Why export industries matter so much
High-value added export industries enable nations to move from perpetual poverty to sustained progress.
The following is an excerpt from my book From Poverty to Progress: Understanding Humanity’s Greatest Achievement. You can purchase discounted copies of my book at my website, or pay full prize at Amazon.
In previous articles, I made the case that we can best understand the nature of human material progress using the concept of the Five Keys to Progress. The Five Keys to Progress are critical because they are the necessary preconditions for a society changing from a state of poverty to a state of progress, and they are actionable in today’s world. In other words, the concept not only helps to understand the world but also how to make it better.
In previous excerpts, I explained:
Key #1: A highly efficient food production and distribution system. This enables societies to overcome geographical constraints on food production so that large numbers of people can focus on solving problems other than getting enough food to eat
Key #2: Trade-based cities packed with a large number of free citizens possessing a wide variety of skills. These people innovate new technologies, skills and social organizations and copy the innovations made by others.
Key #3: Decentralized political, economic, religious and ideological power. It is of particular importance that elites are forced into transparent, non-violent competition that undermines their ability to forcibly extract wealth from the masses. This also allows citizens to freely choose among institutions based upon what they have to offer to each individual and society in general.
In this excerpt, I would like to explain the fourth Key to Progress:
Key #4: At least one high-value-added industry that exports to the rest of the world. This injects wealth into the city or region, accelerates economic growth and creates markets for smaller local industries and services.
Regardless of how productive agriculture or innovative cities are, for progress to take place, a society must have at least one high-value-added industry that exports to the rest of the world. These industries inject wealth into the region and accelerate economic growth. This wealth can then be spent locally by its employees, generating demand for a gaggle of smaller local businesses. They also create a revenue stream for governments to invest in education, health, transportation, sanitation and energy infrastructure.
By exporting to the rest of the world, the industry radically increases the potential demand for their goods. If a farm or city is restricted to customers within their own borders, its economy has far less potential for growth. And the more value that the industry generates, the higher the potential profits. That is why high-value-added industries that are competitive enough to export to the rest of the world are so critical to promoting progress within a region.
The nature of the industry that is needed varies greatly over time. In the distant past, a mineral or crop might be sufficient. More typically today, it requires some form of manufacturing. Textiles, steel, and consumer electronics are all industries that played critical roles in various nations during their initial industrialization
.To successfully export, a city needs the necessary technology, skills, organizations and capital. These factors are typically acquired by copying them from richer regions that already have them, modifying them for the local environment and then slowly learning by doing. Often skilled immigrants from richer nations play a critical training role in the learning of new skills.
The emerging discipline of Economic Complexity gives us the best understanding of how this works. For more, you can read my quick “cheat sheet” on the theory. Cesar Hidalgo and Ricardo Hausmann have played pioneering roles in this field. The best introduction to their views is in the book The Atlas of Economic Complexity: Mapping Paths to Prosperity.
Hidalgo and Hausmann argue that modern societies acquire productive knowledge by distributing that knowledge among many specialized workers. Organizations and markets then combine that knowledge to make useful products. Skills needed for industries can only be taught face-to-face making knowledge transfer very difficult. If an industry is missing only one key skill, it cannot be competitive.
This places poorer nations in a “Catch-22” situation. They cannot create high-value-added industries until they acquire the necessary skills, but they cannot acquire the necessary skills until they already have a functioning industry. This creates a fundamental gap that developing nations have difficulty bridging. On the face of it, this appears to make economic growth impossible. Fortunately, we know from history that economic growth is possible.
The theory of economic complexity gives us the key intellectual breakthrough that industries are related to each other because they share common skills. For example, manufacturing shoes is closely related to manufacturing hats because they share common production skills. Those same industries are far less related to manufacturing tractors or pharmaceuticals because those industries require very different skills.
And skills are not the only factor. Related industries also require similar technologies and organizational needs. This makes it theoretically possible for poor nations to leverage the limited knowledge that they have from current sectors of the economy to other related sectors that offer higher value.
Hidalgo and Hausmann use the analogy of a monkey traveling through a forest in search of food. The monkey is on one side of the forest with few bananas (limited export options) and wants to get to the other side of the forest with many bananas (a number of profitable high-value-added export industries). The monkey can only travel one branch at-a-time.
So what does the monkey do? He gradually moves to the nearest branch with more bananas than the one he is currently on. He then uses the energy gained from the bananas (i.e. the technologies, skills, organizations and capital) to go to the next branch. It is a long, slow process, but eventually, the monkey reaches the part of the forest with many bananas. This assumes, of course, that there are branches that are close to each other along the way. Hidalgo and Hausmann’s breakthrough is that they show through sophisticated statistical techniques that there is a pathway of branches from one side of the forest to the other.
This viewpoint gives us a clear understanding of how economies developed both in the past and the present. Commercial societies in northern Italy, Flanders, Netherlands and England pioneered the innovations that created high-value-added industries. This was a long, slow process because they had no one to copy at first. There was a huge amount of learning by doing, with many mistakes along the way. As long as four of the Five Keys to Progress created the necessary preconditions for progress, they could keep experimenting and innovating for centuries
.Eventually, this led to the critical breakthrough of the Industrial Revolution in Britain. This largely involved the application of fossil fuels to the critical transportation, communication, agricultural and materials sectors. Industrial technologies overcame some, but not all, of the geographical constraints on progress.
Today developing nations face a different problem. All of the necessary technologies, skills and organizations have already been invented, so they only need to copy them rather than creating them from scratch. But because skills typically require a face-to-face transfer, it is hard for people in developing nations to learn everything they need to know. Worse, they face highly competitive industries in the richer nations that are vastly more productive. The one important advantage that developing nations have is cheaper labor.
The logic of this viewpoint leads to a clear economic learning strategy for developing nations:
Identify all your existing domestic industries.
Identify other industries that are both closely related to those industries and which have equal or higher added value.
Leverage the necessary technologies, skills, organizations and capital from existing industries to learn the new skills in the new industry and use the advantage of cheaper labor to outcompete richer nations. This will often involve selling an existing product at a cheaper price than richer nations can produce it for. It also involves focusing on the low end of the market where price is more important than quality while leaving richer nations to focus on the high end of the market.
Keep repeating the process for decades.
It is a nice theory, but does it work? Hidalgo, Hausmann and others give compelling evidence that economic complexity is a useful concept, but it is not yet clear whether it can be put into practice.
By statistical analysis, they show that complexity explains 73% of the variation in income across 128 countries. They also show that the difference between national income and level of complexity is the single best predictor of future economic growth. In other words, poor countries that have established a beachhead in higher-value-added products experience much higher growth rates in the immediate future than those who do not.
What economic complexity theorists have not proven is that poor and developing nations can use their theory to bootstrap their way up the value-added ladder. I know of no nation that has intentionally implemented strategies derived from the theory of economic complexity and then shown clear results in the form of higher economic growth. This is probably because the theory of economic complexity is new and relatively unknown to developing nations.
Nor have economic complexity theorists shown that rich nations actually followed something close to their recommendations in the past. Of course, these nations could not possibly have been acquainted with modern economic theories, but the logic in their time would have been equally applicable. From my readings of economic history, I believe that Europe, the United States, Japan and other newly industrialized nations in Asia have functioned exactly as the theory predicts, but it is hard to present quantitative proof without good data.
We need economic complexity datasets to reach further back in history. Currently, there is little data before 1970. Adding more data might allow us to prove that cities and nations have gradually ratcheted their way up from low-value-added industries to related industries of higher value. They have done so by a blend of learning new skills, copying earlier innovations and local experimentation. Those nations then repeated the process in another related industry. Once one understands the logic of economic complexity, it is difficult to see how they could have grown any other way.
In the meantime, I believe that developing nations (and rich nations to a lesser extent) would be wise to tailor their national economic policies to the theory of economic complexity. It seems much more useful than the vast majority of the advice that other Western experts are currently giving them.
The above is an excerpt from my book From Poverty to Progress: Understanding Humanity’s Greatest Achievement. You can purchase discounted copies of my book at my website, or pay full prize at Amazon.
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This seems to have addressed the few reservations I had about this export factor or element - is it necessary for progress, or merely sufficient? So you need a "break out" component that in turn grows other components, building on each other.
But I do wonder if the critical part is so much a given physical resource as human capital innovation and the entrepreneurship you mention. I am thinking somewhat of Japan, S Korea, and Singapore - or do I not understand their respective growth situations that well?
I perceive that Keynesians look to money capital to create the demand for an economy to grow or to recover from a downturn, making it the "fuel" of the economy. But I consider that money is really only the lubrication of the economy (you need enough to meet the demands for money as an economy grows) but the real fuel is that innovation and entrepreneurship element.
With that in mind I have wondered if an immigration program that gives workers a 6 year visa to come to the US to learn a trade or skill or obtain an education, but then requires them to return home to add those skills to their domestic economy, would be at least part of a beneficial "boot strapping" assist. They might end up competing with us more directly later on, but that is still all to the good in the bigger picture. In the context of this essay's progress factor, the element exported is brain power, which is then reimported at a higher value level. Not the total answer for a country to enter the progress chain, but maybe an assist to it?
Could causality be reversed? Could it be that a high-value export industry is not the cause of additional wealth, so much as a consequence of openness? Perhaps strong local production and exports is an indicator of domestic openness, a willingness to trade, and willingness to import ideas.