Thursday, July 22, 2010

Opportunity Knocking

From a forthcoming paper, Malaysia is ranked in terms of its opportunities and capabilities for future growth:

Development and accumulation of new capabilities: The Index of Opportunities

This column introduces the Index of Opportunities – a ranking of countries by their capacity to undergo structural transformation and develop. It suggests countries at the bottom are in urgent need of implementing policies that lead to higher diversification and sophistication of exports.

Development is about structural transformation. This can be defined as the process by which countries change what they produce and how they do it. It involves a shift in the output and employment structures away move from low-productivity and low-wage activities into high-productivity and high-wage activities; and the upgrading and diversification of the production and export baskets. This process generates sustained growth and enables countries to increase their income per capita. The idea that structural change (in particular the importance of industrialisation) is the engine of growth goes back to Kaldor (1967).

More recently, Hidalgo et al. (2007) and Hausmann et al. (2007) have developed a Capabilities Theory and revived Kaldor’s ideas. They argue that while growth and development are the result of structural transformation, not all activities have the same consequences for a country’s growth prospects. The implication is that a sustainable growth trajectory must involve the introduction of new goods and not merely involve continual learning on a fixed set of goods. A country’s ability to foray into new products depends on whether the set of existing capabilities necessary to produce these products can be easily redeployed for the production and export of new products.

What are these capabilities? They are human and physical capital, the legal system, institutions, etc... that are needed to produce a product. At the firm level, they are the “know-how” or working practices held collectively by the group of individuals comprising the firm. These existing capabilities reflect the package that the country produces and exports with revealed comparative advantage. In the simple theory of comparative advantage Pakistan might not produce Mercedes cars because the opportunity cost would be too high. In capabilities theory, however, Pakistan cannot produce and export Mercedes cars simply because it does not have the necessary capabilities.

The index focuses on exports and comparative advantage, so we’re not talking about other aspects of development here. The results are interesting: among non-high income countries, we’re ranked first in export sophistication but near the bottom in potential for further structural change; about average in terms of diversification, but low on the scale of standardisation (which means less competition).

Overall Malaysia ranks 10th on the index, from a sample of 96 non-high income countries, with China and India coming first, Thailand 4th and Indonesia 8th. The authors attempt to show that a higher calculated index number indicates potential for higher future growth, but eyeballing the chart I’m not sure I’d take that at face value – variance looks to be high and there are plenty of outliers. But judge for yourself.

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