How physics can explain why some countries are rich and others are poor

Published in Slate
Tuesday, August 21, 2007

Milton Friedman, Meet Richard Feynman How physics can explain why some countries are rich and others are poor.By Tim HarfordPosted Saturday, Aug. 18, 2007, at 7:07 AM ET
If economics can tell us something useful about crime, marriage, or carpooling—as I believe it can—then other academic disciplines should have something to tell us about economies. Last month, Science published an example that may turn out to be important. Two physicists, Cesar Hidalgo and Albert-László Barabási, and two economists, Bailey Klinger and Ricardo Hausmann, have been drawing unusual pictures of economic “space” that promise a deeper understanding of the biggest question in economics: why poor countries are poor.
There are many explanations, but some are easier to test than others. One very plausible account of why at least some poor countries are poor is that there is no smooth progression from where they are to where they would be when rich. For instance, to move from drilling oil to making silicon chips might require simultaneous investments in education, transport infrastructure, electricity, and many other things. The gap may be too far for private enterprise to bridge without some sort of coordinating effort from government—a “big push.”
That is an old and intuitive idea in economics, but as an informal argument it leaves a lot to be desired. For a start, while plausible, it might not be true. If it is true, it might be far more so for some kinds of economy than for others. And if there is to be a big push, in which direction should it go?
Testing the idea took three steps. First, economists at the National Bureau of Economic Research broke down each country’s exports into 775 distinct products. Next, Hausmann and Klinger used that data to measure how similar each product is to each other product. If every major apple exporter also exports pears, and every major pear exporter also exports apples, then the data are demonstrating apples and pears to be similar.
Presumably, both economies would have fertile soil, agronomists, refrigerated packing plants, and ports. For the third step, Hausmann and Klinger called upon Hidalgo and Barabási, who specialize in mapping and analyzing networks. The result was a map of the relationships between different products in an abstract economic space. (And look at more maps here.) Apples and pears are close together; oil production is a long way away from anything else.
The physicists’ map shows each economy in this network of products, by highlighting the products each country exported. Over time, economies move across the product map as their export mix changes. Rich countries have larger, more diversified economies, and so produce lots of products—especially products close to the densely connected heart of the network. East Asian economies look very different, with a big cluster around textiles and another around electronics manufacturing, and—contrary to the hype—not much activity in the products produced by rich countries. African countries tend to produce a few products with no great similarity to any others.
That could be a big problem. The network maps show that economies tend to develop through closely related products. A country such as Colombia makes products that are well connected on the network, and so there are plenty of opportunities for private firms to move in to, provided other parts of the business climate allow it. But many of South Africa’s current exports—diamonds, for example—are not very similar to anything.
If the country is to develop new products, it will mean making a big leap. The data show that such leaps are unusual.
None of this is proof that other development prescriptions—provide financing, fight corruption, cut red tape, and lower trade barriers—are useless. Nor is it a green light for ham-fisted industrial policy. Klinger warns: “It’s easy to take the policy implication too far and start trying to pick and choose where to settle in the product space.” But it is a big step forward. Policy-makers should take note, and economists, too.
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The Persistence of Underdevelopment: Institutions, Human Capital, or Constituencies?

Nice paper, Rajan & Zingales (2006)
NBER Working Paper No. 12093
Issued in March 2006

Abstract
Why is underdevelopment so persistent? One explanation is that poor countries do not have institutions that can support growth. Because institutions (both good and bad) are persistent, underdevelopment is persistent. An alternative view is that underdevelopment comes from poor education. Neither explanation is fully satisfactory, the first because it does not explain why poor economic institutions persist even in fairly democratic but poor societies, and the second because it does not explain why poor education is so persistent. This paper tries to reconcile these two views by arguing that the underlying cause of underdevelopment is the initial distribution of factor endowments. Under certain circumstances, this leads to self-interested constituencies that, in equilibrium, perpetuate the status quo. In other words, poor education policy might well be the proximate cause of underdevelopment, but the deeper (and more long lasting cause) are the initial conditions (like the initial distribution of education) that determine political constituencies, their power, and their incentives. Though the initial conditions may well be a legacy of the colonial past, and may well create a perverse political equilibrium of stagnation, persistence does not require the presence of coercive political institutions. We present some suggestive empirical evidence. On the one hand, such an analysis offers hope that the destiny of societies is not preordained by the institutions they inherited through historical accident. On the other hand, it suggests we need to understand better how to alter factor endowments when societies may not have the internal will to do so.

Commitment, Coercion, and Markets: The Nature and Dynamics of Institutions Supporting Exchange

By Avner Grief

ABSTRACT

Markets rest upon institutions. The development of market-based exchange relies on the support of two institutional pillars that are, in turn, shaped by the development of markets. Research in the field of new institutional economics has largely focused upon one such institutional pillar—‘contract-enforcement institutions’—that determine the range of transactions in which individuals can commit to keep their contractual obligations. Yet, markets also require institutions that constrain those with coercive power from abusing others’ property rights. These ‘coercion-constraining’ institutions influence whether individuals will bring their goods to the market in the first place.

This chapter’s discussion of market-supporting institutions is geared toward the issues we know the least about. First, the dynamics of market-supporting institutions and the implied dynamics of markets; second, the inter-relationships between the dynamics of market-supporting and political institutions where the latter comprise the rules for collective decision-making, political rights, and the legitimate use of coercive power. It argues, in particular, that neither the assertion that liberal political institutions lead to markets nor that markets lead to liberal governance are supported by theory or history. Markets and political institutions co-evolve through a dynamic inter-play between contract-enforcement and coercion-constraining institutions.

Many successful market economies have prevailed in the past; there were adequate market-supporting institutions. Early successes, such as those in the Islamic world or China, were not indicators of later development. It was the commercial expansion that began in Europe during the late medieval period that led to the development of markets that support the complex, dynamic modern economy with its wide-scale reliance on impersonal exchange. Why didn’t early success lead to subsequent market expansion? More generally, what does determine the dynamics of market expansion? Addressing these questions is a key to understanding the ‘Rise of theWest,’ the operation of market economies, and the factors that still hinder market development.

The argument advanced here is that markets can rest on different combinations of contract-enforcement and coercion-constraining institutions.

Paper here