Is there a direction in economic development?

Pier Paolo Saviotti, INRA GAEL, Grenoble, and CNRS GREDEG I2C, Sophia Antipolis,

France.

Econ Dev, Stylised facts

STF1) Economic development is characterised by qualitative change.

STF2) The efficiency of existing processes increases in the course of economic development.

STF3) The diversity/variety of the economic system rises during the process of economic development.

Efficiency vs diversity

Efficiency grows when a constant output is produced with (a) decreasing quantities of all inputs or (b) decreasing costs of all inputs

Efficiency at constant quality

Qualitative change: emergence of new entities, qualitatively different (distinguishable) from the pre-existing ones.

N° distinguishable entities Diversity

Development as system transformation

Structural change: change in the structure of the economic system (components + linkages/interactions).

Defined at the level of aggregation of industrial sectors. But: structural change can occur at lower levels of aggregation.

Structural change can occur for activities and actors as well as for outputs, thus also for knowledge, and institutions.

Importance of qualitative/structural

change.

They affect the composition of the economic system. They are determinants of system performance.

Economic development is a process of transformation, involving both quantitative/efficiency change at constant composition and qualitative change.

Development vs Growth

Need to measure = need to transform qualitative differences into quantitative measurements (conventions, approximations)

Changes in efficiency can be easily measured, qualitative changes are much more difficult to measure

Diversity/variety Definition(PPS): number of actors, activities

and objects required to describe the economic system at a given time

Variable to represent analytically changes in composition = N° distinguishable economic species in system

But: also (I) extent of diffusion of new entities in the economic system (balance), and (ii) intrinsic difference between economic species (Disparity) (Stirling)

Modern phenomena

Most people could only purchase the bare essentials to survive until the end of the XIXth century, and many people still do today

Diversity existed only for the rich But in the XXth century diversity

became available for many people in developed societies

Diversity for most

Efficiency and Diversity

Two complementary forces/trajectories : growing efficiency growing diversity

Hypothesis 1: The growth in diversity is a necessary requirement for long-term economic development.

Hypothesis 2: Diversity growth, leading to new sectors, and efficiency growth in pre-existing sectors, are complementary and not independent aspects of economic development.

Compensation

At constant output growing efficiency + saturating demand possibility to produce all demanded output with declining fraction of resources (labour force) Marxian trap

Emergence of new sectors compensates for the falling capacity of existing sectors to create employment

Growing diversity avoids Marxian trap. Supply side: surplus old sectors search

activities new goods & services + creation of demand for new goods & services needs income

Family expenditure Workers UK

Necessities and higher goods/ services

The efficiency in the production of necessities had to increase to leave room for the purchase of higher goods/services

During the XIXth century the share of family expenditures allocated to necessities increased and it started to fall only at the beginning of the XXth century

Necessary condition for social stability and for economic growth

Economic development by the creation of new sectors

A model in which the number of new sectors varies endogenously during economic development

Sector created by an important innovation establishing an adjustment gap (size of the potential market)

Intra sector dynamics

First entrepreneur enters the market (expectation of a temporary monopoly) imitators enter rising intensity of competition inducement for further entry falls until exit starts dominating entry. Innovation has become part of the ‘circular flow’ (Schumpeter, 1912-1934)

Sector oligopoly or monopoly

Demand dynamics

Demand dynamics: Adjustment gap (distance from saturation) is gradually closed leading to a saturated market, but the product/service is improved by means of search activities

The joint dynamics of competition and of demand gives rise to an industry life cycle (ILC)

Creation of new sectors

The decline of mature sectors induces entrepreneurs to look for new opportunities of temporary monopoly, to be found by exploiting new important innovations leading to new niches and sectors.

Competition

Competition both intra- and inter-sector: Intra- sector: density of product/output

population. Entrepreneur induced by expectation of

temporary monopoly to enter. If innovation successful imitation increasing intensity of competition decreasing inducement to enter exit

Inter-sector competition

Inter- sector: different sectors can provide comparable services.

Important component of contestable markets

Total intensity of competition perceived within each sector = intra + inter

Limits the extent of oligopoly/monopoly that could be achieved within individual isolated sectors

Intra and inter sector competition

Search activities

Activities by means of which one scans the external environment looking for alternatives to existing routines (Nelson, Winter, 1982)

Generalized analogue of Research and Development

All economic activities can be divided into routines and search activities

Model equation

)3(**1 iiiii MAICAGFAk

dt

dN

Number of firms

Life cycle: in each sector Ni first increases rapidly, reaches a maximum, and then falls (oligopoly, monopoly)

But, life cycle driven purely by dynamics of competition and demand (See ILC models).

Shape of life cycle affected by several variables (AGi, Di etc).

-

5

10

15

20

25

30

35

40

45

50

1 101 201 301 401

number of firms

Adjustment gap

ti

ti

ti DDAG m ax

1 101 201 301 401

demand o f sector i

t 1 101 201 301 401

maximum demand of sector i

t 1 101 201 301 401 t

adjustment gap of sector i

ti

it

it

iti

p

YYDD

0

Demand

ti

it

it

iti

p

YYDD

0

)ex p (1

1

1 51 4

0ti

iti

SEkkYY

)ex p (1

1

1 71 6

0ti

iit

SEkkYY

tii

ti ucpp 2.10

)ex p ()ex p ( 1 91 80 t

id y ip itiy ip i

tit

i

ti

ti

ti

iti YkYkSEkk

Q

rInvwLucuc

Search activities

)]ex p (1[ 540 t

iit

i DacckkSESE i

Competition

tto ta lII

ti

tto ta l

ti

ICti NRN

NNkIC

1

1

-

1.0

2.0

3.0

4.0

5.0

6.0

1 35 69 103 137 171 205 239 273 307 341 375 409 443 477

Employment

li = ki/Qia = ki/Qi/Ni = (ki*Ni)/Qi

li = Li/Qi

Aggregate employment

- 100

200 300 400

500 600 700

800 900

1 35 69 103 137 171 205 239 273 307 341 375 409 443 477

aggregate employment

Model summary

The model shows that if diversity/variety grows economic development can continue in the long run

Many experiments can be carried out with the model by assessing the effect of varying its parameters on system behaviour and performance

Experiments: micro-macro dynamics, competition and growth, industry life cycles, Emergence of bubbles, etc.

Direction of development Reversal?

Growing efficiency and growing diversity/variety

If the efficiency of basic functions (e.g. Food, housing etc.) were to fall the resources of the system could be concentrated on these functions thus reducing diversity

Possible examples: (I) fall of earth temperature of 50 degrees; (ii) increased environmental fluctuations

We live in a fairly benign environment

Implications for development

Countries at different levels of economic development. Catching up.

How? If world diversity/variety grows then national diversity/variety should grow in parallel keep (national/world) diversity/variety ratio approximately constant

But, short run exceptions : specialization strategies compensating narrow range with increased competitiveness within range, but only viable in short run

Trends and systems

General trends (e.g. towards growing diversity) not followed in exactly the same way by all countries, but interpreted.

Two types of persistent asymmetries: In output structure In institutional and organisational

configurations National Innovation Systems

Heterogeneity vs homogenization

Innovations created at particular places and times asymmetric distribution of in world economic system raise heterogeneity

Diffusive forces (trade, technology transfer etc) tend to homogenize technologies, capabilities etc.

Dynamic steady state where complete homogeneity unthinkable

V j/V w

p ijq ij/p iw q iw

T yp e o f s tra te g y

F u rth e r su b d iv is io n s

C o n d itio n s fo r eco n o m ic p ro g ress

C o m m en ts /P ro b lem s

C rea tiv e d e -sp ec ia lsa tio n , in c reas in g v a rie ty

A lw a ys N o p ro b lem s if req u ired re so u rces , h u m an cap ita l an d N S I av a ilab le

V irtu o u s sp ec ia lisa tio n

P ij q ij , h igh -tech , u p -m ark e t g o o d s

In c re as in g v a lu e an d e ffic ien c y n eed to m o re th an co m p en sa te fo r fa ll in v a rie ty

C an it b e m a in ta in ed in d e fin ite ly?

P ij q ij , e ffic ien c y ,sca le eco n o m ies

V ic io u s d e -sp ec ia lisa tio n

P ij q ij , h igh -tech , u p - m ark e t g o o d s

In c re as in g v a rie ty n eed s to m o re th an co m p en sa te fo r fa ll in v a lu e an d e ffic ien c y

P ro b lem s w ith A ccu m u la tio n o f h u m an cap ita l

P ij q ij , e ffic ien c y ,sca le eco n o m ies

Catch-up strategies

Variety based interpretation of past policies

Two extreme choices: a) only natural resource based sectors; b) add manufacturing (ISI)

a) leads to relative decline in national variety, b) can lead to increasing or constant share of world variety

Empirical studies

Test: calculate output variety/diversity in the course of time for different countries and compare with GDP Growth, labour productivity growth, etc.

But comparable and disaggregated output statistics generally not available

Netherlands study (Frenken et al, 2007): output variety of regions determinant of labour productivity growth & of output growth

Variety and the entropy function

Entropy can measure variety because the greater the number of distinguishable entities there are in the system, the greater the amount of information required to describe it.

Decomposable nature of entropy: variety at several digit levels can enter a regression analysis without necessarily causing collinearity.

Related vs unrelated variety.

Related variety (RV): measured at a lower level of aggregation where any two sectors are likely to show greater similarity (intra-group variety)

Unrelated variety(UV): measured at a higher level of aggregation where two sectors are very different (inter-group variety)

Given the properties of the informational entropy function RV and UV can be combined in the same econometric equation

Variety growth and trade

Netherlands, only related variety is a determinant of employment growth in the regions of the Netherlands in the period considered

Meaning: in order to grow you have to diversify your economy but remaining in the vicinity of your previous production structure

Variety growth & trade (2)

OECD countries (1963-2003): related export variety( 3 digits) short run determinant of economic growth, unrelated variety(1 digit) and semi related variety(2 digits) not short run determinant of economic growth

unrelated variety(1 digit) long run determinant of economic growth

Real GDP growth rate vs Export variety, UN data data 1961-1999

-1 -2 -3 -4 -5Real GDP (log) -0.046*** -0.056*** -0.057*** -0.057*** -0.049*** -0.045***

[0.004] [0.005] [0.005] [0.005] [0.015] [0.005]Overall variety (logs) 0.008***

[0.002]Unrelated variety (logs) -0.019* -0.019** -0.032*** -0.025

[0.010] [0.010] [0.010] [0.016]Related variety (logs) 0.023*** 0.019** 0.028*** 0.036***

[0.008] [0.008] [0.008] [0.014]Openness 0.032*** 0.031*** 0.004

[0.004] [0.004] [0.008]Real GDP per worker -0.008 0.055***

[0.015] [0.017]Population (logs) -0.007 0.007

[0.016] [0.134]Constant 0.854*** 1.062*** 1.087*** 0.933*** 0.931*** 0.838***

[0.080] [0.094] [0.095] [0.096] [0.123] [0.086]Observations 4113 4113 4113 4113 3946 3815Number of Country 134 134 134 134 131 130R-squared 0.07 0.07 0.08 0.09 0.09 0.08

(5’ FDb)

Real GDP per capita growth rate vs Export variety, UN data data 1961-1999Real GDP per capita (log)-0.034*** -0.045*** -0.045*** -0.045*** -0.036** -0.035***

[0.004] [0.005] [0.005] [0.005] [0.015] [0.004]Overall variety (logs) 0.009***

[0.002]Unrelated variety (logs) -0.013 -0.013 -0.034*** -0.021

[0.010] [0.010] [0.010] [0.016]Related variety (logs) 0.018** 0.015* 0.031*** 0.033**

[0.008] [0.008] [0.008] [0.014]Openness 0.031*** 0.031*** 0.003

[0.004] [0.004] [0.007]Real GDP per worker -0.018 0.050***

[0.015] [0.016]Population (logs) -0.052*** -0.403***

[0.010] [0.133]Constant 0.304*** 0.436*** 0.447*** 0.298*** 0.871*** 0.305***

[0.035] [0.047] [0.048] [0.053] [0.122] [0.038]Observations 4113 4113 4113 4113 3946 3815Number of Country 134 134 134 134 131 130R-squared 0.06 0.06 0.07 0.08 0.08 0.07

Related vs unrelated variety, Short vs Long run

Real GDP (log) -0.088*** -0.087***[0.019] [0.019]

Openness 0.033*** 0.034***[0.005] [0.005]

Constant 1.295*** 1.286***[0.162] [0.162]

Unrel. VarietyRelated Variety Unrel. VarietyRelated Varietyt - 0 -0.053*** 0.066*** -0.055*** 0.063***

[0.020] [0.017] [0.019] [0.017]t – 1 0.016 -0.025 -0.039*** 0.032***

[0.024] [0.021] [0.009] [0.008]t – 2 0.019 -0.035* -0.017** 0.008

[0.024] [0.021] [0.007] [0.006]t – 3 -0.041* 0.040* 0.004 -0.008*

[0.024] [0.021] [0.006] [0.005]t – 4 0.039 -0.027 0.018** -0.015**

[0.024] [0.021] [0.008] [0.006]t – 5 0.000 -0.002 0.021** -0.013

[0.024] [0.020] [0.009] [0.008]t – 6 0.038 -0.027 0.006 0.000

[0.023] [0.020] [0.007] [0.006]t – 7 -0.050*** 0.041** -0.033** 0.025*

[0.019] [0.016] [0.015] [0.013]Long run elasticities -0.031* 0.029** -0.095*** 0.092***

[0.016] [0.013] [0.025] [0.023]Observations 3,17 3,17Adjusted R² 0.053 0.051

Unrestricted Model(31)

Restricted PDL(32)

Related vs unrelated variety, Short vs Long run (2)

-.05

0.0

5

0 2 4 6 8

Unrelated Variety Related Variety

Variety, Proximity-1 -2 -3 -4 -5

gdp_gr gdp_gr gdp_gr gdp_gr gdp_gr

lngdp -0.050*** -0.049*** -0.051*** -0.050*** -0.050***[0.015] [0.015] [0.015] [0.015] [0.015]

lnopenc 0.031*** 0.032*** 0.031*** 0.032*** 0.030***[0.004] [0.004] [0.004] [0.004] [0.004]

lnrgdpwok -0,01 -0,01 -0,01 -0,01 -0,01[0.015] [0.015] [0.015] [0.015] [0.015]

lnpop -0,01 0 0,01 0 0[0.016] [0.016] [0.016] [0.016] [0.016]

lunrelvar -0.030*** -0.030***[0.010] [0.011]

lrelvar 0.028*** 0.027***[0.008] [0.009]

rel_p 0.004** 0.005*** 0.005*** 0.004**[0.002] [0.002] [0.002] [0.002]

proximity 0.091**[0.041]

proximity_1dc 0.022** 0.023***[0.009] [0.009]

Constant 0.940*** 0.805*** 0.772*** 0.777*** 0.868***[0.123] [0.115] [0.116] [0.116] [0.125]

Observations 3945 3945 3945 3945 3945

Number of group(countryisocode) 131 131 131 131 131

R-squared 0,09 0,09 0,09 0,09 0,09Standard errors in brackets* significant at 10%; ** significant at 5%; *** significant at 1%

Results

Related export variety determinant of the growth of GDP and of GDP per head in the short run

Unrelated export variety determinant of the growth of GDP and of GDP per head in the long(er) run

Confirmation of previous study of OECD countries (Saviotti, Frenken, JEE 2008)

Interpretation

Countries need to diversify their exports to keep growing, but in the short run they need to do it in the vicinity (similarity), in knowledge and product space, of their previous outputs.(See also Hidalgo et al 2007)

But, diminishing returns to related variety and need to start preparing more radically different types of exports to keep growing in the long(er) run

Trajectories and interpretations

In general we can say that related export variety is a determinant of economic growth

However, within this general trend there can be many interpretations or deviations

The strategies of individual countries are not identical (see previous strategies for catching up)

Export variety of Latin American countries

0.0

5.1

.15

1960 1970 1980 1990 2000

M EX

0.0

2.0

4.0

6

1960 1970 1980 1990 2000

A RG

0.0

2.0

4.0

6.0

8

1960 1970 1980 1990 2000

B RA

0.0

05

.01

.01

5.0

2.0

25

1960 1970 1980 1990 2000

CHL

O ve rall V ar.(red d ash ) - U nr. V a r. (solid b lu e) - R el. V ar. (g ree n lo ng d ash )

The Dynamics of Export Variety (Latin American Countries)

Export variety of Asian countries0

.05

.1.1

5

1960 1970 1980 1990 2000

TW N

0.0

2.0

4.0

6.0

8.1

1960 1970 1980 1990 2000

S GP

0.0

5.1

.15

1960 1970 1980 1990 2000

K OR

0.1

.2.3

1960 1970 1980 1990 2000

CHN

O ve rall V ar.(red d ash ) - U nr. V a r. (solid b lu e) - R el. V ar. (g ree n lo ng d ash )

The Dynamics of Export Variety (Asian Countries)

Export variety of small or expanding countries

0.0

2.0

4.0

6.0

8

1960 1970 1980 1990 2000

IRL

0.0

5.1

.15

1960 1970 1980 1990 2000

E SP

0.0

2.0

4.0

6.0

8

1960 1970 1980 1990 2000

DNK

.05

.1.1

5.2

.25

1960 1970 1980 1990 2000

NLD

O ve rall V ar.(red d ash ) - U nr. V a r. (solid b lu e) - R el. V ar. (g ree n lo ng d ash )

The Dynamics of Export Variety (Small or Expanding Countries)

Export variety of developed market economies

.2.4

.6.8

1960 1970 1980 1990 2000

US A

.1.2

.3.4

.5

1960 1970 1980 1990 2000

GB R

.05

.1.1

5.2

.25

.3

1960 1970 1980 1990 2000

ITA

.1.1

5.2

.25

.3.3

5

1960 1970 1980 1990 2000

FRA

O ve rall V ar.(red d ash ) - U nr. V a r. (solid b lu e) - R el. V ar. (g ree n lo ng d ash )

The D ynamics of Export Variety (D eveloped Market Economies)

Development periods

VARIABLES WHOLE SAMPLE WHOLE SAMPLEWHOLE SAMPLE 62-80 81-99 low GDP per capita middle GDP per capitahigh GDP per capita

-0.0502 -0.0493 -0.0500 0.0225 -0.128 -0.0841 -0.0687 -0.00659[0.0153]*** [0.0151]*** [0.0153]*** [0.0432] [0.0274]*** [0.0356]** [0.0296]** [0.0234]0.0310 0.0330 0.0310 0.0431 0.0232 0.0235 0.0400 0.0310[0.00432]*** [0.00415]*** [0.00432]*** [0.00762]*** [0.00683]***[0.00812]*** [0.00823]*** [0.00782]***-0.00710 -0.00339 -0.00766 -0.147 -8.24e-05 0.0151 -0.0145 -0.0621[0.0151] [0.0151] [0.0151] [0.0445]*** [0.0247] [0.0339] [0.0289] [0.0222]***-0.00613 -0.00278 -0.00482 -0.0249 -0.00926 -0.0780 0.0188 -0.0482[0.0158] [0.0156] [0.0158] [0.0414] [0.0375] [0.0586] [0.0354] [0.0266]*-0.0300 -0.0337 0.00269 -0.0629 -0.0332 0.0279 -0.0323[0.0102]*** [0.0104]*** [0.0203] [0.0180]*** [0.0206] [0.0203] [0.0160]**0.0276 0.0301 0.00289 0.0543 0.0282 -0.0179 0.0313[0.00837]*** [0.00846]*** [0.0173] [0.0142]*** [0.0174] [0.0161] [0.0121]***

proximity_1dc 0.0141 0.0173 0.0292 0.0179 0.0308 0.0152 0.0205[0.00834]* [0.00850]** [0.0144]** [0.0147] [0.0174]* [0.0170] [0.0122]*

Constant 0.940 0.819 0.919 01/01/53 01/02/71 01/01/97 01/01/71 01/01/18[0.123]*** [0.115]*** [0.123]*** [0.293]*** [0.293]*** [0.467]*** [0.295]*** [0.184]***

Observations 3945 3945 3945 1945 2000 1347 1292 1306R-squared 0.088 0.085 0.089 0.115 0.094 0.085 0.122 0.208

131 131 131 106 131 55 73 58*** p<0.01, ** p<0.05, * p<0.1Standard errors in brackets

lngdp

lnopenc

lnrgdpwok

lnpop

lunrelvar

lrelvar

Number of cid

Role of export variety

In general we can say that related export variety is a short run determinant of economic growth (requires further testing)

Unrelated and semi-related export variety are not short run determinants of growth

Unrelated export variety long run determinant of economic growth

Diminishing returns - Emergence of new technologies

However, local or incremental modifications leading to an increase in related variety are likely to lead to diminishing returns. Creation of unrelated variety required for long run but

The period preceding economic returns for unrelated variety is a long term investment but without it economic growth would slow down or cease

Secular trends & National variations

Two long term, secular, trends (laws, forces, trajectories) in economic development (i) growing efficiency & (ii) growing diversity

However, within the general trend described above there can be many national (local) interpretations or deviations

The strategies of individual countries are not identical (see previous strategies for catching up)

Prevalence of related export variety (short run) path dependence (the near future of an economic system depends on what it has done in the recent past)

Long run change must be prepared

Secular trends & National variations(2)

Changing development mechanisms

In P1(1962-1980) related export variety is not a significant determinant of growth but it becomes a determinant in P2 (1981- 1989)

Related export variety is not a significant determinant of growth in the transition from low to middle income but it is in the transition from middle to high income

Mechanisms of economic development and of catching up changed from P1 to P2 & for different income ranges

Changing development mechanisms (2)

In P1 it was possible to catch up by simple imitation, in P2 the countries which caught up managed to construct their national innovation system

Different mechanisms required for the transitions low to middle and middle to high income per capita