What are the Challenges of Economic Growth?

By Ricardo Hausmann (originally published in GrowthPolicy)

The challenges of economic growth are very different in different countries. The U.S. and Europe face a certain set of issues that look very different from the issues faced in China or India, or the issues faced in the Americas or in Sub-Saharan Africa.

It would not be wise to cover all regions of the world with the same brush. There is a subset of countries in the developing world that are growing faster than the rest and are tending to converge towards the developed world, such as China, India, Thailand, and Vietnam. These countries are poised for growth, so you could say “the check is in the mail.” They just need to keep the growth process going and they face a certain set of challenges in doing so.

By contrast, in Latin America and Sub-Saharan Africa, countries just ended a very successful decade of economic growth that was propelled by high commodity prices and cheap access to capital. Right now, growth in these regions has slowed down enormously and creating a more dynamic environment going forward looks much more challenging, because they lack non-resource dynamic export industries that can generate the dynamism that the resource sector no longer can.

So my question would be, “Why does Asia look more promising than the Americas and Sub-Saharan Africa?”

In the economic growth process, countries in the developing world do not grow by making more of the same. In fact, more of the same is not the way rich countries grow either. In the process of economic growth, countries change what they do. They change what they’re good at. They evolve their comparative advantage. So while Israel used to export oranges, now they export IPOs of high-tech firms. Turkey used to export olive oil. Now they export cars and electronics. They do this because they acquire new productive capabilities; they acquire know-how and technology that allows them to do more diverse and valuable things.

Some industries are better stepping-stones than other industries for this process. So if a country is good at producing tea or at oil extraction, these industries don’t naturally prepare it for the next thing. But there’s a much more parsimonious path if you’re moving from garments, to textiles, to toys, to electronics, and to cars, because each new industry can build on the capabilities that were acquired for the previous industry.

To analyze which industries are ripe for the next phase of growth in a country we look at how technologically close are those industries to the ones the country already has. We have measured the relatedness of all pairs of exported products and we can look at what products a country is already good at and what are the most related products that they have yet to develop. This has already been automated in an online tool we call the Atlas of Economic Complexity. There you can explore any country and any industry. It is this tool that lets me say that the opportunities for further diversification into more complex products are greater in India, Thailand, Indonesia, Vietnam, Mexico and China than in most of South America or Sub-Saharan Africa.

For countries in South America and Sub-Saharan Africa, the industries in which they excel are often lousy stepping-stones for further diversification, meaning that, they require capabilities that are not easily redeployed towards other industries. For these countries, the challenge is more significant. They need policies that more consciously address the chicken and egg problems that always bedevil the diversification process.

New activities always face this chicken-and-egg problem. A country cannot make watches if it doesn’t have watchmakers. But you don’t want to become a watchmaker in a country that doesn’t make watches. Even if you wanted to become a watchmaker, you wouldn’t have other watchmakers to learn from because nobody is making watches. This requires a government that can play a smart “coordinator” role, which most governments are not set up to do.

So I believe that growth policies need to be focused on identifying new diversification opportunities and having an activist government trying to solve the coordination failures that these face. It is not about substituting for the market but to solve the market failures associated with chicken-and-egg problems that are ubiquitous in this area. The jobs of the future will be in these new industries directly and in the multiplier effect in the rest of the economy that these industries will have by demanding inputs from others or through the local spending of the incomes that they generate.

For many countries in the developing world, growth is limited by the size and dynamism of the industries that can sell goods and services abroad. This requires these industries to be competitive enough so that foreigners are willing to buy from them, given that they have so many other options to buy from. The speed at which these activities grow eventually determines the speed at which the whole economy grows.