exported by developed economies): the North-African economy has been exporting these products with a revealed comparative advantage since 2012. We find a similar picture in the development paths of several other low- and middle-income economies.

These findings suggest that the development of a comparative advantage in the world economy generally follows a path-dependent process, but path-defying changes, namely changes that are more likely to enhance diversification, are far from uncommon.

Short or long jumps across the product space: are they relevant for economic growth?

Economic diversification is clearly not an end in itself but rather a strategy to achieve economic growth and hence human development. One key issue for discussion is therefore whether countries perform better when diversification is more path-dependent (prevalence of short jumps) or path-defying (prevalence of long jumps or adding unrelated new products to the export basket). To answer this question, we use empirical data to estimate a growth model in which the share or number of path-dependent new entries in the export basket represent the main covariate.We conclude that path-dependent new entries in a country´s export basket are associated with a lower growth performance. This relationship is particularly marked in low-income countries.

In other words, long jumps are more likely to be associated with a high growth rate and are far more common than the academic debate suggests. Structural transformation can take different and often unpredictable forms, and policymakers may therefore want to pursue ambitious and path-defying diversification strategies. The frequency of identified long jumps across the product space calls for a new approach to industrial and innovation policies and a return to the policy agenda of path-defying diversification opportunities.

Further research should focus on the specific factors that underpin successful long jumps not only in terms of country capabilities but also in terms of product features. In fact, while acquiring specialization in certain products might be more feasible because the necessary set of capabilities is ubiquitous or easily accessible, the reverse might be true for other products. These aspects have thus far received very little attention in the economic literature and in policy analysis due to a general scepticism about ‘long jumps’ which, however, is not based on unambiguous evidence. It is now for research to again broaden the horizon.

  • Nicola D. Coniglio is Full Professor in Economic Policy at the University of Bari Aldo Moro (Italy).
  • Davide Vurchio is Assistant Professor in Economic Policy at the Department of Economics and Finance of the University of Bari (Italy).
  • Nicola Cantore is Research and Industrial Policy Officer at the Department of Policy Research and Statistics at the United Nations Industrial Development Organization (UNIDO). 
  • Michele Clara is Senior Industrial Development Officer at the United Nations Industrial Development Organization (UNIDO).

Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).

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