ISRAEL 15 Prof Ricardo Hausmann Agenda

ISRAEL 15 Prof. Ricardo Hausmann

Agenda • Between Growth and Leapfrog • Leapfrog Mechanics: Implications for Israel • Challenge of Public/Private Cooperation • Is there a Leapfrog Recipe? : The Problem with the Washington Consensus • Political Challenges ISRAEL 15 Prof. Ricardo Hausmann -2 -

Between Growth and Leapfrog

Income Per Capita Relative to the US. 2. 4. 6. 8 Israeli Growth, Observations Luxemburg (=1. 2) US Benchmark (=1) § § § 0 § Israel leapt between 1950 -70; Since 70 s stuck at 50% US; No gain compared to West Europe; ~10 countries leapt e. g. Ireland, SK; Israel has constraints yet did better than many countries without resources; Could it do better? 1950 1960 1970 1980 Year ISRAEL 15 Prof. Ricardo Hausmann 1990 2000 -5 -

Some countries have been able to do better . 4 . 6 . 8 US Benchmark (=1) . 2 Income Per Capita Relative to the US Luxemburg (=1. 2) Israel Ireland 0 S. Korea 1950 1960 ISRAEL 15 Prof. Ricardo Hausmann 1970 year 1980 1990 2000 -6 -

Leapfrog Mechanics: Implications for Israel

How do countries grow 1. Increasing Quality of Existing Products 2. Moving to More Sophisticated Products 3. Inventing New Products ISRAEL 15 Prof. Ricardo Hausmann -8 -

Rich Countries Produce Rich Country Goods Relationship between per-capita GDP and EXPY, 2003 Sophistication of exports is measured as the income per capita of countries with a comparative advantage in the country’s export basket • Rich countries do not just produce more of the same • They produce different goods • To grow rich, countries need to change what they produce and export ISRAEL 15 Prof. Ricardo Hausmann -9 -

Strong evidence that countries converge to the level of income of the countries they compete with. Growth in 1992 -2004, controlling for initial income Sophistication Today Determines Tomorrow’s Growth: Countries become what they export Sophistication in 1992 ISRAEL 15 Prof. Ricardo Hausmann -10 -

10. 2 LUX ISR, No Diamonds 10 IRL CHE JPN FIN DEU SWE SVN ISR_no_diamonds GBRISL USA BEL FRA AUT KOR SGP DNK HUN CZE ESP ITA NLD ISR CAN ISR POL SVK MLT MYS EST NZL MEX PRT ZAF HRV LVA AUS GRC KNA CRI LTU NOR ROM ARG URY RUS TTO ISR, With Diamonds 9. 4 lnexpyppp 9. 6 9. 8 MUS 9. 2 Log of EXPY at PPP (export sophistication) Israel’s Export Sophistication is Mixed SAU CHL 9 9. 5 10 10. 5 11 Log of GDP per capita at PPP ISRAEL 15 Prof. Ricardo Hausmann -11 -

But has Improved ISRAEL 15 Prof. Ricardo Hausmann -12 -

Top Contributors to Export Sophistication (2005( Goods with PRODY > 1. 5*EXPY, sorted by overall contribution to EXPY ISRAEL 15 Prof. Ricardo Hausmann -13 -

Exports of business, professional and technical services to the US are outstanding Exports per capita (per million) of ‘other professional and technical services to businesses’ in the US, 2005 (BEA) ISRAEL 15 Prof. Ricardo Hausmann -17 -

How To Advance? Monkeys & Trees Our metaphor: • Products are like trees • Firms are like monkeys • Structural transformation: process whereby monkeys move from the poor part to the rich part of the forest • Easier for monkeys to jump short distance (i. e. to change to products that use similar capabilities) ISRAEL 15 Prof. Ricardo Hausmann -18 -

Increasing Quality of Existing Products is relatively Easy and Fast ISRAEL 15 Prof. Ricardo Hausmann -19 -

Countries with bigger quality gaps grow faster ISRAEL 15 Prof. Ricardo Hausmann -20 -

Israel – at The Top of Its Trees ISRAEL 15 Prof. Ricardo Hausmann -21 -

Moving to different products is more difficult New products face a chicken and egg problem: • Why create inputs for an industry that does not exist? • How can the industry exist, if the inputs are not there? In practice, new products use inputs that have been accumulated to serve other “nearby” products • This creates very strong path dependence ISRAEL 15 Prof. Ricardo Hausmann -22 -

Step 1: Maximum Spanning Tree Our Approach: • Distance between trees • • depends on similarities of required capabilities Distance measured by probability that, if a country is good in one product, it’s also good in another product. What is the shape of a forest? – Homogenous or Heterogeneous? • What does it look like? ISRAEL 15 Prof. Ricardo Hausmann -23 -

Step 2: Overlay Strong Links 0. 4 > 0. 4 – 0. 55 – 0. 65 < ISRAEL 15 Prof. Ricardo Hausmann -24 -

Step 3: Insert Products Nodes sized according to PRODY, darker links are stronger (red is strongest) ISRAEL 15 Prof. Ricardo Hausmann -25 -

Israel’s Product Space in 2000 Israel 2000 Electronics Chemicals Pharmaceuticals Textiles Agriculture ISRAEL 15 Prof. Ricardo Hausmann Garments -26 -

Comparatively, Israel is in a sparse part of the forest ISRAEL 15 Prof. Ricardo Hausmann -27 -

Types of Product Spaces Ease to jump to new products: open forest High Stairway to heaven Parsimonious industrial policy Help jump short distances to other products Bridge over troubled waters Strategic bets Low Little space to improve quality and few nearby trees Low ISRAEL 15 Prof. Ricardo Hausmann Let it be It ain’t broke Ample space to move in all directions Hey Jude: make it better Competitiveness policy Improve the quality of what already exists High Space to improve quality -28 -

Stairway to Heaven: move to nearby products that are more sophisticated and strategic Distance vs. sophistication ISRAEL 15 Prof. Ricardo Hausmann -29 -

Low Hanging ‘Up-market’ Fruit, 2005 ISRAEL 15 Prof. Ricardo Hausmann -30 -

Very Hard, Inventing New Products ISRAEL 15 Prof. Ricardo Hausmann -32 -

The Israeli R&D Miracle: highest R&D spending in the world National Expenditure on R&D as percentage of GDP, 2003 Interpreting the Miracle: • Most is private • Reflected in exports, FDI and M&A S. Fischer – Israel Hi-Tech Conference June 2007 Source: CBS, Bo. I. ISRAEL 15 Prof. Ricardo Hausmann -33 -

A reinterpretation • Israeli “monkeys” achieved a very successful jump to a relatively distant part of the product space that is particularly dense and fertile • Due to de facto industrial policy based on military procurement – ICT products for military use spilled-over into civilian products • More successful than previous attempts – Kfir, Lavi, Sussita • This time, start-ups were very numerous and happened in many products which were unpredictable ex ante • Other related activities – such as venture capital – developed to sustain the private expansion of new applications ISRAEL 15 Prof. Ricardo Hausmann -34 -

Contribution is concentrated in ICT related areas ICT Value Added as % of business sector product 2003 S. Fischer – Israel Hi-Tech Conference June 2007 Source: CBS. ISRAEL 15 Prof. Ricardo Hausmann -35 -

…and some fundamental questions • Is ICT an example of successful intervention to reduce coordination problems? • Can it be replicated in other areas where military involvement plays less of a coordinating role? – Water-tech, drug development, nanotechnology, energy, genetics • What would it take? • Would it be worthwhile? • What are the implications on income equality? ISRAEL 15 Prof. Ricardo Hausmann -36 -

Two possible scenarios The R&D boom was ignited because of serendipitous reasons (military procurement) but now can be sustained for a very long time because it has developed all the institutions that sustain it The R&D boom will fizzle out because it is relatively concentrated in a few areas that were initially favored (ICT), as more countries enter and more applications are developed, the sector will mature Universities, global markets, venture capital ISRAEL 15 Prof. Ricardo Hausmann -37 -

Intermission ISRAEL 15 Prof. Ricardo Hausmann -38 -

Challenge of Public/Private Cooperation

Transformation Requires Public / Private Cooperation • • How to provide highly specific, high dimensional public inputs that are complements in private production? Private inputs: – Prices: information – Profit-motivated firms: incentives – Capital markets: move resources • Public inputs: – No price: where to get the information? – What are the incentives? Political? – Even with incentives, how would resources move? ISRAEL 15 Prof. Ricardo Hausmann Public / Private Cooperation Exchange of Information / Shared Risks Private Inputs Information, Incentives, Resources Public Inputs -40 -

Four Principles for Public / Private Cooperation Open Architecture Transparency Demands, evaluations and decisions should be public knowledge Whenever possible, elicit information about Four required public principles inputs Co-financing Experimentati on and Evaluation Bold moves, tolerance for failures, frequent monitoring, correction over time ISRAEL 15 Prof. Ricardo Hausmann Self. Organization Allow selforganization around critical inputs. Imposing “industry” definitions / requiring agreement is inefficient -41 -

A robust, flexible structure No single, top-down institution An evolving network of organizations Specialized by policy instrument Specialized by type of activity Infrastructure, regulation, labor training, etc. Sectors of industry, trade, etc. Examples: NASA and World Bank ISRAEL 15 Prof. Ricardo Hausmann -42 -

Some policy initiatives Code of Dialogue • Open participation • Self-organization • Co-financing • Transparency • Gov: only public goods Virtual Inter-Ministry Market • Budgetary mechanism to create an internal market within the government for public inputs ISRAEL 15 Prof. Ricardo Hausmann Google-like Search Mechanisms • Create search mechanisms • Focus them on space of possibilities • Empower them to eliminate obstacles • E. g. , Development banks, Industrial parks -43 -

Is there a Leapfrog Recipe? : The Problem with the Washington Consensus

Washington Consensus: All Reforms are Equal Fiscal Discipline Reorientation of Public Expenditure Reform as much and as best as you can Tax Reform Finance Financial Liberalization Low taxes Openness to DFI Human capital Washington Consensus Working Assumptions: § Any reform is good § The deeper the better § The more areas reformed, the better Macro stability Checklist Approach is Wrong! Infrastructure § § § Privatization Deregulation Low social conflict The theory of second-best Latin America since 1990 Policy dimensionality is high Secure Property Rights ISRAEL 15 Prof. Ricardo Hausmann -45 -

Reforms are Contextual Removing Binding Constraints Finance Low taxes Human capital Infrastructure Macro stability ISRAEL 15 Prof. Ricardo Hausmann Low social conflict Working Assumptions: § Policy problems are “high dimensional” § Identify most binding constraints on economic activity § Expend scarce political capital on those reforms only Get the Biggest Bang for the Buck -46 -

Growth Diagnostics: Reforms are Contextual Problem: Low levels of private investment and entrepreneurship High cost of finance Low return to economic activity Low Social Returns Bad Internation al Finance Low Appropriability Government Failures Poor Geography Bad Infrastructur e Low Human Capital Market Failures Information externalities Micro Risks: Property Rights, Corruption, Taxes ISRAEL 15 Prof. Ricardo Hausmann Bad Local Finance Macro Risks: Financial, Monetary, Fiscal Coordinatio n externalities Low Domestic Saving Poor Intermediati on -47 -

Political Challenges

Challenges to creating a broad constituency for leaping 1. Why would society at large support a deep commitment to public-private cooperation if the benefits seem to favor the talented and the lucky? • • Perceived as a social program for the already rich? How does society react to Bill Gates or Steve Jobs? 2. Israel has very low labor force participation • • Those outside need to participate, but have less skills than average; thus requires larger wage inequality Outside IDF network: Israeli ISRAEL 15 Prof. Ricardo Hausmann 3. The likely characteristics of an Israeli leap is intensive in high skills and innovation • Concentrated benefits 4. As structural transformation happens, sectors will be abandoned • Those that compete with poorer countries 5. Conflict between culture of honest and effective public provision and concentrated gains of private profits -49 -