A Network View of Economic Development

Does the type of product a country exports matter for subsequent economic performance? Going back to the 19 century economist David Ricardo, does it matter if Britain specializes in cloth and Portugal in wine for the subsequent development of either country? The fathers of development economics held that it does matter, suggesting that industrialization creates externalities that lead to accelerated growth (). Yet, lacking formal models, mainstream economic theory has not been able to make much of these ideas. Instead, current dominant theories use two approaches to explain the pattern of specialization of countries. The first approach focuses on the relationship between the relative proportions in which countries possess productive factors (i.e. physical capital, labor, land, skills or human capital, infrastructure, and institutions) and the proportions in which these factors are needed to produce different goods(). Hence, poor countries specialize in goods that are relatively intensive in labor and land, while richer countries specialize in goods that use more human and physical capital and demand better infrastructure and institutions. In these models the speed at which each factor (e.g. physical capital, skills, etc.) is accumulated ultimately determines the change in the type of product the country chooses to export. Underlying these models is the assumption that there always exists some combination of goods through which these factors can be expressed. Thus, controlling for initial factor endowments, the particular products a country produces carries no consequence for future economic performance. The second approach emphasizes technological differences () and therefore needs to be complemented with a theory of what may lie behind these differences and how they may evolve over time. The two dominant approaches – the varieties model of Romer () and the quality ladders of Aghion and Howitt () and Grossman and Helpman () – assume a continuum of products in some technological space. As a consequence, there is always a slightly more advanced product that countries can move to as they upgrade their technology. The world of products is therefore abstracted away and ignored when thinking about structural transformation and growth.