In my last post I took a look at an Australian Financial Review (AFR) feature that clearly fell victim to the recent manufacturing fetishisation fad. But what I didn’t address was the throw-away paragraph at the end taking a pot-shot at Australia’s relatively simple economy by comparing it to the likes of Zambia:
“Meanwhile, Australia has slipped a couple of rankings in the Harvard Atlas of Economic Complexity, an index of a country’s ability to make high-value, complex things, and an indicator of future economic prosperity. We are now placed at 105th in this economic race: we’ve edged ahead of Ghana and Namibia, but we’re eating the dust of Zambia and Senegal.”
First, Harvard does not claim that the index is “an indicator of future economic prosperity”. That’s another error made by the AFR article’s author. It’s a measure of knowledge-intensity and the diversity of a country’s exports, and Harvard cautions that it is a conditional indicator of growth, not a prosperity scoreboard; it only tries to predict whether future growth will be above or below the level implied by today’s income for a given country:
“What are the GDP growth prospects of a given country in the next 5-10 years, based on its productive capabilities?”
For example, Japan—consistently among the top 5 most complex economies in the index—is not expected to grow much because its income level already matches its complexity level. Meanwhile, Mexico remains relatively poor despite having the 17th most complex economy, only two spots behind the USA—the world’s most prosperous nation. The index also tends to under-count services, which are 70% of Australia’s economy and relatively more complex than its exports.
Second, scoring well on complexity doesn’t automatically lift prosperity because institutions matter more than complexity. Basically, complexity helps but is neither necessary nor sufficient for current or future economic prosperity. If you want prosperity, you need robust, adaptable institutions—e.g. strong legal, financial, and labour frameworks—that allow a country’s economy to redeploy resources when relative prices shift.
There’s no question that Australia’s lack of complexity means it’s vulnerable to commodity price shocks. But it does not need to try and emulate more complex economies to lock-in future prosperity. Labour and capital are scarce, so forcibly raising complexity today (e.g. with industrial policy) means reducing prosperity relative to the ‘do nothing’ counterfactual.
The only thing policymakers must do to ensure future prosperity is to preserve, or strengthen, Australia’s institutions. That means not racking up debt during the ‘good times’ that come with high resource rents; not gumming up the labour market with excessive industrial relations ‘reform’; ensuring deep, competitive capital markets; and cleaning up red and green tape so entrepreneurs can pivot when prices do.
Do that and Australia will have a much better insurance policy to cover its lack of economic complexity than forcing a premature industrial pivot just to improve an index score.