The Structuralist Revenge:

economic complexity as an important dimension to evaluate growth and development

Igor Rocha1

Paulo Gala2

Guilherme Magacho3

Abstract:

This paper brings elements from the economic complexity literature to the discussions of the structuralist tradition on the central role of manufacturing and productive sophistication to economic growth. The data provided by the Atlas of Economic Complexity strengthened assertions made by structuralist theorists. Using these data, this study sought to verify if countries’ complexity is important to explain convergence and divergence among poor and rich countries and, if so, which are the countries that will be able to reduce the income gap compared to developed countries and which are the ones that will probably remain poor. The econometric analysis revealed that exports complexity is significant to explain convergence and divergence among countries. In short, the higher the complexity of developing countries export basket, the higher is the probability of income convergence

Resumo:

Este trabalho traz elementos da literatura de complexidade econômica para as discussões da tradição estruturalista em economia sobre o papel central da manufatura e da sofisticação produtiva no crescimento econômico. Os dados fornecidos pelo Atlas da Complexidade Econômica reforçam os argumentos dos teóricos estruturalistas. Usando essa base de dados, o presente estudo procurou verificar se a complexidade dos países é importante para explicar convergência e divergência entre países pobres e ricos e, em caso afirmativo, quais são os países que serão capazes de reduzir a diferença de renda em relação aos países desenvolvidos e quais permaneceram pobre. A análise econométrica revelou que complexidade das exportações é significativa na explicação de convergência e divergência entre os países. Essencialmente, quanto maior a complexidade da pauta de exportação de países em desenvolvimento, maior é a probabilidade de convergência de renda.

Palavras chave: complexidade, desenvolvimento econômico, comércio internacional, Cepal, estruturalismo

Keywords: complexity, core-periphery, economic development, international trade, ECLA, structuralism

Jel Code: B2, B5, B23, O1, O14

1 Ph.D at University of Cambridge, UK. Research Associate at the Centre for New Developmentism (CND/FGV), Brazil. Contact: igorlr3@yahoo.com.br. 2 Professor at the São Paulo School of Economics, Getúlio Vargas Foundation (EESP/FGV), Brazil. Contact: paulo.gala@fgv.br.3 Ph.D at University of Cambridge, UK. Research Associate at the Centre for New Developmentism (CND/FGV), Brazil, and Professor at FACAMP, Brazil. Contact: guilherme.magacho@gmail.com.

1. Introduction

In economics structuralism is principally associated with the so-called Anglo-Saxon or Early Structuralism and the Latin American strand. Both strands base their analyses on the concept of complementarities and poverty traps, linkages, and dualism (Ancochea, 2007). The structuralist view usually stresses that economic development is strongly linked to a radical transformation in the structure of production to suppress obstacles, bottlenecks and other rigidities of underdevelopment. Based on the hypothesis that the industrial structure affects both the rhythm and the direction of economic development, the structuralist literature highlights the importance of industrialisation as a process of structural change necessary to economic development. Structuralists state that without industrialisation, it is not feasible for a country to increase employment, productivity and income per capita and, consequently, to reduce poverty. The main argument stresses that the development process involves a production reallocation from low productivity to high productivity sectors where increasing returns to scale prevail. In this theoretical background, economic structuralism has provided many reflections on how economic growth should be understood in a historical perspective of mutual causation in the economic system. While various historical, political and ideological factors contributed to the structuralist view, Keynesian criticism of the neoclassical economics and its argument regarding state interventionism was very important.

Paul Rosenstein-Rodan, Ragnar Nurkse, Arthur Lewis, Albert Hirschman, Gunnar Myrdal and Hollis Chenery are economic thinkers associated with early structuralism or pioneers of development4. Their seminal contributions challenged the neoclassical view of market efficiency to promote structural change and recognised particularities through which the manufacturing industry plays a central role to support and propel economic development. A further theoretical contribution comes from Latin American structuralism, which is mainly related to the Economic Commission for Latin America and the Caribbean (ECLAC), whose works merged into a coherent school of thought in late 1950s. In light of historical experiences, the main thoughts presented in this Latin American version are encapsulated in the works of Raul Prebisch and Celso Furtado, focused on the specific challenges faced by developing countries in a world economy divided in two poles, the “centre” and the “periphery”, and their distinctive productive structures (Prebisch, 1949; Furtado, 1964). Problems relating to dualism in international trade, technology disparities, balance of payments constraints and state interventionism were all emphasised.

Broadly speaking, these authors emphasised that productive sectors are different in terms of their potential to generate growth and development. Manufacturing sectors, with high increasing returns, high incidence of technological change and innovations and high synergies and linkages arising from labour division strongly induce Economic Development (Reinert, 2009, p.9). These are activities where imperfect competition rules, with all its typical features (learning curves, fast technical progress, high R&D spending, economies of scale and scope, high industrial concentration, entry barriers, product differentiation, etc.). This group of high value-added sectors are usually opposed to low value-added sectors typical of poor and middle income countries and its perfect competition market structure (Low R&D content, low technological innovation, perfect information, absence of learning curves, etc.) (Reinert and Katel, 2010, p.7)Therefore, in a structuralist perspective it is also possible to point out the economic policy recommendations for productivity increase from climbing the technological ladder, i.e., moving from low-quality activities to high-quality activities, through technological sophistication of the economy (Bresser-Pereira 2016). In order to achieve this goal, the construction of a complex and diverse industrial system, subject to increasing returns to scale, synergies and linkages between activities is fundamental (Reinert, 2010, p.3). The specialisation in agriculture and mining does not allow this type of technological change.

4 See for instance, Blankenburg, Palma & Tregenna (2008) and Ancochea (2007).1

How could one empirically measure these propositions from classical development economists? Ideally one could study the market structures (perfect versus imperfect competition) of products as revealed in world trade data. From the classification of these structures, one could correlate the product and market structures found with levels of per capita incomes. If the propositions of the classics of development are correct, we should find countries with high per capita income specializing in imperfect competition markets and poor countries specializing in perfectly competitive markets in tradable goods production; something, in fact, easy to see with a quick superficial analysis of current trade patterns, but difficult to “prove” in a more robust way. Despite all the evidence from economic history of several successful stories that followed the recommendations of the classics (Southeast Asia, Japan, etc.) and also of failures, such as Latin America and the Caribbean, one could argue that “hard science type” empirical evidence is still lacking to help reinforce the point of the structuralists. That´s where the Atlas of Economic Complexity developed by Hausmann & Hildalgo (2011) fits in: as an empirical breakthrough, able to give support to the propositions of the classical economists who saw productive sophistication as the way for economic development.

This study is organised as follows. Section 2 recovers the main insights from the structuralist tradition, in both its Anglo-Saxon and Latin American strand. Section 3 links the structuralist approach to the complexity methodology developed by Hausmann & Hildalgo (2011) and seeks to understand through econometric analysis if countries’ complexity is important to explain convergence and divergence among poor and rich countries; and, if so, which are those countries that will be probably able to reduce their income gap as compared to developed countries in the future and which are those that will probably remain poor. Section 4 concludes the paper.

2. The early structuralist approach to manufacturing: first insights

In economic theory, many studies associate the emergence of the Early structuralism with the publication of Rosenstein-Rodan’s “Problems of Industrialization of Eastern and South-Eastern Europe”5. In this study, Paul Rosenstein-Rodan assigned particular emphasis to the transformative power of industrialisation in the economic system (Rosenstein-Rodan, 1943). In a similar line of thinking, Nurkse (1953), Lewis (1954), Hirschman (1958), Myrdal (1957) and Chenery (1960, 1979) pointed out that the study of long-term economic growth is a “sector- specific” process and consequently involves an increase of the industry share, which, in turn, provides the highest potential of productivity, spillover effects, forward and backward linkages, as well as technological and pecuniary externalities. Hence, their focuses were essentially on the internal special properties of manufacturing and on the way in which these properties spread to the economy as a whole, stimulating the process of economic growth. Although not always emphasised by the literature, the essence of these classical contributions relied especially on Allyn Young’s ideas concerning long-term determinants of economic growth which were further extended in their seminal studies. These pioneers of economic development also focused on the identification of bottlenecks and rigidities that block the industrialisation process in underdeveloped economies. However, in spite of general agreement amongst these pioneering economists that industrialisation was the most efficient means to support economic development, the emphasis on growth economics through industrialisation engendered a debate over whether “balanced” or “unbalanced” growth was the best strategy to propel economic development through the special properties of manufacturing.

5 Rosenstein-Rodan (1943).2

2.1 Industrialisation: balanced and unbalanced growth theories

The Early Structuralist approach to manufacturing is particularly associated with Rosenstein-Rodan’s path-breaking research in economic development, which stresses the conditions for economic growth in line with Nurkse (1953). Paul Rosenstein-Rodan and Ragnar Nurkse supported the balanced growth theory based on “classical” arguments concerning long-run determinants of the economic growth, particularly dynamic externalities and increasing returns, as advanced by Allyn Young. This type of argument gave rise not only to the role of demand complementarities and increasing returns (to scale) in manufacturing industries, but also various arguments that justify industrial policy, especially of selective type, on the basis of the existence of interdependence between different activities (Chang et al., 2013). Rosenstein-Rodan (1943) states that a remarkable feature of high-income economies, i.e. developed countries, is a structured and dynamic industrial sector. Unlike developed economies, underdeveloped countries were characterised by the absence of a structured and dynamic industrial sector. As a matter of fact, since industrialisation tends to be concentrated in developed countries, massive and planned investments coordinated by the state are sine qua non conditions for the creation of a new institutional environment and, consequently, the successful carrying out of industrialisation in underdeveloped countries. In this way, Rosenstein-Rodan (1943) describes what later became known as the “big push theory”, i.e. a large-scale development programme geared towards jump-starting the economic growth through the industrialisation process of an underdeveloped economy. Rosenstein-Rodan states that free market mechanisms would only keep or even increase the distributive inequality between countries, showing the growing gap between developed and underdeveloped nations. In his own words “the market mechanism does not realize the ‘optimum’ either in one nation or between nations because it relies on such unrealistic assumptions” and “obscures the nature of the development process” (Rosenstein-Rodan, 1984, p. 209).

Regarding planning, the author highlights two crucial points. The first is related to labour training policies coordinated by the state to transform peasants into industrial workers. This assertion is based on the observation that the automatism of laissez-faire never worked properly in this field. In other words, from the perspective of an individual firm, investing in training labour is very risky since if workers move to another firm a considerable loss of capital may occur. Although not a good investment for a private firm, it is the best investment for the economy as a whole (Rosenstein-Rodan, 1943). The second and most important argument in favour of such large investments refers to the complementary influence between different industries that potentiates the dynamic effects of external economies and balances the process of economic growth. The expansion of the market through the creation of a planned complementary system of industries reduces the risk of demand shortage and, since risk can be considered as cost, it reduces costs and provides the most important set of arguments in favour of a large-scale industrialisation6. In such a way, a big, comprehensive and balanced investment package in manufacturing sectors performed by the state, i.e. “the big push” – using Rosenstein-Rodan’s terminology – is the key to the economic development process through positive linkages effects in the productive chain that enhances the dynamic effects of external economies. From this perspective, industrialisation has a central role in economic development not only because of the terms of trade differential, as noted by Prebisch, but also due to technological and pecuniary external economies which are the main source of increasing returns to scale – a central aspect in the development process – and in turn, are much higher in manufacturing industry than in agriculture7.

6 As argued by Rosenstein-Rodan (1943) in his shoe factory example, the diversity of human wants creates a necessity for a planned effort to generate a sufficient and sustained expansion of the market. 7 Although Rosenstein-Rodan (1943) clearly approaches the discussion of technological externalities, the discussion of pecuniary externalities discussion is less so. However, Rosenstein-Rodan (1961, 1984) explain it taking into consideration their horizontal and vertical dimensions on both demand and supply sides. According to Rosenstein-Rodan, any expansion of the market through the process of industrialisation leads to external economies, both pecuniary and technological. Pecuniary externalities are market-transmitted or inter-industry interdependencies. Horizontal pecuniary external economies occur between firms producing consumer

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In a similar approach, Nurkse stressed that economic growth is “not a spontaneous and automatic affair 8”. With this assertion in mind, Nurkse (1953) describes the forces that limit the development process in underdeveloped countries. The so-called “vicious circle of poverty” is illustrated as “a circular constellation of forces tending to act and react upon one another in such a way as to keep a poor country in a state of poverty” (ibid, p.4). This dynamic, translated in a low level of investment and capital accumulation, operates both on the supply and demand side. In this way, from the supply side a low level of investment arises from the small amount of savings available in the economy as a result of its low income level which, in turn, is a consequence of a low level of productivity. Moreover, low productivity is a direct result of small amounts of capital used in the production process and is related to the low domestic savings presented in the country. From the demand side, similar to Rosenstein-Rodan, the greatest obstacle to development was the atrophy of the domestic market through low demand for goods due to low income level in the economy which, in turn, discourages the formation of capital. The low level of capital used in the production process is associated with a weak level of investments that implies a low level of productivity existing in the country. When the productivity per worker is low, the real income is consequently low and the poverty vicious circle is complete. Additionally, it is important to emphasise that when analysing the underlying causes of the scarcity of capital, Nurkse (1953) did not treat it just as an issue of resource availability. The author recognises that underdevelopment was linked to the kind of product produced by a specific country and how it was traded in the international market. In order to break this circle, a wave of capital investment in various industries should be carried out. This would enlarge the market size, increase productivity and provide an incentive for the private sector to invest. As pointed out by Nurkse, the only way out of the dilemma is a “more or less synchronized application of capital to a wide range of different industries. Here is an escape from the deadlock; here the result is an over-all enlargement of the market (...) most industries catering for mass consumption are complementary in the sense that they provide a market for, and thus support, each other” (Nurkse, 1953, p. 11).

In contrast to Nurkse and Rosenstein-Rodan, Hirschman did not support the “balanced growth theory”, arguing that imbalances generated between sectors could provide corrective reactions, giving arguments in favour of a theory of “unbalanced growth”. According to Hirschman (1958), economic growth is essentially an unbalanced dynamic process, in which successive disequilibria produce the conditions for development in different sectors. In his “unbalanced growth” theory, the productive structure is linked through forward and backward linkages to downstream and upstream industries. These linkages represent physical relations of supply and demand among sectors of the economy. Thus, backward linkages are associated with the magnitude that each sector demands from other sectors of the economy, while forward linkages are associated with the extension that each sector is demanded by other sectors. In this dynamic, manufacturing industry is characterised by both strong backward and forward linkages, enabling this sector to generate higher economies of scale with positive effects in terms of productivity gains and cost savings in later stages of the production chain. From this perspective, as pointed by Toner (1999), Hirschman focused particularly on the intermediate and capital goods sectors while Rosenstein-Rodan and Nurkse focused essentially on productivity growth in the consumer goods sector.

Furthermore, while also concentrating on the role of bottlenecks, external economies and complementarities, Albert Hirschman qualifies the economic development “essentially as the record of how one thing leads to another” involving not only physical relations of supply and demand, but also technological linkages. This leads to the first insights on the concept of spillover effects, which stems from manufacturing to the rest of the economy and is approached by the contemporary economic developmental literature, e.g., the Kaldorian

goods, while vertical pecuniary external economies occur between suppliers and final goods producers. In terms of technological externalities, manufacturing is recognised as a source of effective knowledge (contemporaneously also termed as learning by doing). 8 Nurkse (1953, p.4).

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and Neo-Schumpeterian strands. Additionally, the author’s opposition to Nurkse’s and Rosenstein-Rodan’s strategies relies on the idea that too many financial resources and planning efforts would be necessary to stimulate the economy, concluding that “if a country was ready to apply the doctrine of balanced growth, then it would not be underdeveloped in the first place” (Hirschman, 1958, p. 53-54). In this sense, Hirschman’s strategy rested on the idea that economic policy should focus on specific industries, i.e. key sectors with a strong interdependence or linkages – both backward and forward – with other sectors of the economy9. The backward linkage refers to the potential of a sector to stimulate production and investment of sectors that provide its inputs, whilst forward linkage relates to the capacity of a sector to induce productive activities of sectors which demand its output. Therefore, key sectors, i.e. sectors with strong linkages would be capable of generating higher economies of scale with positive effects in terms of productivity gains and cost savings in later stages of the production chain. As a matter of fact, unbalanced growth theory asserts that certain sectors, particularly manufacturing industries, are the main engines of growth10.

Like Albert Hirschman, Myrdal (1957) centralised his theory on the understanding that economic development is intrinsically a process in disequilibria, breaking with the neoclassical statement of “stable equilibrium”11. Thus, Myrdal’s theory of unbalanced growth is centred on the concept of “cumulative causation” to analyse the problem of development inequality between nations. In this dynamic, trade and economic relations between developed and underdeveloped countries are discussed considering effects that arise from this interaction and may negatively (“backwash effect”) or positively (“spread effect”) impact the development of an underdeveloped economy. Furthermore, according to him, economic development also involves not only economic relationships of supply and demand but also institutional and political structures, denominated non-economic factors, which operating in a process of cumulative causation reveals challenges to be faced by underdeveloped countries12.

In Myrdal’s concept of “circular cumulative causation”, the main idea relies on the fact that free market forces would tend generally to increase regional disparities. The assertion made by Myrdal was important because, while international economic inequality grew and became a common concern in many schools of thought, the neoclassical theory of international trade insisted on the idea that there was a gradual equalisation tendency of factor prices and income across countries. Even focused on social aspects of this cumulative causation, Myrdal’s theory provided the fundamental framework for later complementary heterodox theories, such as the Latin American Structuralist approach – with a strong influence in Celso Furtado – and the Kaldorian theory which concentrated in the demand-supply relationships in the manufacturing sector. As a general link between all pioneers of economic development, although wrapped in a critical assessment of the level of state intervention in the economy, both approaches – “balanced growth theory” and “unbalanced growth theory” – directly or indirectly paid attention to the role of the industrialisation process as a way to overcome underdevelopment. In the context of Latin American development problems, it is important to highlight that ECLAC participated actively in these discussions providing important contributions notably from the works of Raúl Prebisch, Celso Furtado and Aníbal Pinto. From this background, the following section seeks to provide the main reflections on the obstacles encountered by underdeveloped countries in face of the absence of a dynamic industrial structure.

2.2 Latin American structuralism 9 Input-output models made possible measurements of linkages. In fact, during the 1960s and 1970s, different indicators of forward and backward linkages based on the Leontief inverse matrix were developed in order to fulfil the theoretical approach.10 According to Ancochea (2007), the selectivity of some sectors as proposed by unbalanced growth economists received different names, such as the “propulsive industry” (Perroux, 1955), “leading sector” (Rostow, 1952, 1978), or the “development block” (Dahmen, 1987). For instance, see (Hirschman, 1987).11 To Myrdal, neoclassical trade theories were “never developed to comprehend the reality of great and growing economic inequalities and of the dynamic processes of under-development and development” (Myrdal, 1957, p.51).12 See also Ho (2004).

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In modern economics, Latin American structuralism should be placed in a methodological tradition which has its origin in Raul Prebisch’s (1949) study “El desarrollo económico de la América Latina y algunos de sus principales problemas”. With Prebisch leading a group of outstanding economists, the Economic Commission for Latin America and the Caribbean (ECLAC) sparked remarkable insights and explanations regarding the causes of Latin American underdevelopment13. Latin American structuralist writers challenged the neoclassical theory through a critique of the prevailing international trade and proposed a theory of peripheral capitalism incorporating core elements presented in the French14 and Anglo-Saxon structuralist traditions, as well as in Keynesian thinking15 (Furtado, 1967; Love, 1995, 1996; Sunkel, 1989, Palma, 1987, Blankenburg, Palma & Tregenna, 2008).

Based on this theoretical background, the basic analytical components of ECLAC and other Latin American structuralists were grounded in historical methodology, the study of domestic determinants of economic growth and technological progress, as well as an evaluation of arguments in favour and against state intervention (Bielschowsky, 1998). In this sense, many prominent works followed ECLAC thinking and provided important insights, criticisms and complementarities for the understanding of the Latin American underdevelopment. Through a sharp critique of neoclassical economics and its idea that specialisation based on comparative advantages, whatever its nature, was a superior solution for economic growth, the Latin American Structuralist school gave life to an important interpretation where the productive structure matters to the pace and scope of the development process. Comparing commodity-producer economies and industrialised countries, Prebisch (1949) noted that productivity was essentially higher in the manufacturing sector than in primary activities. This dichotomy in levels of productivity between the productive structure of developed (centre) and underdeveloped (periphery) countries, the so-called structural heterogeneity, was also analysed by Furtado (1959, 1961) and Pinto16 (1965, 1970).

For Furtado (1961), the mainspring of capitalist development is technological progress through a process of incorporation and diffusion of new techniques with a consequent increase in production and productivity17. Therefore, underdevelopment is seen as a partial and blocked version of development, either because of the uneven spread of technical progress or the limited transmission of productivity gains to 13 The French structuralism represented by innovative contributions of François Perroux (1939) defined structural economics as a science which analyses the relations characteristic of an economic system situated in time and space. According to him, economic analysis should incorporate institutions and structures over time. See Blankenburg, Palma & Tregenna (2008).14 Perroux (1950) anticipated important elements of ECLAC’s theory, particularly with regards to the centre-periphery model, which was an extension of the concept of economic systems where “the economic world is conceptualised in terms of hidden or explicit relationships of ‘force’, ‘power’ and ‘constraints’ between dominant and dominated entities” (Blankenburg, Palma & Tregenna, 2008, p. 2). Perroux’s theory is based on different analytical levels, i.e., markets, firms and international economy and clarifies interactions between different entities with distinctive structures of power and the consequences in terms of trade and finance. According to Perroux growth does not appear everywhere and all at once; “it appears in points or growth poles with variable intensities; it spreads along diverse channels and has varying terminal effects for the whole of the economy” (Perroux, 1955, p 308). Thus, the intensity and magnitude of growth poles are determined by the fundamental role played by propulsive industries, which are in turn highly innovative and, according to Perroux, sources of technological progress. These industries constitute the pillar of economic development and generate positive effects (spread effects) in other regions, such as the increase in income and employment and at the same time produce structural change through economic growth. Moreover, through the development pole theory, Perroux also exerted a fundamental influence on the ECLAC’s division of the world between centre and periphery and Furtado’s early work including his doctoral dissertation at Sorbonne. See Furtado (1995).15 The Latin American structuralist school was also concerned, to a greater or lesser extent, with a coalition of the industrial bourgeoisie, the middle class and the urban working class, under the coordination of the developmental state to propel the economic development. According to the structuralist approach, it is the developmental state which is the main agent of change since it is the only institution capable of transcending sectional interests and thereby able to pursue the national interest (Kay, 1989). 16 Although the concept of structural heterogeneity was a central element in works of Raúl Prebisch or in Celso Furtado in the form of “dualism”, it was with Anibal Pinto that the concept of structural heterogeneity solidifies during the 1970s. See for instance Pinto (1970, 1971, 1976).

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wages. According to him, in developed countries, dynamic growth is headed by technical progress while in underdeveloped countries it is determined primarily by external demand for imports. While the centre countries internalised new technology by developing an industrial capital goods sector and by spreading the improved technology to all economic sectors, the periphery remained dependent on imported technology which in turn was mainly confined to the primary export sector. Consequently, a sizeable low-productivity pre-capitalist sector continued to survive in the periphery producing a continuous surplus of labour and consequently keeping wages low. Without the processes of industrialisation, the asymmetry between the centre and periphery would not only perpetuate but also deepen.

In relation to this dynamic, Pinto (1965) highlighted the persistence of structural heterogeneity. According to Pinto, developed countries had a much more homogeneous level of productivity than the periphery. The heterogeneity in underdeveloped countries – expressed in sectors where the productivity is high or “normal” with others where the productivity is lower or several times lower in the same economic structure – would generate problems of underemployment in face of the occupational mismatch. As the occupational structure is a mirror of the productive one, economies with high productivity tend to generate more employment while structures with very low productivity tend to generate underemployment (Rodriguez, 2006). Pinto (1970) identifies three levels of productivity in Latin America: i) the primary sector with low productivity and low earnings, keeping similarities with the prevailing forms of production since the colonial period; ii) the middle sector that is neither the upper end nor the lower end and thus is near to the average of the economy as a whole; and iii) the modern sector with high productivity levels and gains, which are similar to the average of developed economies. Given these different levels of productivity, the rate of technical progress incorporation and productivity increase would be significantly higher in central economies vis-à-vis peripheral economies, which in turn are specialised in primary products. In this way, a shift from less productive sectors to those with higher productivity – notably the manufacturing industry – would promote an increase in the aggregate productivity, a stimulus in the technological diffusion and an increase in real wages18.

While various writers contributed to the Latin American structuralist paradigm, Prebisch’s original ideas were pivotal in launching a critical perspective on the neoclassical approach to the mutual profitability of free trade between developed and developing countries, whose influence was very remarkable in Latin America. In his thinking, a key structural economic characteristic of peripheral economies refers to the deterioration in their terms of trade over time due to different income-elasticity of demand – also known as “dynamic disparity of demand”. Thus, contrary to what the comparative advantage theory suggested, prices of primary products produced and exported by peripheral countries, such as in Latin America, tended to present an

17 In a complementary approach, Tavares (1972, p. 50) highlights the problem to create technical progress endogenously and the consolidation of a diversified productive structure with increasing share of national content in domestic production.18 During the 1980s, Fernando Fajnzylber provided important contributions in relation to the underdevelopment theory emphasising the Latin American bottlenecks, especially regarding technical progress and productivity. Fajnzylber (1983) explained the low technological dynamism that characterised Latin American industrialisation through a convergence of structuralist thinking, the French regulation school and evolutionary economics. According to Fajnzylber, an economy which does not have an “endogenous nucleus of technological dynamism” cannot overcome underdevelopment. Moreover, since the sector of capital goods materially incorporates technological progress, policies to strengthen this sector should be carried out to establish an endogenous nucleus of technological dynamism and stimulate the diffusion of technology to other sectors as well as reverse the Latin American structural deficit in the current account. Without a strong developmental state to build this “endogenous nucleus of technological dynamism” as occurred in developed countries and in late industrialising countries (LICs) such as East Asia, including Japan, and in absence of an industrial vocation, i.e, business leadership capable of inducing transnational companies to build this “endogenous nucleus of technological dynamism”, underdevelopment would be maintained. According to Fajnzylber, in Latin America, the problem with transnational companies (TCs) was the establishment of productive structures based on technology transferred by headquarters which therefore did not contribute to the process of technological innovation. To clarify the understanding of how to overcome the inheritance of past mistakes, the author defends that Latin America should not only focus the macroeconomic stabilisation and debt reduction, but also push the technological frontier inducing TCs to adopt innovative domestic behaviour.

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antagonistic evolution when compared to prices of manufactured products exported by industrialised countries. This means that the centre’s imports of primary products from periphery rise at a lower rate than its national income, while the periphery’s imports of manufactured goods from the centre grow at a faster rate than its income. Since demand for manufactured goods increases more rapidly than the demand for primary goods, the well-known Engel’s law, there is a tendency to deteriorate the terms of trade of those economies specialised in the production and export of primary goods in comparison to central industrialised economies.

In other words, prices of manufactured goods would be structurally higher in relation to primary products. This meant that peripheral economies would have to export more to achieve the same value of industrial exports over time. In central economies adjustments along the global economic cycle are made through export quantities, due to the high level of industrialisation. On the other hand, in peripheral economies, adjustments occur through export prices due to the primary specialisation19. In contrast to the free trade doctrine, these movements would be gradually accentuated in the absence of a dynamic industry. Thus, overcoming underdevelopment would not be possible through the international division of labour, in which peripheral countries would be doomed to a specialisation in primary products. In this sense, industrialisation was seen as a way to modify this process. Thus, through a productivity increase, the deterioration of the terms of trade could be reduced, the technological progress incorporated and a process of income distribution promoted20.

The limits of spontaneous industrialisation in developing countries clearly revealed the need for an active state intervention in the industrialisation process. Although the state should have the capacity to promote particular sectors through the creation of public companies, it should especially focus on planning (Ancochea, 2007). For this purpose, many other Latin American “structuralists” sought to map different stages of the industrialisation process in a similar manner, often distinguishing between the so-called stages of industrialisation, i.e. internalising the production of consumer goods, consumer durables, intermediary inputs and capital goods. Therefore, it is not by chance that during 1950s and 1960s this argument gave rise to the support of import substitution industrialisation (ISI) model, principally in Latin America. ISI was a trade and economic policy programme based on the premise that a country should attempt to reduce its foreign dependency through the local production of manufacturing goods. For this purpose, the developmental state would coordinate the process of industrialisation from light to heavy industries through imports of intermediary and capital goods necessary to obtain a diversified and interdependent productive structure. In each stage of the industrialisation process, a gradual replacement of imported goods for domestic production would spread technological and productivity gains over the economy.

Broadly speaking, the idea expressed by the Latin American Structuralism was that, despite the spread of modernity, backwardness and wide differences in labour productivity between economic sectors and subsectors, and between regions and segments of the population, tended to be maintained and sometimes expanded (Bielschowsky, 2009). According to these authors developing countries could be characterised by a dual structure where a late agricultural sector and a sophisticated industrial sector would coexist. The manufacturing importance vis-à-vis a concentration in primary commodity exports was a central concern of the structuralist approach associated with ECLAC. In this way, industrialisation based on production sophistication is seen as the only way for developing countries to catch up. As a general trend, these aspects would be a central issue in the Latin American structuralist strand. The Kaldorian theory which concentrated

19 In a complementary way, see Prebisch (1950, 1959) and Singer (1950).20 These dynamics were also pointed out also by Furtado (1959). In this sense, Furtado’s works are closely connected to Prebisch’s, especially regarding endogenous dimensions of underdevelopment and its determinants. In general, the economic thinking of ECLAC and Celso Furtado addressed particularly the different stages of industrialisation in a similar manner, often distinguishing between the so-called phases of industrialisation.

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on the demand-supply relationships in the manufacturing sector complements this view giving further elements to explore the importance of the industrialisation process, more specifically the manufacturing sector.

3. Economic complexity, growth and development

Despite of many historical evidences regarding a vast range of successful development strategies based on the manufacturing sector as source of sustainable economic growth, there still remains a lack of robust empirical content to reinforce the structuralist approach. In this context the recent Atlas of Economic Complexity developed by Hausmann & Hildalgo et al. (2011) emerge as important empirical innovation, able to provide support to propositions of the structuralist view that states production sophistication as a central way to overcome underdevelopment. Hausmann & Hildalgo et al. (2011) used computational, network and complexity techniques to create a simple model for comparison of trade data across countries, able to measure a country’s productive sophistication or “economic complexity”. Starting from an analysis of a given country’s exports basket, they can indirectly measure its productive sophistication. The methodology devised to build the economic complexity indices using Big Data culminated in an atlas that collects extensive material on countless products and countries over 50 years starting in 1963.

The two basic concepts used to measure whether a country is economically complex are the ubiquity and diversity of the products in its exports basket. If a given economy is capable of producing non-ubiquitous, rare and complex goods, this indicates the presence of a sophisticated productive structure. This measure obviously involves a scarcity problem, particularly of natural resources like diamonds and uranium, for example. Non-ubiquitous goods can be divided into those with high technological content, which are therefore difficult to produce (airplanes), and those that are highly scarce in nature, such as diamonds, which are therefore naturally non-ubiquitous. To control for this issue of scarce natural resources in complexity measurements, the authors of the Atlas use an ingenious technique: they compare the ubiquity of the product made in a given country with the diversity of the exports of countries that also produce and export this good. To illustrate: Botswana and Sierra Leone produce and export something that is rare and therefore non-ubiquitous, rough diamonds. On the other hand, their exports are extremely limited and undiversified. These, then, are instances of non-ubiquity without complexity. At the opposite end of the ubiquity spectrum we could mention image-processing medical devices (X-ray equipment) which practically Japan, Germany and the United States (complex countries) alone can manufacture and export; these are non-ubiquitous complex products. In this case the export composition of Japan, USA and Germany is extremely diversified, indicating that these countries are highly capable of making many different things. In other worlds, non-ubiquity with diversity means “economic complexity”. On the other hand, countries with highly diverse export composition made up of ubiquitous goods (fish, meat, fruits, ores, etc…) do not show high economic complexity; they produce and export what all others can do. Diversity without non-ubiquity means lack of economic complexity.

One of the main virtues of such economic (ECIs) and product complexity (PCI) indicators is the fact that they operate based on quantitative measures obtained from linear algebra calculations to arrive at their results. There is no account of qualitative issues relating to the production and exports of those goods. That is, no judgment is made as to what is regarded as complex or non-complex. Along these lines, the authors rate several countries and arrive at robust correlations between income per-capita levels, inequality and economic complexity (Hausmann et al 2011 and Hartman et al 2015). Japan, Germany, Switzerland and Sweden are always ranked among the top ten countries in terms of complexity. Economic development may be treated as the mastery of more sophisticated production techniques, which usually lead to output of higher value added per worker as argued by classic development authors. This is what economic complexity indicators ingeniously capture from measures of ubiquity and diversity of exports from various countries.

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The Atlas’ results are in line with predictions from classical development economists regarding specialization patterns in world trade: rich countries tend to specialize in producing manufactured goods, poor countries in commodities; an aspect we will explore in greater depth ahead.

In this sense, the Atlas of Economic Complexity offers yet another important empirical contribution: by calculating the probability of products being jointly exported by several countries, the Atlas also creates an interesting measure of the productive knowledge embedded in products and of the local capabilities needed for their production; the “product space” (Hidalgo et al 2007). The greater the probability of two products being co-exported, the greater their “proximity” and the more indication that they contain similar characteristics and therefore require similar productive capabilities for production; they are “siblings” or “cousin” products. The co-exportation indicator ultimately serves as a measure of each product’s “productive connection”, that is, an indication of the productive ties linking various products as a result of their shared requirements for production. Highly connected goods are therefore loaded with knowledge and technological potential; they are “hubs of knowledge”, whereas those with low connectivity have low knowledge multiplication potential. To illustrate: countries that make advanced combustion engines probably have engineers and knowledge that enable them to produce a series of similar and sophisticated things. Countries that only produce bananas or other fruit have limited knowledge and are probably incapable of making more complex goods. It is important to emphasize that the difficulty observing these differences arises from our inability to directly measure and capture such local productive skills. What one observes in international trade are the products, not countries’ ability to produce them.

Some examples from the Atlas of Complexity illustrate the point: machinery in general and cars are highly “connective” and complex in terms of knowledge content, and are therefore “hubs of knowledge”; iron ore and soybeans have very low connectivity and are non-complex. Manufactured goods stand out from other kinds of goods in terms of complexity and “connectivity”. Commodities in general lack these characteristics. Empirically, the Atlas clearly shows that manufactured goods are generally characterized as more complex and connected whereas commodities emerge as non-complex and non-connected goods. Out of the 34 main communities of goods in the Atlas calculated by their network compression algorithm (Rosvall and Bergstrom (2007), one finds that machinery, chemicals, airplanes, ships and electronics stand out as the more complex and connected goods (hubs of knowledge). On the other hand, gemstones, oil, minerals, fish and shellfish, fruit, flowers, and tropical agriculture show very low complexity and connectivity. Grains, textiles, construction material and equipment and processed food occupy an intermediate position between more and less complex and connected goods. 

3.1 Complexity and growth: empirical evidence

In the economic growth literature there are two empirical approaches to analyse countries’ GDP per capita convergence and divergence. The sigma-convergence approach refers to the reduction of countries’ GDP per capita dispersion. Essentially, countries’ income are compared in two periods and, if the dispersion is reducing, one can conclude that there has been convergence; instead, if the dispersion is increasing, there has been divergence of income among countries. On the other hand, the beta-convergence approach compares the growth rate of poor countries’ and rich countries’ GDP per capita. If poor countries are growing faster than rich ones, there has been GDP per capita convergence, but if rich countries are growing faster one can conclude that there has been divergence. Although being conceptually not so precise as the first approach, the second approach has some advantages. By using controls in econometric regressions, in the beta-convergence approach it is possible to differentiate conditional convergence from unconditional convergence. One of the simplest way of measuring convergence in this approach is by regressing countries’ GDP per capita (in log) on their output growth, as in equation (1). If the beta coefficient is statistically significant and negative it

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means that the higher are countries’ GDP per capita the lower are their growth rate, and hence there is unconditional convergence.

growthi ,t=α+ β ln (GDPpc¿¿ i ,t−1)+ui ,t (1)¿

However, in this approach it is possible to add control variables such as presented in equation (2). These controls enable us to analyse the existence of conditional convergence – or convergence when all other variables remain unchanged. Again, in this analysis, if one finds a statistically significant negative beta coefficient one can conclude that there is conditional convergence because low-income countries are growing faster than high-income countries if all other variables remain unchanged.

growthi ,t=α+ β ln (GDPpc¿¿ i ,t−1)+γ Z i ,t+ui ,t (2)¿

In our analysis we go beyond this approach and evaluate whether the beta coefficient changes according to countries’ exports complexity. Essentially, we try to understand if countries’ complexity is important to explain convergence and divergence among poor and rich countries and, if so, which are those countries that will be able to reduce the income gap to developed countries and which are those that will probably remain poor. The most appropriate econometric technique to tackle this issue seems to be heterogeneous regressions21. The Economic Complexity Index (ECI) will not be used as a control variable in the baseline equation, but as a variable of heterogeneity. Since our dataset consists of countries with different degrees of complexity, we can add an interaction term between GDP per capita and ECI to the regression model in order to capture the impact of exports complexity on conditional and unconditional convergence. Therefore, the partial effect of GDP per capita on growth, that is, the coefficient of the interaction term, varies according to countries’ exports complexity. This estimate may shed light on some important issues in the current debate concerning the effectiveness of promoting export sophistication for boosting growth.

3.2 The baseline model

Let us begin by analysing the impact of GDP per capita on output growth without considering the heterogeneous effect provided by the inclusion of the ECI on the regression. The model to be estimated follow the basic structure of the model presented in equations (1) and (2). However, because output growth impact positively on GDP per capita, we use a System GMM estimator (Brundel and Bond, 1998) to instrumentalise the dependent variables. This estimator extends the standard Arellano and Bond (1991) GMM estimator by utilising lagged differences as instruments for equations in level and lagged levels as instrument for equations in first difference. Hence, there is no need to find exogenous regressors as instruments for the GDP per capita, for the variables used as controls and for the variables used to assess the heterogeneous effects.Thereby, the following model is estimated:

growthi ,t=α+δ growthi , t−1+β1 ln (GDPpc¿¿i , t−1)+¿ γ Z i ,t+u i ,t (3 ) ,¿¿

where Z is a matrix of control variables.

21 See Agung (2014:278-285) for a detailed presentation of this method and prior applications. Woodridge (2002:170-171) presents an example of this method for a panel data model.

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Differently from equations (1) and (2), where the coefficient of ln (GDPpc¿¿ i , t−1)¿ refers to the convergence coefficient, in dynamic panels, where a lagged variable of the dependent variable is included in the regression, it works a short-term coefficient. However, as we are interested on the long-term relationship, the coefficient under consideration to analyse convergence is β:

β=β1

1−δ( 4 ) .

Time series for income growth are taken from the Penn World Table 8.1, as well as some variables used as control such as government expenditure as a share of GDP and population growth. There is a number of variables that can be used to explain growth. In order to enhance comparability, we decided to take into account government expenditure as a share of GDP, population growth and exports as a share of GDP. Neoclassical growth models use ‘government expending (%GDP)’ as a proxy for government burden. These models argue that government can be a heavy burden on the economy when they impose high taxes, promote inefficient programs, do not eliminate unnecessary bureaucracy, and distort market signals. The proxy commonly used to account for the government burden is the ratio of government current expenditures to GDP. They argue that excessive government consumption is mostly used to maintain the bureaucracy’s payroll. However, neoclassical economists, by and large, also acknowledge the importance of public investments on health, education, and security to promote growth. The ‘population’ is included as an explanatory variable that accounts for the growth of the labour force. Finally, exports as a share of GDP is used as a proxy to export-orientation. This work consists of a sample of 147 countries and covers the period 1979-2011. Our estimates were done based on four-year period averages. This is a standard procedure in panel data analysis, as it reduces the effects caused by unit roots. Table 1 presents the results for the regressions without controls (unconditional convergence) and with controls (conditional convergence):

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Table 1 – GDP per capita convergence – baseline model(1)

growth(2)

growthgrowt h t−1 -0.000169 -0.0185

(0.105) (0.101)ln (GDPp ct−1) 0.0231 0.212

(0.207) (0.236)G /GDP -0.0603**

(0.0262)pop growth 0.879***

(0.245)X /GDP 0.00985*

(0.00574)Constant 1.424*** -0.0708***

(1.649) (2.302)Long-term impact (β) 0.0231 0.208

(0.207) (0.236)Observations 1237 1237

Number of code 170 170Hansen test 8.060 9.343

Hansen p-value 0.327 0.229Standard errors in parenthesis; ***: p<0.01, **: p<0.05, *: p<0.1.(1): no controls; (2) controlled by population growth, government expenditure as a share of GDP and exports as a share of GDP.Long term impact: long-term impact of undervaluation on growth rate; calculated based on equation (4).

As can be seen from Table 1, in both estimations the long-term impact of GDP per capita on growth is positive, indicating that there is divergence in countries’ income levels. However, they are not statiscally significant different from zero at the 95% significance level, and hence one can conclude that there are neither unconditional nor conditional divergence in countries’ income. The inclusion of controls in estimation (2) indicates that other variables may impact on countries growth rate. Government expenses as a share of GDP impact negatively, whilst population growth and exports as a share of GDP impact positively. Nevertheless, the inclusion of these variables does not change the main result of our estimation. The beta-coefficient (the coefficient associated with convergence or divergence) remains statically equal to zero.

3.3 Heterogeneous analysis

As discussed before, the ECI reflects the diversification and ubiquity of countries’ export basket. The value of this index varies significantly for countries in the same stages of development. As can be seen from Table 2, the ECI of Brazil, Russia, Indonesia and South Africa in 2014 was around zero, whilst this value was negative in Egypt, Argentina and Nigeria. The Chinese ECI, on the other hand, was around 1.0 in 2014, as well as the Mexican, the Thai and the Malaysian indices. Although not so significant, variation is also verified in developed countries. Japan, Germany, Switzerland and South Korea presented a high level of export complexity in 2014 – the ECI was around 2.0, whilst Canada presents a low value, 0.48, and Australia and Saudi Arabia’s ECI were negative.

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Table 2 – Export Complexity Index (ECI) – major economies (1995 and 2014)Major developed economies Major developing economies

1995 2014 1995 2014United States 2.049728 1.356961 China 0.205849 1.102516

Japan 3.097456 2.209021 India -0.12514 0.238223Germany 2.645996 1.922099 Brazil 0.558866 -0.00237

United Kingdom 2.046284 1.481103 Russia 0.373692 0.051867France 1.941901 1.291047 Mexico 0.80577 1.040655Italy 1.763991 1.352926 Indonesia -0.55073 -0.02842

Canada 1.005954 0.482014 Turkey -0.04953 0.420847South Korea 1.133752 1.823794 Argentina 0.001373 -0.21944Australia -0.00495 -0.62675 Nigeria -2.15742 -2.13209

Spain 1.400973 0.824179 Thailand 0.133436 0.940312Netherlands 1.489492 0.974603 Egypt -0.59635 -0.17276Switzerland 2.463272 1.873856 South Africa 0.227118 -0.00416

Saudi Arabia 0.164556 -0.54189 Thailand 0.133436 0.940312Source: The Atlas of Economic Complexity

The main idea behind complexity is that the higher is the economic complexity of a country, the better are its conditions to promote faster growth rates. We analyse this by using heterogeneous regressions. The beta coefficient (the coefficient related to convergence) is replaced by a function of countries’ ECI, and hence convergence (or divergence) will not be a parameter but it will depend on countries’ export complexity. Firstly, the following model is estimated:

growthi ,t=α+δ growthi , t−1+β1 ln (GDPpc¿¿i , t−1)+¿¿¿

+β2 ln (GDPpc ¿¿ i , t−1)ECI i , t+¿ γ Z i ,t+ui , t (5 ) .¿¿

Differently from equation (3), in equation (5) there is an interaction term associated with β2. This term, which is the multiplication of the log of GDP per capita and the ECI for a given period (which in our analysis is 1995), is the one that enable us to interpret the relation between growth and GDP per capita not linearly but as a (linear) function of the ECI. The beta coefficient (the long term relationship between GDP per capita and growth) is now given by:

β=β1+β2 ECI i ,t

1−δ(6 ) .

From this equation it is clear that the higher is β2, the higher is the impact of the ECI on the beta coeffitient. Thereby, a negative β2 implies that complexity is positively related with convergence (as a negative β implies convergence), and a positive value for this coeffitient implies that complexity is positively related with divergence (as a negative β implies divergence). The results of this estimation (for unconditional and conditional convergence) is presented in Table 3:

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Table 3 – GDP per capita convergence – heterogeneous model(3)

growth(4)

growthgrowt h t−1 -0.0641 -0.0734

(0.0823) (0.0762)ln (GDPp ct−1) 0.310 0.0439

(0.307) (0.236)ln (GDPp c t−1 )∗ECI i ,t -0.0918*** -0.0849**

(0.0282) (0.0350)G /GDP -0.115***

(0.0234)pop growth 0.150

(0.260)X /GDP 0.0177***

(0.00427)Constant 0.0283 4.886*

(2.466) (2.515)Observations 841 841

Number of code 147 147Hansen test 12.67 11.60

Hansen p-value 0.0805 0.115Standard errors in parenthesis; ***: p<0.01, **: p<0.05, *: p<0.1.(1): no controls; (2) controlled by population growth, government expenditure as a share of GDP and exports as a share of GDP.

Although the term associated with GDP per capita is not statistically significant different from zero at the 95% level, in both equations the term associated with the interaction of GDP per capita and ECI is negative and statistically different from zero. It indicates that countries with high export complexity are more capable of reducing the income gap to developed countries than countries with low export complexity. The conditional convergence coefficient can be estimated for each country based on equation (6). In the case of countries which the ECI is close to zero, such as Brazil, Indonesia, South Africa and Russia, the convergence coefficient is calculated ignoring the parameter of the interaction term, such as in equation (4). For these countries, the beta coefficient (the long-term relationship between GDP per capita and growth) is 0.0409, which indicates divergence as the value is positive (although not statically significant). For Egypt, Argentina and Nigeria, the results based on equation (6) indicates that divergence is even more relevant. The beta coefficient calculated based on Egypt’s ECI is 0.0546, based on Argentina’s index is 0.0583, and it is 0.225 based on Nigerian exports basket. On the other hand, in the case of China, Mexico, Thailand and Malaysia, the results indicate convergence rather than divergence. The beta coefficient calculated based on the Chinese ECI is –0.0461, based on the Mexican index is –0.0414, based on the Thai is –0.0335, and based on Malaysian export basket is –0.0280. From these results it is possible to conclude that exports complexity is important to explain convergence and divergence. If developing countries have export baskets similar to the Chinese in term of complexity, for example, there would be convergence among countries income. However, if their export complexity is similar to Argentina or Nigeria, there would be divergence. Thereby, the higher is the complexity of developing countries export basket, the higher is the probability of income convergence among countries.

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4. Concluding remarks

This paper sought to collaborate with the structuralist literature on the central role of manufacturing and productive sophistication to economic growth. Both Anglo-Saxon and Latin American Structuralism strands stressed that economic development is narrowly linked to a radical transformation of the productive structure of an economy in favour of the manufacturing sector to overcome underdevelopment. Structuralism states that a dynamic process of industrialisation is a necessary condition for increasing employment, productivity and income per capita and, consequently, reducing poverty. According to this approach, the process of economic development involves a shift of production from low productivity to high productivity sectors where increasing returns to scale prevail. The data provided by the Atlas of Economic Complexity strengthen assertions made by structuralist theorists. In other words, it is an empirical breakthrough that supports propositions of classical economists where manufacturing and productive sophistication are the drivers of sustainable and thriving economic dynamism. With these elements in mind this study sought to verify if countries’ complexity is important to explain convergence and divergence among poor and rich countries and, if so, which are those countries that will be able to reduce the income gap compared to developed countries and which are those that will probably remain poor. Our empirical results show that export complexity is important to explain convergence and divergence among countries. The results revealed that when developing countries export baskets are similar in terms of complexity, it generates convergence among countries in terms of income. On the other hand poor exports basket in terms of complexity, such as in Argentina or Nigeria, causes divergence in terms of income. The higher the complexity of developing countries export basket, the higher the probability of income convergence with high income countries.

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