CID Working Paper No. 276: Implied Comparative Advantage
Ricardo Hausmann, Cesar A. Hidalgo, Daniel P. Stock, and Muhammed A. Yildirim, from the Center for International Development at Harvard University, published their working paper No. 276 in January 2014, with a revision in July 2020, exploring the concept of “Implied Comparative Advantage.” This research delves into how the comparative advantage of a location influences its industrial structure, moving beyond traditional models to consider the interconnectedness of industries and locations.
Traditional economic models often analyze comparative advantage in isolation, without fully addressing how advantages in different sectors or regions relate to each other. This paper introduces a novel approach using a Ricardian-inspired model to demonstrate that valuable information about these interdependencies is embedded within the observed patterns of industries across locations, and vice versa. By examining simple correlations in these patterns, the authors develop a measure of “implied comparative advantage.”
This implied comparative advantage measure leverages the information contained within related industries and locations to predict a location’s current industrial composition. The research provides compelling evidence of these patterns across diverse contexts, including international goods export and the distribution of employment, payroll, and establishments across industries in subnational regions within the US, Chile, and India.
Furthermore, the study reveals that deviations between observed and implied comparative advantage are strong indicators of future industry growth, particularly over longer periods like a decade. This predictive power is evident in both the intensity of industry growth and the emergence of new industries. These findings suggest that the seeds of long-term comparative advantage evolution are already present in the existing patterns of production.
Key Concepts and Methodology
The core idea revolves around understanding that comparative advantage is not just about what a location currently excels at, but also about what its existing industrial and economic landscape implies it could excel at. This “implied” aspect is crucial because industries are not isolated entities; they are interconnected and often share underlying capabilities, resources, or knowledge bases.
The researchers utilize a Ricardian-inspired model, drawing from the classical theory of comparative advantage pioneered by David Ricardo. However, they extend this framework to incorporate the relationships between industries and locations. The core methodology involves analyzing correlations in the patterns of industrial activity.
For instance, if locations that are strong in industry A are also frequently strong in industry B, this suggests a relatedness between A and B. Similarly, if industries C and D tend to co-locate in similar regions, this also points to a connection. By quantifying these correlations across a wide range of industries and locations, the researchers can construct a network of relatedness.
This network then allows for the calculation of “implied comparative advantage.” For a given location, its implied comparative advantage in a particular industry is not just based on its current specialization in that industry, but also on its specialization in related industries. Essentially, it leverages the “wisdom of the crowd” effect embedded in the broader economic landscape.
Empirical Evidence Across Diverse Contexts
The strength of this research lies in its empirical validation across a variety of economic settings. The paper examines:
- International Trade: Analyzing global export data, the study demonstrates that the implied comparative advantage measure effectively predicts countries’ export specialization patterns. Countries tend to export goods for which they exhibit a high implied comparative advantage.
- Subnational Regional Economies: The research further investigates regional economic data within the United States, Chile, and India. Using data on employment, payroll, and the number of establishments across industries within subnational regions, they find consistent evidence supporting the concept of implied comparative advantage. Regions tend to develop industries that align with their implied comparative advantages.
The consistency of these findings across different levels of economic aggregation – from international trade to subnational regions – strengthens the robustness and generalizability of the implied comparative advantage concept.
Predictive Power for Future Growth
One of the most significant contributions of this research is the finding that deviations between observed and implied comparative advantage are predictive of future industry growth. Locations that are underperforming relative to their implied comparative advantage in a particular industry are more likely to experience growth in that industry in the future.
This predictive power is particularly strong at longer time horizons, such as a decade or more. This suggests that the implied comparative advantage measure captures underlying economic forces that shape long-term industrial evolution. It is not just a snapshot of the present but also a glimpse into potential future development paths.
This insight has significant implications for economic development policy. By understanding their implied comparative advantages, regions and countries can identify potential growth sectors that are aligned with their existing economic structures and capabilities. This can inform strategic investments and policy interventions to foster sustainable economic development.
Conclusion: Unveiling Hidden Pathways to Economic Development
The concept of “implied comparative advantage” offers a valuable new lens through which to understand economic development and industrial evolution. It highlights the importance of inter-industry and inter-location relatedness in shaping economic landscapes. By moving beyond static analyses of current comparative advantage, this research provides a dynamic perspective that captures the inherent potential within existing economic structures.
The empirical evidence presented in the paper, spanning international trade and subnational regional economies, robustly supports the validity and applicability of this concept. Furthermore, the predictive power of implied comparative advantage for future industry growth underscores its practical relevance for economic forecasting and policy formulation.
In conclusion, this research demonstrates that comparative advantages show themselves not only in current specializations but also implicitly in the broader patterns of economic activity. By understanding and leveraging these implied advantages, regions and nations can unlock hidden pathways to future economic growth and prosperity.
JEL Codes: O41, O47, O50, F10, F11, F14
Affiliated Research Program: Growth Lab
