Economic Complexity And China's Industrial Upgrading

Over the past 40 years of adopting the Reform and Opening Up policies,China has accelerated its integration into the globalization process,and has achieved economic and social development known as the"Chinese miracle."However,the recent world economy is facing profound adjustments due to the trade frictions caused by the United States.Researchers and policy makers have focused on profound changes in the external environment which may have great impact on China’s development especially the quality of development.On December 13,the Politburo meeting of the Economic Bureau of the CPC Central Committee pointed out that China will "face the complicated international environment in 2019 and we should analyze the changes home and abroad in a dialectical way."This judgement has significant meaning.China’s economy is shifting from a high-speed growth stage to a high-quality development stage.The main connotation of high-quality development is the transition from total expansion to structural upgrading,from "low-hanging fruit" to"high-hanging fruit",which is also important for China not to fall into potential"Middle Income Trap".Hence,how to achieve sustainable economic growth and structural upgrading under the change of external conditions are of great theoretical and practical significance.And these questions are what this paper aims to answer.Industrial upgrading is an important driving force for economic growth.Successfully identifying industrial upgrading potential and gains is the key to industrial policy design.It is very meaningful to promote the high-quality development of China’s economy in the future and to overcome various potential pitfalls above.However,the homogeneity hypothesis of traditional industrial theories has certain defects in assumptions because products are heterogeneous.This puts higher requirements on the theory of industrial upgrading.First,traditional industrial upgrading theories promoted by Gereffi(1999)applies to intra-industrial upgrading,or vertical upgrading,holding the view that industrial upgrading is a process of climbing up the global value chain.It belongs to the first three categories of the typical four types of industrial upgrading,namely technology upgrading,product upgrading,function upgrading and the inter-industry upgrading(Humphrey and Schmitz,2000).However,when it comes to the forth type,the inter-industry upgrading,the traditional industrial theories have some shortcoming in explaining how upgrading takes place among industries,which would be seen as horizontal shift.This macro angle matches structural transformation better and has policy implication for the undergoing supply-side reform in China.Second,traditional industrial upgrading theories have some difficulting in solving the problem of product heterogeneity.Romer and its successors like Grossman and Helpman(1991)as well as Aghion and Howitt(1998)built quality ladder theories based on homogenous Dixit-Stiglitz(1977)production functions.This function assumes that the distance between exsiting products and now products is decided by fixed costs,regardless of products’ comparative advantage in global trade,especially the Revealed Comparative Advantage(Balassa,1965).This homogenous view weakens its explanatory power.Scale-free network provides a heterogenous network helping capture industrial networks which reveals new insights about development.To improve a country’s position in a global production network requires accumulation of capability and know-how,which was manifested by the move to denser areas in the Product Space.This view is different from climbing up along the value chain,rather it means to move to hubs in a network.Denser areas and hubs imply more know-how and high potential for future development.The Product Space provides possible guidance of industrial upgrading from the perspective of heterogenous network may help to offer a macro angle.of structure reform along with global perspective to reflect China’s position against dynamic global background.It emphasizes the importance of capability and know-how,and the diversification of their accumulation.Ricardo Hausmann and Dani Rodrik from Harvard University,together with Cesar Hidalgo from MIT have been leading the theoretical frontiers of development economics since the introduction of the Product Space theory.This theoty has widely been accepted by international organizations including the World Bank,the United Nations trade database,and the Asian Development Bank.Their use of global export data provides global perspective on global capabilities with a visual interface to guide policy makers through heterogeneous networks.The theoretical contribution of this paper is in threefold,one is the completion of theory.The Product Space is a multidisciplinary theory spanning development economics,complex network theory,cognitive science,and learning theory.The most important and fundamental one is research breakthrough of networks.Paul Romer,winner of the 2018 Nobel Prize in Economics,once commented that "Anybody interested in the future of mathematical theory in economics should read Cesar Hidalgo’s book".However,the existing literature has not yet noticed such academic influence,which may prevent researchers from understanding and innovating from root of theoretical change.The third chapter of this paper systematically explores the specific influence of heterogeneous network theory on the formation of the Product Space theory from the origin of thought,which is quite rare in domestic and foreign literature.This paper fills the gap of interdisciplinary research in a wholistic way,which lies at the core of the Product Space theory per se and distinguishes itself from the Solow growth theory which focuses on the Total Factor Productivity.The second theoretical contribution lies in the depth of theoretical exploration.This study has done a complete review of the whole process of the formation and development of the Product Space theory and its key indices.Through in-depth study,this paper provides a rather complete basis of relative research,which helps other researchers to locate the Product Space theory in the academic map.Product space theory itself is still in the process of development.The lack of necessary in-depth understanding is likely to cause misuse of indicators and even lead to misleading conclusions.The third possible theoretical contribution is to provide a response to Rodrik’s question,what is so special about China’s exports?Professor Dani Rodrik put forward a question about "what is special about China’s exports" and concluded that China’s export sophistication had far exceeded the level of countries that are several times higher than China’s own GDP.This has triggered widespread concern among academics and policy makers about the rapid approach of China’s complexity to developed countries.This paper believes that Rodrik has raised an important issue,but the use of the indicator itself has its own problem,which has led to wrong conclusion.This paper checks this argument with the Economic Comlexity Index(ECI)and finds that China’s economic complexity is not significantly higher than its own GDP level.Though China’s ECI has improved rapidly 2000-2016,it is not enough to draw the conclusion that Rodrik had made.This paper tested it empirically using the export data of 61 countries with available data to measure the ECI from 2000 to 2016.Empirical results help to prove the relationship between the ECI and economic growth through panel regression.The practical significance of this paper is to propose that economic growth and industrial upgrading policies should base on"existing capabilities"and improve ECI by making smart jumps.This paper provides China’s specific location since 2000-2016 in a global perspective based on the Product Space theory,and formulates industrial policies in both short run and long run based on China’s existing capabilities,distance and opportunity gains through quantitative and visual methods.All the policy recommendations are entirely derived from theoretical analysis to encounter global changes,which aim to play a useful role in formulating industrial policies suitable for the current stage.In the long run,in order to continue to improve economic complexity and promote long-term economic development,it is important to guide knowledge and skills into new production areas through policy priorities,promote knowledge and information flow,and remove barriers that hinder the circulation of talents and knowledge.By doing this,a country can folly make the use of"diversity bonus"of its knowledge stock,so that industrial upgrading can gain continuous drive to transform and sustain economic development.