The challenge of development is to increase collective know-how and express it with the greatest diversity and complexity in economic activities

 

1. What do you think are the key determinants of a country’s economic and social development?

Life in modern-day society is complex. It requires numerous complementary ingredients and, if just one of them is missing, it will have huge negative effects. Thus, two equally poor countries may suffer from the absence of very different ingredients. This is also why simple recipies, such as education, microcredit or “institutions”, are inadequate answers. But if I had to come up with a synthetic vision to encompass all developing countries, I would say that the secret to development or, in any case, the most difficult ingredient to accumulate is collective know-how or knowing-how-to-do things. The secret to prosperity is technology, but technology is expressed in three kinds of elements: tools or equipment, codes or prescriptions, and know-how or tacit knowledge. While tools and prescriptions are easy to disseminate, know-how is hard to spread, because it is acquired slowly through imitation and repetition, in the same way that we learn to walk or learn a language as children. Nobody learns to play a sport or diagnose a patient by reading about it. It requires years of practice.

2. Why does collective know-how matter so much?

It is a phenomenon with two elements that make it a major obstacle in development. First, modern technology often requires collective know-how, in that the task to be done can only be accomplished by a diverse but cohesive team. It is like a symphonic orchestra: in order to play a symphony, it is not sufficient to have one violinist, however skilful he might be. The capacity to create teams of people with sufficiently diverse know-how to be able to play the piece is often the most difficult aspect of disseminating a technology.

The second is that even if a violinist teaches his art to others, which allows the reproduction of the know-how he already possesses, he cannot teach others to play the oboe.  And if nobody in the country knows how to play the oboe, then there is nobody who can train others for that instrument. The absence of oboe-players makes it imposible to play any pieces that require an oboe part. Thus, having the first person with a certain type of know-how is a challenge like the chicken and egg dichotomy: nobody knows how to do something that they have never done, but nobody can do what they do not know how to do. The main challenge in development is to find ways to resolve this issue, which is a problem of coordination.

This feature of development means that less developed countries not only produce less per capita, but also that they produce a lesser variety of products in general and those they do produce tend to be more simple, in that they require less collective know-how. They tend to be quartets rather than symphonies.

3. Are there common denominators even amongst the different approaches of economic theory that could be universally applicable to all countries, to speed up their economic growth and reduce poverty and inequality?

The answer to this question depends on the degree of abstraction to which it is formulated. If the idea is to come up with a shopping list of policies that all countries should adopt regardless of their context, I think the answer is clearly negative. There is no one-size-fits-all, however much in the past, development drives focussed on finding such a formula.

For me, as I said before, the challenge of development is to increase collective know-how and express it with the greatest diversity and complexity in economic activities. The obstacles impeding progress are potentially many and the manners of resolving them highly diverse. What all countries require is a capacity to organise the search for new opportunities and to overcome the obstacles along the way. The search may focus on doing what was already being done but better. Or it may focus on initiating new things. In my opinion, such new things play a central role in long-term growth. The capacity to identify opportunities and obstacles and coordinate their resolution may be the determining factor in development.

4. In the socioeconomic development of Latin America, what role is played by politics and what role is played by economics?

One of the most pointless debates is the dilemma of the state versus the market. Really, the two modes of organisation, when understood properly, are not substitutes for each other but mutually supportive or complementary. Substitutes are things like tea or coffee. Complements are things like coffee and sugar. The more tea you drink, the less coffee you want, but the more coffee you drink, the more sugar you want. The market and the state need each other. That is why rich countries have more of both.

The market is an exchange of property rights and the state defines and defends these rights. The market needs infrastructure, rules, regulations and many services that cannot practically be organised through the marketplace. The market is a system through which every player earns their living doing things for others. What they earn depends on the value that others place on what they do for them. This recursive relationship is, by and large, what makes it possible for the market to self-organise.

Politics is the mechanism by which societies administer the functions and the roles of the state. Politics decides on the millions of pages of legislation and on the responsibilities and resources of thousands of public entities. In order for functions as dissimilar as meteorology and national defence to be discussed in a coherent manner, politics must create an idea of “us”, a collective identity in whose name things are being done. This identity is based on an idea of who we are, where we come from and where we want to go together.

Latin America and the Arab-speaking world are the only two areas in the world where many states speak the same language. In general, countries define themselves by their language to a large degree: the French, the English, the Hungarians, the Finns, etc. There are countries with more than one language, such as Spain, Belgium, Canada or Nigeria, where this very fact has created difficulties in generating a shared identity. In the end, the language defines a set of people that can communicate with each other. Latin America has the opposite problem. What does it mean to be Venezuelan or Costa-Rican that makes one sufficiently different from a Panamanian or a Columbian to make it worth having a different state, if it is not language that creates that distinction?

5. Why does the identity of a nation matter so much?

I believe that countries encounter serious difficulties when they haven´t properly resolved the problem of their identity and their history, as this leads them to think badly about their present and their future. An example is the interpretation of the history of Latin America created by the pro-Cuban Latin-American left, exemplified in the book “The Open Veins of Latin America: Five Centuries of the Pillage of a Continent”. According to this history, the region has been victim to foreign domination: we are heirs to the Indians and the slaves exploited by the Spaniards and by American imperialism. These foreign powers exercise their dominion through the exploitative white elite. The path towards the future is one of a class struggle in which there is a clash with the foreign powers that dominate us. Within this logic, we can understand the Cuban regime or the Chavista regime. But this view of the world is a perfect recipie for the failure of a nation.

An alternative way of seeing things is that we are all the heirs to everything that came before us, including the Spanish whites and many immigrants who came in the decades following Independence. The conquistadores and the colonisers have more to do with us than with the Spaniards who live in Spain nowadays. At the end of the day, there is a reason why we speak Spanish. Our identity is a melting pot. Our progress depends not on class struggle but on cooperation among all citizens and between us and the rest of the world. Cooperation is not a zero-sum game and the art of politics is to identify and exploit opportunities to achieve a win-win situation.

In this alternative view, there is no room for racism, sexism and exclusion. Not only are they unjust, but they also hamper a society’s progress. In the end, if everybody earns their living in a society by doing things for others, the more productive others are, the more they will do for me. That is why a society should invest in ensuring that all its citizens are productive, giving them the skills and capacities they need for that. The investment will repay itself many times over.

This alternative view leads us to think of politics and society in a very different way. It is a matter of cumulatively constructing a unit on the basis of cooperation and our diversity should be the source of strength not conflict.

6. Which Latin-American countries do you think provide a model to follow on the path towards greater economic inclusion?

I do not much like the idea of seeking out models to follow, because each country is playing with very different cards. Everybody in Latin America should feel dissatisfied with our achievements and aspire to greater things. I do believe that there is much to admire in the achievements of Chile in the macro-economic sphere, and in some aspects of its infrastructure and social policy. But its failure to do more to diversify and to promote innovation will cost Chile dearly in coming years. Moreover, Chile needs greater social mobility. The neighbourhood where you were born will determine your future too much. The game is not sufficiently open to all who could contribute to building up the country in line with their possibilities. Even so, I think that, on balance, it is the country that is closest to getting it right.

7. What would your proposal be to empower women more and reduce the current inequalities?

Latin America has some cities where life is unbearable. The process of urbanisation has been so chaotic and there has been so little solidarity that low-income people are forced to live far from the jobs in the modern part of the economy. So the time they take to reach work is unusually long. This is not helped by a rather precarious transport infrastructure. All in all, it means that working in the formal economy is not just an eight-hour working day. It also involves a commute of a further four hours. And if a mother has to spend twelve hours a day out of the home, who is going to look after the children when they get out of school? We need to re-think our use of the urban space, our housing policy, our planning regulations and our investment in mobility. Working and having a family should not be mutually exclusive. The current situation has led many women to opt for jobs closer to home, which has obliged them to move into the informal economy and reduced their productivity, simply because the formal economy is located too far away.

To add insult to injurty, our labour legislation is written by men and for men. The legislation does not allow for flexible working time, a mechanism that women tend to value more than men.

Finally, there is the issue of day care that would allow women with small children to go out to work while at the same time giving children a pre-school education, which seems to offer very high returns.

8. As former Planning Minister in Venezuela, can you describe what initiatives you set in motion to encourage economic development in your country of origin?

Public policy is a team game, not a game for individual players. The government of which I was a member faced the challenge of getting Venezuela out of the dead-end it was in, with multiple exchange rates, very negative real interest rates, price controls,  high fiscal deficits and enormous subsidies for goods that were consumed more by the rich than by the poor. This strategy creates distorted incentives and prevents diversification in a country, which was something fundamental for an oil-exporter having to cope with low prices per barrel. To put it briefly, the government had inherited a situation very similar to the one facing Venezuela today.

The government managed to unify the exchange rate, free up prices and interest rates, reduce indirect subsidies, and create one of the first systems of conditional directed transfers. It also managed to privatise a large number of publicly-owned companies and to renegotiate its foreign debt. The economy began to pick up fast, but political events ended up throwing the recovery off track.

All the achievements were reversed during the Chávez period. Now in Venezuela one dollar will buy you over 9000 litres of gasoline; the bolivar is worth 140 times more on the official market than on the parallel market; and inflation, despite price controls and scarcity, is over 200%. Whole swathes of the economy have been nationalised. I think that very few things that the government I was a member of achieved have survived.

9. What was the biggest challenge you had to deal with while you were Chief Economist of the Inter-American Development Bank?

My experience at the IDB was extremely enriching. Enrique Iglesias and his vice-president, Nancy Birdsall, asked me to set up a research department from scratch. I had to create a team and define an agenda, establish lines of contact with the rest of the bank, with the policy-makers in the region, with academia, the finance industry and public opinion throughout the region. In managing this, I very much followed the advice given to me in another context by Presidente Carlos Andrés Pérez: “Don’t look sideways, look forwards.” Looking sideways, in this context, meant imitating the World Bank and the International Monetary Fund. At the end of the day they were organisations with much bigger, more mature research departments. So looking forward, I decided to focus on issues that my previous experience indicated were most important for Latin America.

We were the first to study the causes of macro-economic volatility in Latin America; the impact of budget institutions in the countries’ fiscal performance; the role of the “original sin” (the inability to denominate foreign debt in local currency), and currency mismatches in macro-economic crises, and many other issues. We developed a network of research departments in Latin America and the Carribean, and a network of Central Banks and Ministries of Finance in Latin America. I left IDB fifteen years ago, but the team I set up continues to achieve successes with very important contributions in areas such as productivity and productive development policies. The networks I mentioned have continued to grow and now constitute an important instance of intellectual integration in the region.

10. You have advised governments in more than forty developing countries on the design and application of development and growth strategies and policies. What were your most exciting or most frustrating experiences?

Sometimes both things go together. From 2004 to 2008, I chaired an international support committee for the South African economy team. I was accompanied by Dani Rodrik, James Robinson, Abhijit Banerjee, Philippe Aghion, Robert Lawrence, Jeffrey Frankel and many others. We carried out 24 studies, with position papers on the strategies and policies to be implemented. The government paid us a lot of attention under the presidency of Thabo Mbeki and his finance minister, Trevor Manuel. But then Mbeki lost power, and the current president, Jacob Zuma took a different tack from what we had recommended. The country is now suffering serious problems because of that. I learnt a lot there, but I also feel frustrated by the final outcome.

In Kazakstan, where I have been working since 2004, I helped to define the fiscal rules for the country and the way the national oil fund should work. I must say that the rules have left the country in an enviable position for coping with the drop in oil prices. From 2004 to 2013, the last full year of high prices, before they started to fall in the second half of 2014, the country had kept up rapid growth, but even so it had managed to save in its Fund the equivalent of seven years of oil revenue contributions to the budget. That is more than in Saudi Arabia, where they only saved 3-years’ worth, and Venezuela, where instead of saving, the boom was used to increase debt. Moreover, Kazakstan has got through this last year and a half without having to reduce public spending and without lowering the level of the fund.

For just over two years, I have been working intensely in Albania, with the prime minister, Edi Rama. The Harvard Development Center that I run has helped to define and implement a good number of reforms in taxation, electricity, industrial policy, agricultural policy and others. Here, I have learnt the importance of bold political leadership and the capacity to communicate what is being done and why it is being done.

Right now, I am helping Mexico, Colombia and Peru to define diversification policies and strategies. It is still too soon to extract lessons, but I have learnt that internal diversity in these countries is enormous, and each region within the same country needs a different focus.

11. As Professor of the Practice of Economic Developmentat Harvard, one of your courses is called: “Why are so many countries poor, volatile, and unequal?” Could you briefly tell us what answer you give to your students?

Briefly, countries are poor because they lack collective know-how and that prevents them from making much use of the technology that exists world-wide. There are deep reasons that make it hard to acquire such know-how, as I explained before. This means there is little diversity and complexity in their economic and export activites.

This lack of diversity,  which concentrates their risks, makes them volatile. And they lack the key markets that allow rich countries to transfer risks, such as a debt market in domestic currency.

A fundamental and very harmful part of income inequality has to do with productivity inequality. Chiapas, the poorest state in Mexico, has a per capita income not that different from Guatemala. Nuevo León, however, has nine times more income per capita than Chiapas, slightly above Korea’s. This inequality is due to the complementarity of inputs that characterises modern production. In Nuevo León, they have many inputs so they can do many things with them, and quite complex things. In Chiapas do they not have many inputs and, therefore, they can only do a few things which are relatively simple. But it is not only that. This same logic means that it becomes more attractive to bring added inputs to places where many inputs already exist, such as Nuevo León, because that way the new input has far more possibilities to combine with other inputs and make interesting things. The challenge resulting from this inequality is not so different from the challenge facing development: the logic of complementarity between many inputs, including know-how, makes development difficult and unequal. Ideally, we would want all the inputs to be available in all the different places throughout the country. But this is not feasible. Countries face the dilemma of putting some inputs everywhere or putting all the inputs in some specific places. The first strategy leads to all places having low productivity. The second leads to growth clusters and an increase in inequality. We need better strategies to deal with this trade-off.

12. In a few words, please define the meaning of some concepts you have brought into economic parlance, such as: “original sin”; “self-discovery”; “dark matter” and “economic complexity”.

Original sin is the impossibility of denominating foreign debt in local currency. As all developing countries normally have a net foreign debt, the original sin means a foreign exchange mismatch at the macro level, and this has serious consequences. In difficult times, the depreciation of the local currency makes it more expensive to service the debt, which means countries lose access to credit markets, preventing them from pursuing an anti-cyclical fiscal policy. To avoid depreciation, governments are obliged to raise interest rates in bad times, making their monetary policy pro-cyclical. With the original sin, countries lose their stabilisation mechanisms and increase their probability of falling into financial crises.

Self-discovery is the process that leads an economy to “discover” that it is able to do something well that it did not do before, but that the world already knows how to do. The challenge for development is not making innovations on a global scale but in developing activities in the country or region that are new for that region but not for the whole world. Thailand went from exporting jute and rice to exporting cars, tractors and chemicals. It discovered something about itself, namely its capacity to make automobiles; it did not discover automobiles.

Dark matter is the consequence of know-how. There are two types of capital in the world: simple capital and smart capital, i.e., capital mixed with know-how. When China invests in American treasury bonds, it is sending simple capital. When Toyota invests in Thailand, it does not just send money but also its know-how; and it obtains a return on both the money and the know-how it put in. In our accounting practices, we do not measure the return on know-how, which appears as “surplus” return on investment. This surplus return is the payment for the know-how and is the dark matter. The United States is a great exporter of know-how, but as this is not recorded in the financial accounts, it accumulates as large current-account decificits, which reached USD 9 trillion from 1980 to 2013, equivalent to 60% of one year’s GDP. This explains why, despite these deficits, the country does not pay anything for its foreign debt in net terms, but rather makes money on it: although the book value of its liabilities is higher than its assets, its assets yield more than its liabilities, so the net return is positive. In Latin America what happens is quite the contrary. The region is a net importer of know-how. Between 1980 and 2010, before copper prices fell, Chile had had a very small current-account deficit, so it had low net foreign debt. However, in 2010 it paid interest and dividends worth over 7% of its GDP, equivalent to a foreign debt of 140% of GDP at 5%. This was because Chile’s foreign assets comprise simple capital, whereas its liabilities are smart capital. The accounts do not reflect the large amounts of dark matter that Chile imports.

Economic complexity arises from the know-how economy. The world has far more know-how than would fit into any one person’s head. The only way to accumulate know-how in a society then, is to put different bits of know-how into different heads. To use this know-how in production, the heads have to be joined together. The broader the network of heads that need to be joined to make a product, the more complex the product is. Economic complexity is the other side of the collective know-how coin: it is what the society does to use the know-how.

13. From your viewpoint, what were the main lessons you learnt from being a board member of theInstituto de Microfinanzas de Acción Internacional?

Microfinance grew out of a very simple idea: granting credit generates fixed costs of evaluation and monitoring. The cost of processing and evaluating a USD 10,000 loan is not that different from the cost of processing and evaluating a USD 100,000 loan. To recover such costs, the bank has to charge more on the 10,000-dollar than on the 100,000-dollar loan. Below a certain size, it does not make sense to lend, because if you want to recover your fixed costs, the interest rate on the loan would be unpayable. That is why 100-dollar loans tend not to don’t exist.

Microfinance is based on reducing the fixed costs to extend the credit market to smaller borrowers. So far so good. The problem is that an unrealistic discourse and unreachable expectations were added on, going beyond just the economic improvement.

The assumption that led to such enthusiasm was that if people managed to access capital, it would radically change the world. But the world has not changed and all serious assessments of microfinance find small and often negative impacts. Microfinance is much older than mobile phones, but nowadays there are billions of people with mobile phones and only hundreds of millions with microloans. That is a very small part of the banking system, even in Bangladesh. As I see it, this reflects the issue of know-how. I can give capital to all the women in a neighbourhood. But if what they know how to do is to set up a small bar or sell sweets, the returns on the capital will be very low and possibly below the cost of the loan.

Moreover, microfinance was not designed to select high-potential businesses and accompany their growth. Group borrowing based on solidarity obliges each entrepreneur to insure the other members of the group and this makes them reluctant to bear the risks of others. It is the opposite model to what venture-capital funds follow, where it is equity rather than debt that is invested, and one success pays off many failures. The more we broaden the availability of micro-debt, the more important the know-how constraint will become.

14. Last September, the 2030 Sustainable Development Agenda was adopted, with 17 goals and 169 targets which will definitely be quite a challenge for the international community. Do you think countries are ready (and willing) for the profound changes that the Agenda suggests for their economies, politics, culture and lifestyles in order to reach the goals? What role does civil society play in its implementation?

I am not a great fan of this agenda or its goals. This is a mechanism to allow rich-country governments to go to their parliaments and justify the aid they give to poor countries. I do not think it is the way that poor countries should establish their objectives. No rich country would accept such interference in their sovereignty. Moreover, I believe it is deeply anti-democratic. The role of politics is precisely to define goals. It is not up to the UN to tell its members what goals they should achieve. Nor can I see why these goals should be the same for all the countries. Apart from that, my experience is that the Milennium Goals worsened the way international aid worked  and I think this mechanism will aggravate the problem.

I prefer a system with less central planning: a system in which donors and receivers meet in an aid market, where they do things that reflect both parties’ common values. International coordination should be on the procurement procedures, transparency and an evaluation of results. I have written about that, and nothing so far has led me to change my mind. Anyway, I think it is somewhat irrelevant for Latin America, given that international aid plays a very minor role in the region.

15. Can you comment on the book by Robinson and Acemoglu: “Why Nations Fail”?

I learnt a lot from Acemoglu and Robinson but I fundamentally disagree with their central thesis. For me, they are anti-Marxist in the theoretical sense of the term. Marx thought that the modes of production came first. From there, the different parts of society entered into relations of production. To regulate such relations and legitimate them, an institutional superstructure was developed. Acemoglu and Robinson see the causality the other way round. It is the superstructure that determines what is produced and how.

If Marx proposed the thesis, Acemoglu and Robinson came up with the antithesis. So we should seek out the synthesis. For me, institutions and production co-evolved. Societies did not develop institutions that they did not need for activities that did not exist. The development of institutions often stems from the desire to reduce the transaction costs generated by the reality of production and trade. They are not pre-defined by History.

Acemoglu and Robinson place the accent on the institutions, while I place it on the know-how. They start off their book talking about Nogales, Arizona and Nogales, Sonora. According to them, the differences between the two are due to the institutions. But the differences between the two Nogales are small compared to the differences between Nogales, Sonora and any equivalent-sized town in Chiapas, such as Ocosingo or Comitán de Domínguez. How is it possible that with the same constitution, the same judiciary, the same exchange rate, the same financial system, language and religion, towns in the same country are so much more different from each other than the two Nogales? Wouldn’t there appear to be something quantitively very important missing in what Acemoglu and Robinson tell us?

16. Tell us something about your personal or professional life that you would like to share with our readers.

Something that surprises many people is that, while both my wife and myself are economists, our three children are making their careers in the arts. Michel, the eldest, is developing a regional theatre in Miami – Miami New Drama (MiND) – and in January 2016 will be presenting a musical that he wrote, called “The Golem of Havana”. Carolina lives in Panamá and is working to develop a new art museum for the city. Joanna lives in New York, were she does comedy, above all for the Flama channel in Youtube, and she has literally millions of followers. In our Whatsapp chat, apart from talking about our own challenges, we follow the painful vicissitudes of Venezuela several times a day. It looks as though we are now ushering in times of change.

 

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