Even nations can do with a bit of diversification

After centuries dominated by the Atlantic, and then the ascendancies of the Pacific Rim, it is the nations on the rim of the Indian Ocean that could dominate growth for the next generation.

The next decade should at last see the ascendancy of India, and the long-delayed rise of east Africa, while the US and Europe suffer relative stagnation, and China’s growth begins to peter out.

These predictions may sound outlandish, but they come from fascinating research done by the Center for International Development at Harvard University, which has a successful record of identifying which countries are positioned to grow. Based on the latest global trade data for 2013, they aim to identify the drivers of why some countries grow while others do not.

How do they do this? Valuable natural resources can help, for a while. But in the longer term, Ricardo Hausmann, who heads the centre, finds that growth is driven by economic complexity.

His theory is that countries “accumulate productive knowledge by developing their respective capacity to make both more products, and products of increasing complexity”. This underpins their economic growth.

If a country has people skilled in one area whose skills can easily be transferred to another area, it has greater knowledge collectively — and this will allow it to compete more effectively and grow faster than others. Hausmann’s team tries to measure this collective know-how.

That leaves countries that focus on agriculture or extracting resources — which do not create skills that can readily transfer to other products or industries — at a long-term disadvantage.

Resources, indeed, can become a curse. Countries well endowed with materials can lose discipline, and their ability to innovate, as they grow fat off their easily earned proceeds.

The latest data show the countries whose economic complexity has reduced the most are almost all dependent on resources — and include Australia in the bottom 10, as well as more predictable names such as Libya and Venezuela.

Countries with no natural bounty to sell — such as Japan or South Korea — need to be cleverer and more nimble, diversify into new industries and develop the skills needed for growth.

Armed with this theory, Hausmann’s group develops growth forecasts by looking not at the volume of exports but at the diversity and complexity of the products that a country is exporting. On this basis, the latest trade data show countries such as India, Kenya and the Philippines making strong gains by diversifying.

That leads to the forecast that the countries that lead growth over the next decade are bunched around the Indian Ocean.

Many at this point will be a little impatient. Grand long-term predictions are all very well but will not help to navigate a short term which has just seen an almighty electoral surprise in the UK, and a sudden sell-off in bonds from historically inflated prices.

In the case of German Bunds, the short-term volatility has been breathtaking. Ten-year Bund yields surged 73 basis points in three weeks, and then fell 25 basis points in the next 24 hours — inflicting losses in the process — but stay lower than at any time ever before this year.

Further opportunities to make and lose money lie ahead. The US unemployment data for April were reassuring but just strong enough to leave some analysts suggesting that the Federal Reserve could embark on interest rate rises as soon as next month.

Such a hawkish surprise, still unlikely, would spark a further sell-off of bonds.

Someone will make money from short-term moves. Why, then, waste time on the academic abstractions of a team from Harvard?

Because it gives vital clues to markets’ longer-term direction. The bond market chaos is driven by alarm at the outlook for economic growth — and on this subject, the Hausmann findings are not reassuring.

Most importantly, the research projects annual growth of only 4.6 per cent for China over the next decade. That is far below the quasi-formal 7 per cent target of the Communist party, sustained for more than two decades.

For many analysts, anything below 6 per cent would be a “hard landing”. Much is riding on Chinese growth, so this is vital.

The projections for the US (2.4 per cent) and Europe (ranging from 2.3 per cent in Italy to 3.7 per cent in Spain) suggest that low bond yields are justified, even if recent lows were excessive.

Hope lies in the rising Indian Rim. If India overtakes China and delivers the 7.6 per cent that Hausmann expects, and the east African nations at last unlock Africa’s potential, that would relieve much human pain — and, less importantly, would buoy the economies and markets of the rest of the world.

In the short term, there is no money to be made from this long-term research. Those focused on the longer term should pay it great heed.

— Financial Times