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    The  Real Raw Material of Wealth - article by Ricardo Hausman on local value added.

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      A very interesting article by Ricardo Hausmann:


      JUL 26, 2014

      The  Real Raw Material of Wealth

      TIRANA – 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 industrialization 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  emphasizes 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  realized 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 subsidize downstream activities. In principle,  efficient taxation of extractive industries should enable societies to maximize  the benefits of nature’s bounty. But there is no reason to use the capacity to  tax to favor 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 revolutionize 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?



      Read more at http://www.project-syndicate.org/commentary/ricardo-hausmann-advises-poor-countries-not-to-focus-solely-on-adding-value-to-natural-resource-exports#xCDoqfRCVHXKPfbv.99