WP/21/202ADiversificationStrategyforSouthAsiabyWeichengLian,FeiLiu,KatsiarynaSvirydzenka,BiyingZhangIMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement.每日免費獲取報告1、每日微信群內(nèi)分享7+最新重磅報告；2、每日分享當(dāng)日華爾街日報、金融時報；3、每周分享經(jīng)濟(jì)學(xué)人4、行研報告均為公開版，權(quán)利歸原作者所有，起點財經(jīng)僅分發(fā)做內(nèi)部學(xué)習(xí)。掃一掃二維碼關(guān)注公號回復(fù)：研究報告加入“起點財經(jīng)”微信群。。?2021InternationalMonetaryFund WP/21/202IMFWorkingPaperAsiaandPacificDepartmentADiversificationStrategyforSouthAsiaPreparedbyWeichengLian,FeiLiu,KatsiarynaSvirydzenka,BiyingZhuAuthorizedfordistributionbyRanilSalgadoJuly2021IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement.AbstractWhileSouthAsiahasgonealongwayindiversifyingtheireconomies,thereissubstantialscopetodomore.Somecountries–India,Nepal,andSriLanka–canbuildontheirexistingproductioncapabilities;others–Bangladesh,Bhutan,andtheMaldives–wouldneedtoundertakeamoreconcertedpush.Weidentifykeypoliciesfromalargesetofpotentialdeterminantsthatexplainthevariationinexportdiversificationandcomplexityacross189countriesfrom1962to2018.OuranalysissuggeststhatSouthAsianeedstoinvestininfrastructure,education,andR&D,facilitatebankcredittoproductivecompanies,andopentotradeinordertodiversifyandmoveupthevaluechains.GiventheCOVID-19pandemic,investingindigitaltechnologiesaspartoftheinfrastructurepushandimprovingeducationareofevengreaterimportancetofacilitatetheabilitytoworkremotelyandassistresourcereallocationawayfromthelessviablesectors.JELClassificationNumbers:F63,L52,O14,053Keywords:diversification,economiccomplexity,economicdevelopment,SouthAsiaAuthor’sE-MailAddress:WLian@;FLiu@;KSvirydzenka@;BZhu@ContentsAbstract 2I.Introduction 5II.DiversificationofExports:AFirstLook 6III.SouthAsia’sProgressonDiversification 9IV.WhichPoliciesCouldFosterDiversificationinSouthAsia? 16A.AConceptualFramework 16B.RegressionMethodology 19C.DriversofExportDiversificationandEconomicComplexity 21V.DiversificationinTimesofCOVID-19 30VI.Conclusions 35References 36FiguresFigure1.DiversificationandIncomePerCapita,2001-2014 8Figure2.DiversificationandVolatility,1962-2014 8Figure3.ExportDiversification 9Figure4.EconomicsComplexity 9Figure5.DiversificationinSouthAsiaImprovedOverTime,1972–2016 11Figure6.ExtensiveandIntensiveMargin 13Figure7.QualityLadder,2014 13Figure8.EconomicComplexityOutlookIndex,2016 14Figure9.TheProductSpaceinIndiaandBangladesh 15Figure10.WhatFactorsDriveDiversificationandComplexity 17Figure11.MappingFactorstoObservableData 19Figure12.ImpactofStructuralIndicatorsonEconomicComplexityRelativetoOneStandardDeviationoftheDistributionoftheEconomicComplexityIndex 26Figure13.ImpactofStructuralIndicatorsonExportDiversificationRelativetoOneStandardDeviationoftheDistributionoftheExportDiversificationIndex 26Figure14.ImpactofStructuralIndicatorsonExportComplexityRelativeto75PercentileoftheCross-CountryDistributionofAnnualChangesinEconomicComplexity 27Figure15.ImpactofStructuralIndicatorsonExportDiversificationRelativeto75PercentileoftheCross-CountryDistributionofAnnualChangesinExportDiversification 27Figure16.SouthAsia:SelectedStructuralIndicators 28Figure17.PotentialGainsfromImprovementsinUnderlyingStructuralIndicators 29Figure18.Tele-workabilitybySector 31Figure19.DiversificationversustheEaseofWorkingRemotely 32Figure20.FactorsthatFacilitateTele-Workability 33Figure21.DigitalizationinSouthAsia:RoomforImprovement 35TablesTable1.ImpactofStructuralFactorsonEconomicComplexity 23Table2.ImpactofStructuralFactorsonExportDiversification 243AnnexesAnnex1.DataSourcesandDefinitions 39TableA.1.DataSources 40TableA.2.SummaryStatistics 41Annex2.ListofCountriesandTimeSamplesUsedinRegressions 42TableA.1.EconomicComplexity 42TableA.2.ExportDiversification 43Annex3.SummaryStatisticsoftheRegressionSample 44TableA.1.EconomicComplexity 44TableA.2.ExportDiversification 45Annex4.RobustnessChecks 46TableA.1.LaggedRegressors–EconomicComplexity 46TableA.2.LaggedRegressors–ExportDiversification 47TableA.3.ClusteredStandardErrors–EconomicComplexity 48TableA.4.ClusteredStandardErrors–ExportDiversification 494INTRODUCTIONDiversificationandstructuraltransformationplayimportantrolesintheprocessofeconomicdevelopment.Increasesinincomepercapita,especiallyattheearlystagesofdevelopment,areoftenaccompaniedbyatransformationofproductionandexportstructures,diversificationintonewproductsandtradingpartners,andincreasingthequalityofexistingproducts–qualityupgrading.Thisrelationshiphasbeenfoundanddiscussedin“SustainingLong-RunGrowthandMacroeconomicStabilityinLow-IncomeCountries:TheRoleofStructuralTransformationandDiversification”(IMF2014).Cherifetal.(2018)foundthatexportsophisticationistheonlyrobustdeterminantofgrowthamongstandardgrowthdeterminantssuchashumancapital,trade,financialdevelopment,andinstitutions,andthatothergrowthdeterminantsmaybeimportanttotheextenttheyhelpimproveexportsophistication.Morerecently,theCOVID-19pandemichasgivenanevengreaterimpetusforcountriestodiversifyand,asthepermanentimpactonsectorsbecomesclearer,creatingtheneedtofacilitatethereallocationofresourcesfromlessviabletomoreviablesectors.Inthispaper,wedocumentSouthAsia1’sprogressondiversificationandexplorepolicyoptionstopromotegreaterexportdiversificationandeconomiccomplexity.Themainfindingsofthispaperareasfollows:SouthAsia’sliberalizationpathhasbeenassociatedwithgreaterdiversificationofexports–fromrawagriculturaltogarmentsandservices.However,thereisstillsubstantialscopetoincreasethediversityofSouthAsianexportstocatchupwithitsneighbors.India,Nepal,andSriLankaareespeciallywellpositionedtoimprovethecomplexityoftheirexports,giventheirexistingproductionfacilities.Bangladesh,Bhutan,andtheMaldiveshavemoreclusteredproductspaceandwouldneedtoundertakeamoreconcertedpush,integratingeconomicdiversificationstrategyintotheirnationaldevelopmentplans.Toimprovethediversityandcomplexityofitsexports,SouthAsianeedstoinvestininfrastructure,education,andR&D,facilitatebankcredittoproductivecompanies,andincreaseopennesstotrade,evenifreducingtradebarrierscouldleadtogreaterspecializationbyacceleratingthereallocationofresourcestowardsthecountry’scomparativeadvantageatthetimeofopening.Otherfactors–suchasastablemacroeconomicenvironmentandthelevelofinvestmentmorebroadly–couldalsopotentiallyassisttheprocessofincreasingdiversificationandcomplexityofexports.2Inthispaper,SouthAsiaincludesBangladesh,Bhutan,India,theMaldives,Nepal,andSriLanka.Theseotherfactorsdonothaveastatisticallysignificantlinktodiversificationandcomplexityinregressionscontrollingforotherstructuralindicators.5GiventheCOVID-19pandemic,adoptingandinvestingindigitaltechnologiesaspartoftheinfrastructurepushandimprovingeducationareofevengreaterimportancetofacilitatetheabilitytoworkremotelyandassistresourcereallocationawayfromthelessviablesectors.Therestofthepaperisstructuredasfollows.SectionIIexploresthebenefitsofdiversification,andSectionIIIassessesSouthAsia’sprogressondiversification.SectionIVdiscussestheconceptualframeworkofdiversificationdriversandstudieswhatpoliciescanhaveasignificantimpactondiversificationandcomplexityinregressionsusingalargecross-countrydataset.SectionVlinkstothecurrentCOVID-19context,andSectionVIconcludes.DIVERSIFICATIONOFEXPORTS:AFIRSTLOOKDiversificationisanimportantelementofeconomicdevelopment.Diversificationcanoccurinthestructureofthedomesticeconomymorebroadlyorinthecompositionofitstradablegoodsbaskets.Morediversifiedtradenotonlymeansarichersetofproducts–itisobviouslydesiredifexpandingproductsetsoccursthroughmovingupthevaluechainintohigherqualityproducts–butalsoexportdestinationsandsourcesofimports.ThispaperstudiestheevolutionofexportdiversificationandexportcomplexityinSouthAsiaandthestructuralforcesbehindtheirevolution.Bothmeasuresarebasedontradeingoods,whereasinafewplaces,theanalysisissupplementedbyinformationrelatedtoserviceexports.Outputdiversification,measuredbyvalueaddedofrealsectors,anddiversificationintermsoftradingpartnersareinterestingissues,butnotthesubjectwestudyinthispaper.Exportdiversificationcaptureshowvariedacountry’sexportbasketisintermsofitsproducts.ItisconstructedusingTheilindex,whichsumstheextensiveandintensivemarginsofdiversification(IMF,2014):?=+(1)Forbothindices,lowervaluesindicatehigherdiversification.Theextensivemarginindexiscalculatedforeachcountryinagivenyearas:=?ln??(2)isthetotalnumberofwherekrepresentseachgroup(traditional,new,andnon-traded);exportsineachductsexportedineachgroup;istherelativemeanof6Theintensivemarginindexforeachcountryinagivenyearis:=?1?ln???(3)∈wherexrepresentsexportvalue.Extensivemarginmeasuresdiversificationintermsofthenumberofexportproducts—themoretypesofexportproductsacountryhas,themorediversifieditisintermsofextensivemargin.Extensiveexportdiversificationthusreflectsanincreaseinthenumberofexportproducts.Intensivemarginconsiderstheroleofexportvolumesacrossactiveexportproducts.Acountrywillbelessdiversifiedintermsofintensivemarginwhenexportrevenuesaredrivenbyafewproducts,eventhoughthecountrymightbeexportingmanydifferentgoods.Countrieswithamoreevenlybalancedmixofexportswillhaveahigherdegreeofintensivediversification.Economiccomplexitycapturesboththediversityandcomplexityofacountry’sexports.ItisatermpopularizedbyHausmannetal.(2011)andisdevelopedfromtheconceptofrevealedcomparativeadvantage(RCA).3Economiccomplexityisacombinationofthediversityofaneconomy(definedasthenumberofproductsinwhichtheeconomyhasRCA)andtheubiquityoftheseproducts(capturedbythenumberofcountriesthathaveRCAinthisproduct).Economiccomplexityisthusameasureoftheknowledgeinaneconomyasexpressedintheproductsitmakes.Thereisgrowingevidence,asshowninFigure1,thatuntilaneconomyreachesanadvancedeconomystatus,higherpercapitaincomeisbroadlyassociatedwithgreaterexportproductdiversificationandeconomiccomplexity.IMF(2014)andCadotetal.(2011)findapositiverelationshipbetweenexportdiversificationontheonehandandpercapitaincomeandgrowthontheotherhandforcountriesatlowerlevelsofdevelopment.Hausmannetal.(2011)andAnand,Mishra,andSpatafora(2012)findasimilarlinkforeconomiccomplexity.AneconomyhasRCAinaspecificgoodifitsshareintheeconomy’sexportsislargerthanthegood’sglobalexportshare,basedonBalassa’sdefinition7Figure1.DiversificationandIncomePerCapita,2001-2014ExportDiversification,2001-2014123Morediverse4Export5All6SouthAsiaPoly.(All)7020,00040,00060,00080,000100,000GDPPerCapita(currentU.S.dollars)Sources:IMF(2014);WorldBank.

EconomicComplexityIndex

EconomicComplexityIndex,1962-201843210-1-2-3Morecomplex-4All-5SouthAsia100,000020,00040,00060,00080,000GDPpercapita,currentU.S.dollarsSources:TheAtlasofEconomicComplexity;WorldBank.Diversificationcontributestogrowthandeconomicdevelopmentdirectlywhenresourcesmovefromlow-productivitytohigh-productivitysectorsandtheeconomyaccumulatesknow-how.Indirectly,diversificationliftsgrowthandincomelevelsbyshiftingresourcesfromsectorswherepricesarehighlyvolatileandcorrelated,suchasminingandagriculture,tolessvolatilesectors,suchasmanufacturing,resultingingreatermacroeconomicstabilityandlowervulnerabilitytoadversetermsoftradeshocks(seeKorenandTenreyro,2007,andHaddadetal.,2013).Figure2showsthatmorediversifiedandcomplexcountriestendtohavelowervolatilityofoutput.ExportDiversification

Figure2.DiversificationandVolatility,1962-2014ExportDiversificationandGrowthVolatility,1962-2014EconomicComplexityIndexandGrowthVolatility,1963-2017736Index2y=-0.915ln(x)+1.0534AllSouthAsia5R2=0.2545MoreComplexity1Log.(All)4y=1.0805ln(x)+1.9048diverseR2=0.1593All0More3SouthAsiaEconomic-1complex2Log.(All)1Lessvolatility-2Lessvolatility0510152025-30051015202530VolatilityVolatility8SOUTHASIA’SPROGRESSONDIVERSIFICATIONAsSouthAsianeconomiesliberalizedinthe1980sand1990s,creatingspacefortheprivatesectortogrowandopeningtotrade,theirexportstructureunderwentrapidtransformation.Theexportmixchangedfromrawproductstogarmentsandservices,andseveralSouthAsiancountriesincreasedthediversityandcomplexityoftheirexportedproducts(Figures3,4and5).ExportdiversificationimproveddramaticallyinNepal,andbothdiversificationandcomplexityincreasedinIndiaandSriLanka.Figure3.ExportDiversificationFigure4.EconomicsComplexity9India’spro-businessreformsinthelate1980sandearly1990sledtoasignificantreductionintariffsandeasedcontrolsonthedomesticprivatesector,whiletheemphasisontertiaryeducationcreatedahighlyeducatedlaborforce.Asaresult,Indiamanagedtotransitionfromexportingteaandfabricsin1970stoamoresophisticatedexportbasketofcarparts,capitalgoods,andpharmaceuticalsandlaidthefoundationforitsremarkableservicesector–ledgrowth.India’sshareofworldserviceexportsdoubledtoover17percentinadecadethrough2010–14,recordingthelargestincreasegloballyforthesector.Allinall,India’sexportdiversificationincreasedtoalevelbroadlycomparabletothatofregionalpeers,suchasChina.InBangladesh,reformsandtradeliberalizationattractedFDIintheready-madegarmentsector.Thisfacilitatedtechnologytransfertodomesticentrepreneurs,helpingBangladeshdiversifyfromexportingjuteandteatolabor-intensivegarments,catalyzingexport-ledgrowth.Eventually,theexportbasketbecamehighlyconcentratedagain,withgarmentsaccountingforaround80percentofexports.SmallerSouthAsianeconomiesdiversifiedfromexportingrawfoodproductsandagriculturalproduceintotourismandinformationandcommunicationstechnology(ICT).TheMaldivesdiversifiedfromfishintotourism,Nepalfromrawfoodproducts(juteandrice)toinformationandcommunicationstechnologyandtourism,andSriLankafromteatotourismandgarments.4Bhutanbenefitedfromexportinghydropowerelectricity,whichnowaccountsfor30percentofitsexports.Figure5showsexportsofgoodsandservices,whilediversificationandcomplexityindicespresentedinFigures3and4arebasedondataforgoodsexportsonly,becauseservicesdataisonlyavailablefrom1980.Sowhiletheexportsofgoodshavebecomemorediversified,theoverallexportmixbecamemoreconcentratesintoservicesinsomecountries.10Figure5.DiversificationinSouthAsiaImprovedOverTime,1972–2016(Shareofdifferentsectorsinexportbasket)11Figure5.DiversificationinSouthAsiaImprovedOverTime,1972–2016(Continued)(Shareofdifferentsectorsinexportbasket)12(Lowervaluesindicatehigherdiversification)Figure6.ExtensiveandIntensiveMarginThereisstillsubstantialscopetoincreasethediversityofSouthAsianexports.MostcountriesinSouthAsialagbehindChinaandtheASEAN(Figure3).Thisispartlybecausetheirexportbasketsarehighlyconcentrated.Thediversificationindexcanbedecomposedintothesummationofextensiveandintensivemargins.Acountryislessdiversifiedwhenitsexportrevenuesaredrivenbyonlyafewsectors(intensivemargin),eventhoughthecountrymightbeexportingmanydifferenttypesofgoods(extensivemargin).WhileSouthAsiancountriestendtoexportdifferenttypesofgoodsandtheirextensivemarginsaresimilartothoseofChinaandtheASEAN(Figure6),theirexportrevenuestendtobedominatedbyspecificproducts.Asaresult,mosthaveworseintensivemarginsanddiversificationthanChina,withtheexceptionofIndia.Byexportingmoreofthedifferenttypesofproductforwhichproductivecapacitiesalreadyexist,SouthAsiacouldimproveondiversification.

0MDVBGDLKAASEANNPLCHNIND12345ExtensiveMarginIntensiveMargin6Source:IMF(2014).Itisimportantnotonlytodiversify,butalsomoveintomorecomplexproducts.IndiaisthemostdiverseinSouthAsia,withthediversityofitsexportbasketsimilartothatofChinaandaheadofthatoftheASEAN.However,whenonetakesaccountofcomplexity,ChinahassurpassedIndiastartingfromearly2000s(Figure4),eventhoughbothcountrieshadsimilarlevelsofcomplexityfortwopriordecades.SouthAsiahasalotofroomtoclimbuptheglobalqualityladder(Figure7),calculatedastheunitvalueofexportedgoodsadjustedfordifferencesinproductioncostsandforselectionbiasstemmingfromrelativedistance(Henn,Papageorgiou,andSpatafora2013).Producinghigherqualityvarietiesofexistingproducts,buildingoncomparativeadvantage,iseasierthandiversifyingintocompletelynewareas.Forexample,inBangladesh,thecomplexityoftheready-madegarmentindustryremainsrelativelylow.InIndia,thereisscopetofurtherclosethetechnologygapintheautocomponentindustry.

Figure7.QualityLadder,20141.4BGDINDMDVNPLKORLKACHN0.40.2012345678Miscell9.manuf.animalstobaccomate-al&vegcalsgoodsneryrialsfuelsoilsarticlesSource:IMF(2014).13India,Nepal,andSriLankaareFigure8.EconomicComplexityOutlookIndex,2016especiallywellpositionedtoimprovethecomplexityoftheirexportsascapturedbytheeconomiccomplexityoutlookindex(Figure8).Theindexmeasurestheaveragecomplexityofproductsthatareclosetothecountry’scurrentsetofproductivecapacities.Itcapturesthecomplexityofproductsintowhichitisfeasibleforthecountrytodiversifyinto–thatis,howstrategicallypositionedacountryisinitsproductspace.Giventhecurrentproductionstructures,itwillbeeasierforIndia,Nepal,andSriLankatodiversifybecausetheyhavemanycomplexproductsneartheircurrentsetofproductivecapabilities.Indiahasthehighestdiversificationpotentialintheworld.Thisismoreintuitivelyseenthroughavisualizationcalledproductspace(Figure9).Theproductspacedepictstheconnectednessbetweenproducts,basedonthesimilaritiesofknow-howrequiredtoproducethem.Forexample,Indiaexportsseveralproductsatthecoreoftheproductspace,suchascarsparts,ships,andmobilephones.Inotherwords,IndiahasRCAinexportingvariousmanufacturingproductsthatarerelatedtomorecomplexgoods.TheexistingfacilitiesmakeiteasierforIndiatodiversifyintosimilarproducts.Ontheotherhand,althoughBangladeshhasbeensuccessfulindominatingthegarmentssector,ithasalowercomplexityoutlookbecausetheready-madegarmentsectorislessconnectedtoother,morecomplexindustries.Asaresult,itwouldbeharderforBangladeshtomoveupthecomplexityscalewithoutconcertedpolicymeasures.Improvingeconomicdiversificationandcomplexityrequiresdifferentstrategiestailoredtocountry-specificcircumstances.ForcountriessuchasIndia,whoarewellpositionedintheirproductspace,thiswillinvolveexpandingtheirexistingtechnologicalknow-how.Forcountrieswithrelativelyclusteredproductspace,suchasBangladesh,itwillrequiretakingalonger-termview,expandingproductspacebyaddressingbottlenecksandintegratinganeconomicdiversificationstrategyintothenationaldevelopmentplans.Thenextsectionstudieswhatpoliciescouldbemoreconduciveintheseefforts.14Figure9.TheProductSpaceinIndiaandBangladeshNote:Colorednodeisaproductthecountryexports.Thesizeofthenodeistheshareofthisproductincountry’sexports.15IV.WHICHPOLICIESCOULDFOSTERDIVERSIFICATIONINSOUTHASIA?A.AConceptualFrameworkManyroutesleadtoamorediversifiedeconomy.Afundamentalforceisstructuraltransformation,withresourcesshiftingfromagriculturetowardsmanufacturingandfurthertowardsservicesasthecountrydevelops(Herrendorf,Rogerson,andValentinyi,2014;HansenandPrescott,2002;McMillanandRodrik,2011).Somemayevenleapfrogmanufacturingaltogether(Rodrick,2016;CarmignaniandMandeville,2010).Arecentstudy(IMF,2019)arguesthatSouthAsia,especiallyIndia,shouldgrowallsectorsoftheeconomyinabalancedway,includingincreasingagriculturalproductivity,expandingmanufacturinginasustainableway,andbuildingontherelativelystrongpositionofhigh-skillservices,tocopewiththechallengeof150millionpeopleenteringthelabormarketby2030.Economicdiversificationandexportdiversificationareintrinsicallylinked.ImbsandWacziarg(2003)showthatthedegreeofexportdiversificationoverdevelopmentstagesisbroadlythesamewhetheronelooksattheoveralleconomyorjustmanufacturing.Ithasaninverted-Ushape,asinFigure1.Diversificationtendstoimproveuptoacertainpoint,andascountriesgrowricher,theystarttore-specialize.Thispatternisnotdrivenbyrichcommodityexporters.Therecouldbemultipletheoreticalexplanationsforthispattern.First,technologicalprogress–eitherthroughinnovationortechnologyadoption–leadstothecreationofnewproducts,improvestheefficiencyofproductionprocess,andboostsgrowth.Themarginalboostfromtheseprocessespeteroutastheeconomyreachestechnologicalfrontier.Second,diversificationcomesfromconsumers’loveofvariety,andeconomicgrowthtotheextentthatitincreasesconsumers’purchasingpowernaturallyleadstotheproductionofmorevarietiesifnotallofthemcanbeimported.Diversificationmayalsobederivedfromahysteresiseffectifolderindustriesthatarenotcompatiblewithacountry’scomparativeadvantagecontinuetolinger.Intherealworld,countriesspecializeindifferenttypesofproductsandachangeintheendowmentstructureshouldleadthemtoshifttonewindustries(Schott,2003;Xiang,2007),butincumbentinterestsandpoliticalprotectionmayslowthedestructionofolderfirms.Athigherincomelevelsspecializationeventuallydominates,ascountriesreduceexternalandinternaltradecostssignificantly,sothattheycouldachieveastateofhigherincome.WhatpoliciescouldfosterexportdiversificationandeconomiccomplexityinSouthAsia?Inourregressionanalysis,weusethefollowingconceptualframeworktotrytodisentangletheintertwinedandoftenmutuallyreinforcingeconomicfactors(Figure10).Manyofthediversificationdriversaresimilartothedriversofeconomicgrowth.Theavailabilityoftheneededfactorinputs—physicalcapitalandinfrastructure,humancapital,andtechnological16Figure10.WhatFactorsDriveDiversificationandComplexityFactorqualityTechnologyandRegulationandOtherstructuralandcostefficiencyuncertaintyfactorsPhysicalInnovationMacroOil/DutchcapitalstabilitydiseaseInfrastructureFinanceRegulatoryIncomeperenvironmentcapitaHumanTradecapitalopennessknow-how—aswellastheirqualityandcostdeterminewhetheryoucanengageinanewproductionprocess.Itishardforcountriestocreateproductsthatrequirecapabilitiestheydonothave.Toproducesemiconductors,amanufacturingfacilityneedstheknow-howtostartoutandR&Dtokeepupwithcompetitors,butalsoaccesstopower,water,chemicals,andotherrawmaterials,itneedscomplexmachineryandaneducatedlaborforcetooperateit,androadandportinfrastructuretobeabletoexportthefinalproduct.Withthefactorinputsinplace,theeaseofresourcereallocationdetermineshowfasteconomicdiversificationandimprovementsincomplexitytakeplace.Opennesstotradeandfinanceandfinancialdevelopmentmorebroadlyhavethepotentialtocontributetobothfactoraccumulationandthereallocationofresourcestomoreproductiveactivitiesbybringingintheforeignknow-how,financinginvestment,andgivingaboosttocompetition.Macroeconomicandpoliticalstabilityandregulatoryenvironment—includinglowinflationandpublicdebt,absenceofconflictandeaseofdoingbusiness—createanenablingenvironment,withinwhichfirmsoperateandcaneitherimpedeorfacilitatecreativedestruction.Presenceofalargeextractivesector,suchasoilandgas,canimpedediversificationbyabsorbingtheresourcesthatcouldbeusedotherwiseandinflatingthepriceofnon-tradables,leadingtoDutchdisease.Onewouldalsoexpectthatdiversificationiseasierathigherincomepercapitalevels;thisfactorisimportanttocontrolforreversecausality.Multiplestudiesshowthatthequalityofinstitutions,innovationandtechnologyadoption,tradeopenness,politicalstability,andtherightmixofmacroeconomicpoliciesaregenerallyassociatedwithhighergrowth(AcemogluandRobinson2008;Christiansenetal.,2013;Ostryetal.,2009;Pratietal.,2013).Nonetheless,importantcaveatsexist,forexample,such17positiveassociationwasfoundtoexistonlyinmiddle-incomecountries(Christiansenetal.,2013),wasshowntobehighlyheterogeneousandtobeinfluencedbyacountry'sconstraintsontheauthorityoftheexecutivepowerandbyitsdistancefromthetechnologyfrontier(Pratietal.,2013),andthereweresignificantlydifferentgrowtheffectsacrossalternati