The real raw ma­te­rial of wealth

Financial Mirror (Cyprus) - - FRONT PAGE -

Poor coun­tries ex­port raw ma­te­ri­als such as co­coa, iron ore, and raw di­a­monds. Rich coun­tries ex­port – of­ten to those same poor coun­tries – more com­plex prod­ucts such as choco­late, cars, and jew­els. If poor coun­tries want to get rich, they should stop ex­port­ing their re­sources in raw form and con­cen­trate on adding value to them. Oth­er­wise, rich coun­tries will get the lion’s share of the value and all of the good jobs.

Poor coun­tries could fol­low the ex­am­ple of South Africa and Botswana and use their nat­u­ral wealth to force in­dus­tri­al­i­sa­tion by re­strict­ing the ex­port of min­er­als in raw form (a pol­icy known lo­cally as “ben­e­fi­ci­a­tion”). But should they?

Some ideas are worse than wrong: they are cas­trat­ing, be­cause they in­ter­pret the world in a way that em­pha­sises se­condary is­sues – say, the avail­abil­ity of raw ma­te­ri­als – and blinds so­ci­eties to the more promis­ing op­por­tu­ni­ties that may lie else­where.

Con­sider Fin­land, a Nordic coun­try en­dowed with many trees for its small pop­u­la­tion. A clas­si­cal econ­o­mist would ar­gue that, given this, the coun­try should ex­port wood, which Fin­land has done. By con­trast, a tra­di­tional devel­op­ment econ­o­mist would ar­gue that it should not ex­port wood; in­stead, it should add value by trans­form­ing the wood into pa­per or fur­ni­ture – some­thing that Fin­land also does. But all wood-re­lated prod­ucts rep­re­sent barely 20% of Fin­land’s ex­ports.

The rea­son is that wood opened up a dif­fer­ent and much richer path to devel­op­ment. As the Finns were chop­ping wood, their axes and saws would be­come dull and break down, and they would have to be re­paired or re­placed. This even­tu­ally led them to be­come good at pro­duc­ing ma­chines that chop and cut wood.

Fin­nish busi­ness­men soon re­alised that they could make ma­chines that cut other ma­te­ri­als, be­cause not ev­ery­thing that can be cut is made out of wood. Next, they au­to­mated the ma­chines that cut, be­cause cut­ting ev­ery­thing by hand can be­come bor­ing. From here, they went into other au­to­mated ma­chines, be­cause there is more to life than cut­ting, af­ter all. From au­to­mated ma­chines, they even­tu­ally ended up in Nokia. To­day, ma­chines of dif­fer­ent types ac­count for more than 40% of Fin­land’s goods ex­ports.

The moral of the story is that adding value to raw ma­te­ri­als is one path to di­ver­si­fi­ca­tion, but not nec­es­sar­ily a long or fruit­ful one. Coun­tries are not lim­ited by the raw ma­te­ri­als they have. Af­ter all, Switzer­land has no co­coa, and China does not make ad­vanced mem­ory chips. That has not pre­vented these coun­tries from tak­ing a dom­i­nant po­si­tion in the mar­ket for choco­late and com­put­ers, re­spec­tively.

Hav­ing the raw ma­te­rial nearby is only an ad­van­tage if it is very costly to move that in­put around, which is more true of wood than it is of di­a­monds or even iron ore. Aus­tralia, de­spite its re­mote­ness, is a ma­jor ex­porter of iron ore, but not of steel, while South Korea is an ex­porter of steel, though it must im­port iron ore.

What the Fin­nish story in­di­cates is that the more promis­ing paths to devel­op­ment do not in­volve adding value to your raw ma­te­ri­als – but adding ca­pa­bil­i­ties to your ca­pa­bil­i­ties. That means mix­ing new ca­pa­bil­i­ties (for ex­am­ple, au­to­ma­tion) with ones that you al­ready have (say, cut­ting ma­chines) to en­ter com­pletely dif­fer­ent mar­kets. To get raw ma­te­ri­als, by con­trast, you only need to travel as far as the near­est port.

Think­ing about the fu­ture on the ba­sis of the dif­fer­en­tial trans­port-cost ad­van­tage of one in­put lim­its coun­tries to prod­ucts that in­ten­sively use only lo­cally avail­able raw ma­te­ri­als. This turns out to be enor­mously re­stric­tive. Prox­im­ity to which par­tic­u­lar raw ma­te­rial makes a coun­try com­pet­i­tive in pro­duc­ing cars, print­ers, an­tibi­otics, or movies? Most prod­ucts re­quire many in­puts, and, in most cases, one raw ma­te­rial will just not make a large enough dif­fer­ence.

Ben­e­fi­ci­a­tion forces ex­trac­tive in­dus­tries to sell lo­cally below their ex­port price, thus op­er­at­ing as an im­plicit tax that serves to sub­sidise down­stream ac­tiv­i­ties. In prin­ci­ple, ef­fi­cient tax­a­tion of ex­trac­tive in­dus­tries should en­able so­ci­eties to max­imise the ben­e­fits of na­ture’s bounty. But there is no rea­son to use the ca­pac­ity to tax to favour down­stream in­dus­tries. As my col­leagues and I have shown, these ac­tiv­i­ties are nei­ther the near­est in terms of ca­pa­bil­i­ties, nor the most valu­able as step­ping-stones to fur­ther devel­op­ment.

Ar­guably, the big­gest eco­nomic im­pact of Bri­tain’s coal in­dus­try in the late seven­teenth cen­tury was that it en­cour­aged the devel­op­ment of the steam en­gine as a way to pump wa­ter out of mines. But the steam en­gine went on to rev­o­lu­tionise man­u­fac­tur­ing and trans­porta­tion, chang­ing world his­tory and Bri­tain’s place in it – and in­creas­ing the use­ful­ness to Bri­tain of hav­ing coal in the first place.

By con­trast, de­vel­op­ing petro­chem­i­cal or steel plants, or mov­ing low-wage di­a­mond-cut­ting jobs from In­dia or Viet­nam to Botswana – a coun­try that is more than four times richer – is as unimag­i­na­tive as it is con­strict­ing. Much greater cre­ativ­ity can be found in the UAE, which has used its oil rev­enues to in­vest in in­fra­struc­ture and ameni­ties, thus trans­form­ing Dubai into a suc­cess­ful tourism and busi­ness hub. There is a les­son here for the United States, which has had a ma­jor ben­e­fi­ci­a­tion pol­icy since the 1973 oil em­bargo, when it re­stricted the ex­port of crude oil and nat­u­ral gas. As the US in­creas­ingly be­came an en­ergy im­porter, its lead­ers never found any rea­son to aban­don this pol­icy. But the re­cent shale-en­ergy revo­lu­tion has dra­mat­i­cally in­creased the out­put of oil and gas in the last five years. As a re­sult, the do­mes­tic nat­u­ral-gas price is well below the ex­port price.

This is an im­plicit sub­sidy to the in­dus­tries that use oil and gas in­ten­sively and may at­tract some in­ward for­eign in­vest­ment. But is this the best use of the govern­ment’s ca­pac­ity to tax or reg­u­late trade? Would the US not be bet­ter off by us­ing its ca­pac­ity to tax nat­u­ral gas to stim­u­late the devel­op­ment of the con­tem­po­rary tech­no­log­i­cal equiv­a­lent of the rev­o­lu­tion­ary en­gine?

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