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The Specialization Myth

Mareeg.com-CAMBRIDGE – Some ideas are intuitive. Others sound so obvious after they are
expressed that it is hard to deny their truth. They are powerful, because they have
many nonobvious implications. They put one in a different frame of mind when looking
at the world and deciding how to act on it.

One such idea is the notion that cities, regions, and countries should specialize.
Because they cannot be good at everything, they must concentrate on what they are
best at – that is, on their comparative advantage. They should make a few things
very well and exchange them for other goods that are made better elsewhere, thus
exploiting the gains from trade.

But, while some ideas are intuitive or obvious, they can also be wrong and
dangerous. As is often the case, it is not what you don’t know, but what you
mistakenly think you know, that hurts you. And the idea that cities and countries
actually do specialize, and that therefore they should specialize, is one of those
very wrong and dangerous ideas.

When an idea is both intuitively true and actually false, it is often because it is
true on one level but not on the level at which it is being applied. Yes, people do
specialize, and they should specialize, too. Everyone benefits from each of us
becoming good at different things and exchanging our knowhow with others. It is not
efficient for a dentist and a lawyer, for example, to be the same person.

But specialization at the individual level actually leads to diversification at a
higher level. It is precisely because individuals and firms specialize that cities
and countries diversify.

Consider a rural medical facility and a major city hospital. The former probably has
a single general practitioner who is able to provide a limited suite of services. In
the latter, doctors specialize in different areas (oncology, cardiology, neurology,
and so on), which enables the hospital to offer a more diverse set of interventions.
Specialization of doctors leads to diversification of hospital services.

The scale at which specialization of individuals leads to diversification is the
city. Larger cities are more diversified than smaller cities. Among cities with
similar populations – say, Salvador and Curitiba in Brazil, or Guadalajara and
Monterrey in Mexico – more diversified cities are richer than less diversified
cities. They tend to grow faster and become even more diversified, not only because
they have a larger internal market, but also because they are more diversified in
terms of what they can sell to other cities and countries.

What is true at the level of cities is even more applicable at the level of states
and countries. The Netherlands, Chile, and Cameroon have a similar population size,
but the Netherlands is twice as rich as Chile, which is 10 times richer than
Cameroon. Looking at their exports shows that the Netherlands is three times more
diversified than Chile, which is three times more diversified than Cameroon.

As my colleagues and I recently argued, one way to understand this is to think of
industries as stitching together complementary bits of knowhow, just as words are
made by putting together letters. With a greater diversity of letters, the variety
of words that can be made increases, as does their length. Likewise, the more bits
of knowhow that are available, the more industries can be supported and the greater
their complexity can be.

Cities are the places where people that have specialized in different areas
congregate, allowing industries to combine their knowhow. Rich cities are
characterized by a more diverse set of skills that support a more diverse and
complex set of industries – and thus provide more job opportunities to the different
specialists.

In the process of development, cities, states, and countries do not specialize; they
diversify. They evolve from supporting a few simple industries to sustaining an
increasingly diverse set of more complex industries. Achieving this implies solving
important coordination problems, because an industry that is new to a city will not
find workers with industry experience or specialized suppliers. But policymakers can
do a lot to solve these coordination problems.

This is why the idea that cities, states, or countries should specialize in their
current areas of comparative advantage is so dangerous. Focusing on the limited
activities at which they currently excel would merely reduce the variety of
capabilities – or “letters” – that they have. The challenge is not to pick a few
winners among the existing industries, but rather to facilitate the emergence of
more winners by broadening the business ecosystem and enabling it to nurture new
activities.

This is all the more important today, because the globalization of value chains is
delocalizing supplier-customer relations. Cities and countries would be ill-advised
to focus on a few “clusters” and consolidate the value chains in their location, as
is so often recommended. Instead, they should worry about being a node in many
different value chains, which requires finding other industries that can use their
existing capabilities if they were somehow expanded and adjusted to new needs.

Competition inevitably tends to winnow out the less efficient firms and industries.
It is not the policymakers’ role to hasten their death. Their task is to identify
productivity-enhancing interventions that can harness economies of agglomeration by
adding new activities and productive capabilities, making the whole bigger than the
sum of the parts.

Ricardo Hausmann is a professor of economics at Harvard University, where he is
also Director of the Center for International Development.

Copyright: Project Syndicate,

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