Self-discovery in practice

It is remarkable to see something in theory work so well in practice.  Ricardo Hausmann and I wrote a paper several years ago called "Economic Development as Self-Discovery," where the idea was that entrepreneurship in a developing country consists of discovering the underlying cost structure--what can and cannot be produced profitably.  Initial investors in a new line of economic activity face a great amount of uncertainty, since foreign technology always needs some local adaptation.  Plus, their cost discovery soon becomes public knowledge--everyone can observe whether their projects are successful or not--so the social value they generate exceeds their private costs.  If they succeed, much of the gains are socialized through entry and emulation, whereas if they fail, they bear the full costs.

Some of the what I have been seeing in Ethiopia is a picture perfect illustration of this process at work.  Most notable in this respect is the flower industry, which was started by some courageous entrepreneurs who had observed the success of the industry in nearby Kenya and wondered if it could be made to work in Ethiopia as well.  Even though much of the technology is standard, local soil conditions make a lot of difference to the economics of growing flowers, and a whole range of other services--from daily cargo flights to high-quality cardboard packaging--has to be in place before the operation can succeed.  To its credit, the Ethiopian government understood the need to subsidize these pioneer firms, through cheap land and tax holidays, and the industry took off.  Exports have reached $100 million from zero in just a few years.  There are now around 90 flower farms in the country, with latecomers the beneficiary of the tinkering that early investors have undertaken.   

A somewhat similar story in an earlier stage of development is playing out in textiles.  The largest investment here to date is being undertaken by a foreign firm--a Turkish one as it turns out.  Once finished, the operation will be fully integrated from spinning to finished garments and will employ 10,000 workers.  All the output will be exported.  The Turkish investor is a bit of a risk-lover, by his own admission.  He told me that there are many firms in Turkey waiting to see how he will do.  If he succeeds, you can be sure a good many will follow in his footsteps.

These are the discovery efforts that have been going on.  One must presume that there are many more that could be taking place, but which are not, because it is difficult for pioneers to capture a large enough part of the social surplus they generate, even with the subsidy programs in place.    

Comments

[A]

This is why it is a real pity that screwy macro policies (and resultant sharp real appreciation) may end-up strangling all these fledgling enterprises!

[david]

Would you say that the gouverment took a decisive role in this context, or would this market flourish anyway?

[Tim Worstall]

Confirming in a way that Nordhaus paper on Schumpeterian profits. That the vast majority of the returns to innovation do not flow to the innovators.

[JR]

I think the development as self discovery idea is highly problematic. There are modelling problems, in that you assume that the developing country doesn't know ex ante what it's good at making, and secondly that there is something it is good at making. In fact, no-one is inherently good at making anything. Of course you needed to do this to make it mathematically plausible model but in my view this makes it a theoretically implausible one. It assumes that countries are exogenously good at doing something - did Ethiopia really 'discover' that it's good at growing flowers, that it is correcting a failure in the knowledge market?

You also have a very fundamental modelling problem in the assumption that when people flood in, the people who first made the discovery lose money. What mechanism would wipe out the profits of a globally competitive firm? Wages rise therefore people start bidding away labour. You would have to assume so many people make flowers that wages rise, which is totally implausible, it wouldn't have an effect on the wage rate. If wages don't rise, then discovery doesn't suffer from a market failure at all. Discovery is a public good.

Also this argument does not explain why infant industry protection failed in droves, but that's another issue.

[maze]

If I understood Mr.Rodrik right, industry protection is not supposed to be any good in this line of thinking because it would not amend the problem of the positive externality which affects other entrepreneurs inside the country and not industries in other countries.

You mention modeling problems, Professor Rodrik backs his argument with, no not sophisticated econometric stuff, but a simple real life observation of a Turkish firm. Reminds me of Stiglitz's sharecropping story and the observations of agriculture in developing countries.

[robertdfeinman]

A perfect example of a poor nation getting suckered into providing luxury goods for the wealthy ones.

How is growing flowers (and shipping them by air) helping to solve issues of food shortage, consumption of fossil fuels (transportation, fertilizer and pesticides) and use of scarce tillable land for necessities?

Instead of promoting self sufficiency or regional trade the country gets to become a client state of the west and dependent upon it by supplying a market which it doesn't have any control over. If next year the Europeans decide they don't want flowers anymore then what happens to the local economy?

I see this story, not as a "success", but as yet another example of a new type of economic neo-colonialism.

[Roots]

Hooray for Prof. Rodrik. Allowing entrepreneurs to take risks and make profits is key to innovation and long-term growth. Without these benefits, there is no reason to take risks in such uncertain environments.

Too bad most economists don't get this. On a related note, this is why combating corruption is so important too. In many emerging economies entrepreneurs spend their time perfecting the art of rent-seeking and overcoming unnecessary bureaucratic regulations rather than running their businesses and innovating.

[seth edenbaum]

I'd like to see some studies of the environmental impact of industrial flower production.

[Phillip Huggan]

African origin flowers are 6x less GHG intensive than Europe-origin flowers. I guess if your teenage date likes flowers the African ones are okay. But she is still expecting flowers on special days in her 30s you can just tell her they could be growing food instead and that you didn't forget V-day, you donated the gift money to a clean-burning cooking-stove charity instead.

[D. Watson]

Many more businesses fail than succeed, and in general that knowledge is transmitted less rapidly than success. If even entrepreneurs are on a voyage of discovery (which I can agree with), how is the government supposed to know better which entreps to back?

If, instead of picking winners through some mystic process, government subsidizes all new entreps, it will end up creating a lot more failures by lowering the costs to people of failing. Whether those losses are greater than the gains to society from supporting winning enterprises that would not have made it otherwise is an empirical question that would be exceptionally difficult to answer: too many counterfactuals and a mess of an identification strategy in the face of self-selection bias.

I recognize these arguments are not new, but in so doing I wonder that you didn't address them.

[Sandro Perricelli]

How about the self-discovery happening in tbe Bolivarian bloc in Latin America?

[Gulzar]

The challenge is to distinguish between the "good" and "bad" entrepreneurs (or ideas). It is great that the Ethiopian Government supported the initiative and the flower industry took-off. But for every such successful examples of support, there are many times more un-successful examples, most of whom were always destined to fail and supported in the first place due to political or other not so good considerations.

The right will construe these failed examples as another reason why governments cannot "pick winners". But in the absence of any government support, such ideas will remain still-born and the market cannot take off.

As examples of East Asia, China and even India have shown that governments can assist in "picking winners". But that requires a high standard of bureaucratic and political leadership.

There is a similar example in the financing of urban infrastructure in developing economies - a "first mover disadvantage", that affects both lenders and local bodies. I have blogged on it here, in the Indian context,

http://gulzar05.blogspot.com/2008/06/first-mover-disadvantage-in.html

[Gulzar]

contd.
I have a post on Governments and support for entrepreneurship here

http://gulzar05.blogspot.com/2008/12/governments-and-support-for.html

[Angel]

Try to travel south, so that you get the whole (not that benign) picture. Best

[Justin Rietz]

I think the recent world-wide economic crisis shows the downfalls in government attempts to grow an economy by throwing the balance of its efforts behind export oriented businesses. Exporters are beholden to the whims of foreign demand, and when this dries up for whatever reason, they suffer. If the majority of a country’s economic prosperity has come from exports, the entire nation is hit especially hard.

In addition, goods demanded locally will be in short supply as the government has upset the supply and demand discovery mechanism inherent in a free market. When foreign demand drops, the economy cannot fall back on local demand as local businesses are not producing what local consumers want.

Yes, the country’s government could attempt to devalue its currency further, though there is no guarantee this will work. However, what is often ignored – and I have posed this question many times before on this blog with no response from Dani – is that citizens suffer, especially those living near or below a subsistence level. Their wages are worth less, and they do not benefit from the lower prices that result from the competition between domestic and imported goods.

[Justin Rietz]

I think the recent world-wide economic crisis shows the downfalls in government attempts to grow an economy by throwing the balance of its efforts behind export oriented businesses. Exporters are beholden to the whims of foreign demand, and when this dries up for whatever reason, they suffer. If the majority of a country’s economic prosperity has come from exports, the entire nation is hit especially hard.

In addition, goods demanded locally will be in short supply as the government has upset the supply and demand discovery mechanism inherent in a free market. When foreign demand drops, the economy cannot fall back on local demand as local businesses are not producing what local consumers want.

Yes, the country’s government could attempt to devalue its currency further, though there is no guarantee this will work. However, what is often ignored – and I have posed this question many times before on this blog with no response from Dani – is that citizens suffer, especially those living near or below a subsistence level. Their wages are worth less, and they do not benefit from the lower prices that result from the competition between domestic and imported goods.

[Diego Vallarino - Uruguay]

You considered that the Self-Discovery process is a Public Private Partnership? In all process stages? I mean, the first stage of Self-Discovery is based in the private sector skills and then the public sector start to support with public policies

[eee_eff]

A relevant post, as this concept of entrepreneurs as autonomous computers, discovering information as the act, has obvious parallels in evolutionary computing and the acquiring of traditional knowledge:

Types of Knowledge
Sunday, 17 December 2006

An interesting excerpt from Collapse by Jared Diamond, about the native intelligence of New Guinea highland farmers, the utility and longevity of that knowledge.

http://enigmafoundry.wordpress.com/2006/12/17/types-of-knowledge/

[Youri_Kemp]

To Justin,

I think it has been the import countries, which showed the true weakness in the global economic system. It is but one, half equal part of the equation. While it is true that export driven production has caused a ripple in the Chinese river and in export countries world over, saying that carte-blanche, when all they have to do, is, simply, increase domestic consumption, is not a fair argument to make. Which they will do, as they rack up tariffs and import quotas. Also, it is far from the real root of the endemic issues with the global business system.

Also, on the import side, if they have no money to fund their lifestyles, they don’t have it. While an export country, has to simply adjust its export practices and production towards it, an importing country, if it does not have money to import, has to go about finding non-efficient means of subsidizing their lifestyles.

More importantly, this current crisis, shows the ultimate power of global finance over the system itself. Without it, there would be no export or import, no “aid for trade” and no trade finance.

Who would have thought that these guys (international financiers), even though there are inherent problems in the system regardless--brought on by derivatives in particular-- would shut the money tap, off!!

Unheard of in a capitalist society, where folks who wanted capital, could not get access to capital. The obvious reasons- based on current market behavior- for a new governance system for finance is stark and compelling. No longer can this happen. While I would not want governments to be a continual lender- the Argentine Economic crisis and its implications at the root level comes to mind- something has to be done for the long term.

But, to get back to your premise--export oriented businesses—importing countries have been hurt more than anything. In fact, I would say that import driven countries, have done more damage to the economy than does export countries. They need the demand on the flip-side and the distortions of this current mess is not in trade, but in the ability to fund daily business. Export countries, like China for example, have built up huge reserves and have been exporting under erroneous pricing mechanisms.

While exporters have been hit due to the decrease in demand, the damage inflicted upon them have been minimal compared to import countries because, while their export markets have been shrinking, countries like China and India, were dumping in any event. Second, they have been manipulating the supply and prices, to an ultimate advantage throughout this process. This means that they had little to lose with their major exports, when the prices were artificially low in the first place, comparative to import countries who needed goods they could not produce and now, can’t buy the goods.

While their pricing mechanisms are seriously out of whack, especially now as I bring in another example with oil in the OPEC countries, they took a late hit compared to import countries.

While I appreciate your position, Justin, I don’t think it is an accurate statement to make, considering the circumstances on how these exporting countries, built up huge reserves; maximized full production capacity and; have not had a chance to spend their export driven reserves, on domestic investments i.e. social and infrastructural. Also, I don’t think it is fair, to make the linkage, or, to suggest a linkage, that export driven countries have hurt themselves and have hurt the world economic system, more than anything. Or, to suggest that, their issues are particular and because of it, it should be magnified and hence, be the issue we take into consideration as a root cause i.e. all evil intentions and bad for the world.

Import countries, on the other hand, faced the brunt of the hit from both angles. While export countries, got fat off of the hog on cheap exports at outrageously out of whack prices- an example of this is the low Chinese currency- importing countries, got hit with loss of credit, unstable export prices (due to the fluctuations and volatility this credit squeeze wrought) and, the credit squeeze’s impact on their foreign direct investment and foreign reserve currencies. They [ importing countries with dynamic growth potential ] have triggered more fear and instability in the global market, than has the losses in the export sectors in the emerging markets. In fact, Asian markets, have not been reacting to the trade data, which have been showing lower export numbers. They appear to be unshaken by the data as stocks and bond yields, are showing themselves to be resistant to current global market pressures.

From the developing world, straight to a heavily importing country like the UK- which gives us a linkage contrast of shades from dark to grey- are having issues in dealing with this issue of unstable prices and loss in foreign direct investment--the UK, while it has an established market economy, has higher investment taxes per average than most would want to take the risk on investing; this is endemic to import countries, and their heavy and lengthy tax structures, formal or informal, on direct investment.

Hence, not to change the subject, the UK, is in for a painful 2009--more painful than most and, are going to be in more debt until, at least, 2012.

Did you see the British pre-budget report and their attempt at a stimulus package? Govt. borrowing and losses in import taxes, with a lower VAT for 2010 and more social welfare. I guess the treasury must have a hidden kitty.

If the UK was any other country, it would not have been taken serious and the IMF, or, who ever they had borrowed the money from, would have put in stringent stipulations on where this money would be spent and the types of reforms needed to ensure that this, does not happen again!!

But, to end it off, while export countries have been hit and an issue has presented itself- as many analysts have been warning Chinese authorities in particular- and, a late hit at that, they have not had it worse than the import competing countries and certainly, they were not the cause for the deepening of this recession and the problems within --while they played a part, their part, in a global economic sense, has not been as significant as international finance itself and then the linkages, importing countries, with potential for dynamic development and specialized investment yield potential, has shown to this system.

In fact, all exporting countries, would have to do for themselves, is increase domestic demand. Keep their production patterns, and, if they can, specialize production patterns and still come out as exporters at the end of it.

Best,

Youri
http://globalviewtoday.blogspot.com/

[Youri_Kemp]

(Second half of my finishing off my post to Justin) LOL....I write too long!

While their pricing mechanisms are seriously out of whack, especially now as I bring in another example with oil in the OPEC countries, they took a late hit compared to import countries.

While I appreciate your position, Justin, I don’t think it is an accurate statement to make, considering the circumstances on how these exporting countries, built up huge reserves; maximized full production capacity and; have not had a chance to spend their export driven reserves, on domestic investments i.e. social and infrastructural. Also, I don’t think it is fair, to make the linkage, or, to suggest a linkage, that export driven countries have hurt themselves and have hurt the world economic system, more than anything. Or, to suggest that, their issues are particular and because of it, it should be magnified and hence, be the issue we take into consideration as a root cause i.e. all evil intentions and bad for the world.

Import countries, on the other hand, faced the brunt of the hit from both angles. While export countries, got fat off of the hog on cheap exports at outrageously out of whack prices- an example of this is the low Chinese currency- importing countries, got hit with loss of credit, unstable export prices (due to the fluctuations and volatility this credit squeeze wrought) and, the credit squeeze’s impact on their foreign direct investment and foreign reserve currencies. They [ importing countries with dynamic growth potential ] have triggered more fear and instability in the global market, than has the losses in the export sectors in the emerging markets. In fact, Asian markets, have not been reacting to the trade data, which have been showing lower export numbers. They appear to be unshaken by the data as stocks and bond yields, are showing themselves to be resistant to current global market pressures.

From the developing world, straight to a heavily importing country like the UK- which gives us a linkage contrast of shades from dark to grey- are having issues in dealing with this issue of unstable prices and loss in foreign direct investment--the UK, while it has an established market economy, has higher investment taxes per average than most would want to take the risk on investing; this is endemic to import countries, and their heavy and lengthy tax structures, formal or informal, on direct investment.

Hence, not to change the subject, the UK, is in for a painful 2009--more painful than most and, are going to be in more debt until, at least, 2012.

Did you see the British pre-budget report and their attempt at a stimulus package? Govt. borrowing and losses in import taxes, with a lower VAT for 2010 and more social welfare. I guess the treasury must have a hidden kitty.

If the UK was any other country, it would not have been taken serious and the IMF, or, who ever they had borrowed the money from, would have put in stringent stipulations on where this money would be spent and the types of reforms needed to ensure that this, does not happen again!!

But, to end it off, while export countries have been hit and an issue has presented itself- as many analysts have been warning Chinese authorities in particular- and, a late hit at that, they have not had it worse than the import competing countries and certainly, they were not the cause for the deepening of this recession and the problems within --while they played a part, their part, in a global economic sense, has not been as significant as international finance itself and then the linkages, importing countries, with potential for dynamic development and specialized investment yield potential, has shown to this system.

In fact, all exporting countries, would have to do for themselves, is increase domestic demand. Keep their production patterns, and, if they can, specialize production patterns and still come out as exporters at the end of it.

Best,
http://globalviewtoday.blogspot.com/

[eee_eff]

Who would have thought that these guys (international financiers), even though there are inherent problems in the system regardless--brought on by derivatives in particular-- would shut the money tap, off!!

But it is very important to remeber that not all development has been created equal. China, having been very dependent of Foreign Direct Investment when comparted to India, should have a much harder landing in the current crises, right?

[eee_eff]

"African origin flowers are 6x less GHG intensive than Europe-origin flowers."

Please provide some substantiation. This should include the factoring in of the transportation, I find it hard to believe that a flower locally, in London say, would require less GHG than that produced in Ethiopia, and shipped to London. If it did, that would mean the process in London should be improved..

[Justin Rietz]

Youri-

Thank you for your response. I should have been more clear - I meant to contrast different developing economy policy approaches, specifically export-led growth policies versus non-interventionist policies. I by no means meant to suggest that developed “import countries” such as the U.S. are any better off than developing “export countries”, and I would agree with you that they are in fact in a worse position. In my opinion, U.S. economic policy has been a disaster, and the country is now suffering because of it.

What I meant to argue is that a developing country would be better off with government policies of economic non-intervention rather than policies that push export-led growth (what I will call an “artificial export focus”), specifically because growth would be less volatile. During a world economic boom, an artificial focus on exports will create greater growth (this is the point in the first place), but during world economic busts such a policy results in a bigger drop in growth (again, in comparison to a policy of economic non-interventionism).

I still have not seen the following problem addressed: Government policies to promote exports (currency devaluations, import tariffs) are detrimental to consumers, especially those that aren’t employed in the export industries. The lack of competing imports in combination with fewer local producers of domestic goods results in higher domestic prices. In China, for example, hundreds of millions of people living in the country side have not benefited from the economic boom, yet they are harmed by the higher prices resulting from the government’s currency devaluations. Hence, these people’s well-being is sacrificed in the name of more rapid economic growth.

[Youri Kemp]

To Justin,

Great qualification. However, shouldn't we consider that while they artificially had export led growth, that without the surpluses, they would not have de-coupled and be, possibly, in a worse position in this economic crisis?

The fact that China and the other EM's, have money to throw around, is because they made a killing off of us during the times of plenty. The thing is now: can you trust them?

I would like to think that they would be in a deeper stew, the EM's, if they had not gained export surpluses while they had the chance to.

As I said, who would have thought financiers, would have shut off the tap and say "no credit"...it is a once in a lifetime thing, that no one could have predicted as the outcome even if they could have predicted the cause.

To eee_eff:

That is an interesting point. One in which I have no ready made answer for.

But, I am going to defend my position, by saying this; India, has not been as forthcoming or as watched compared to the Chinese economy.

Perhaps there is more bad news to come? Also, India, is more liberal, on the face of it and historically, than that of China. So, a Chinese collapse, can be catastrophic and protracted. And, India, weathering the storm, can be attributed to their democratic market make-up.

More acutely, the ability for the Indian government, to adjust to market demand over that of the Chinese government.

While I am not defending Indian protectionist policies, their policies towards market flexibility, and, more active and meaningful international cooperation, compared to China, would explain at least a few disparities to why they would, should, have a softer landing.

If it turns out to be that India, has fared better than China, per value, then, I would have strong feelings to believe that the Chinese, shot themselves in the foot and head.

Best,

Youri
http://globalviewtoday.blogspot.com/

[Youri Kemp]

To Justin,

Great qualification. However, shouldn't we consider that while they artificially had export led growth, that without the surpluses, they would not have de-coupled and be, possibly, in a worse position in this economic crisis?

The fact that China and the other EM's, have money to throw around, is because they made a killing off of us during the times of plenty. The thing is now: can you trust them?

I would like to think that they would be in a deeper stew, the EM's, if they had not gained export surpluses while they had the chance to.

As I said, who would have thought financiers, would have shut off the tap and say "no credit"...it is a once in a lifetime thing, that no one could have predicted as the outcome even if they could have predicted the cause.

To eee_eff:

That is an interesting point. One in which I have no ready made answer for.

But, I am going to defend my position, by saying this; India, has not been as forthcoming or as watched compared to the Chinese economy.

Perhaps there is more bad news to come? Also, India, is more liberal, on the face of it and historically, than that of China. So, a Chinese collapse, can be catastrophic and protracted. And, India, weathering the storm, can be attributed to their democratic market make-up.

More acutely, the ability for the Indian government, to adjust to market demand over that of the Chinese government.

While I am not defending Indian protectionist policies, their policies towards market flexibility, and, more active and meaningful international cooperation, compared to China, would explain at least a few disparities to why they would, should, have a softer landing.

If it turns out to be that India, has fared better than China, per value, then, I would have strong feelings to believe that the Chinese, shot themselves in the foot and head.

Best,

Youri
http://globalviewtoday.blogspot.com/