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Ricardo Hausmann on Venezuela, Inequality in Productivity, and Policy Lessons for International Development

March 2019. GrowthPolicy’s Devjani Roy interviewed Ricardo Hausmann, Professor of the Practice of Economic Development at Harvard Kennedy School and Director of the Center for International Development at Harvard University, on Venezuela, inequality in productivity, and policy lessons for international development. | Click here for more interviews like this one.

Links: Ricardo Hausmann’s faculty page at Harvard Kennedy School | Project Syndicate op-eds | Center for International Development (CID) at Harvard University | Twitter | Wikipedia

Growthpolicy.org. Where will the jobs of the future come from?

Ricardo Hausmann: The jobs of the future will come from killer apps that have yet to be invented. We are in a period similar to when the dot-com bubble burst in 2000-2002. Among those most severely affected were the companies that had invested in the internet backbone, like Cisco. The idea was that there was too much installed capacity and not much demand for bandwidth. But that was before iTunes, Facebook, Twitter, E-Bay, Instagram, LinkedIn and Netflix were invented. Today, bandwidth is scarce.

Similarly, people fear that we may be going into a period in which we have excess capacity of human effort. What we need are new goods and services that can make valuable use of people’s willingness to work. The gig economy is a first innovation in this direction. Uber and Lyft have made it possible for people to radically increase their mobility at a lower cost, while allowing others to have a very flexible access to work. Finding ways in which somebody’s need becomes another person’s livelihood is the name of the game. It has always been. Once upon a time, mattresses and pillows were seen as wasteful eccentricities. Now they are seen as necessities. As goods become cheaper, we can all have more of them, provided we find something useful we can do for others. That depends on innovation. I am agnostic as to whether that innovation will be forthcoming at the required pace.

Growthpolicy.org. What should we do about income inequality?

Ricardo Hausmann: I am not sure that this is the right way to pose the question. My focus is mainly on developing and transition countries. What strikes my attention is the enormous inequality in productivity. For example, Chiapas, the poorest state in Mexico has a productivity per worker which is about 1/8th that of Nuevo León. Within Chiapas, the capital Tuxtla Gutiérrez has a productivity that is 30% higher than the Mexican average, but the poorest municipalities in Chiapas are also about 8 times poorer than Tuxtla Gutiérrez. Even across neighborhoods of the same cities you can observe these huge differences in productivity.

When you talk about inequality of income, the image people have is that there is a pie which is being sliced very unevenly. Inequality in productivity suggests that different places are baking pies of radically different sizes. This is because high productivity requires access to many networks, some physical and others social: you need electricity, water, roads, urban transport, logistics and banks, but also access to education, labor training, healthcare, and a diverse labor force with complementary skills and that can get to work in 2 hours or less. Those places are scarcer than you might think. Witness the incredible inequality in commute times and in real estate prices, an indication of how much people pay to have a good location and what those who cannot afford it must endure.

The solution to inequality in productivity is not redistribution but inclusion. It involves the costly extension of networks so that people can become more productive. Inclusion is empowering. Redistribution that does not foster inclusion is just compensation for being excluded. It is a distant second best, at best.  Inclusion may be fiscally expensive; it will require taxing the rich to pay for what it takes to include the excluded. While there might be a discussion about whether redistribution is bad for growth, inclusion is definitely good for growth.

Growthpolicy.org. How should we prevent the next financial crisis?

Ricardo Hausmann: The cost of financial stability is eternal vigilance. We know how to prevent the last crisis, but we are not very good at preventing the next crisis. Financial regulation has a similarity with civil aviation. Banks and airplanes work well most of the time, but every so often they crash, with really bad consequences. Regulators do a forensic analysis of every crash in order to find regulatory changes that would prevent their recurrence. As a consequence, airplanes have become increasingly safe. But there is a problem with making innovations safe. New airplanes may come with new unknown failures, as we have just seen with the Boeing 737 MAX. The problem with financial markets is that innovations are much more frequent than in airplanes. Each major crisis has been related to a new financial instrument that was not in existence when the previous crisis took place: The Savings and Loans crisis in 1987, LTCM in 1998, and sub-prime mortgages in 2008 are just a few examples. In general, crises happen after a boom period in a new, poorly understood asset class. That is why vigilance needs to be forward looking.

Growthpolicy.org. The Center for International Development at Harvard University, which you direct, has been carrying out a project on a morning-after plan for your home country, Venezuela. Recently, you commented on the current situation stating, through an incredibly perceptive analogy, that “Venezuela is like a taxi driver who owns his taxi but doesn’t have gasoline and doesn’t have the money to buy the gasoline. So, his labor goes unused, his car goes unused.” I have two questions on Venezuela: What immediate steps must be taken to terminate what you call “a humanitarian crisis of Syrian proportions”? Second, what long-term policy measures do you suggest will restore the market mechanism in Venezuela, or Adam Smith’s “invisible hand”?

Ricardo Hausmann: The Venezuelan crisis, which started in 2013, is probably the worst economic crisis the world has ever seen outside of war or state collapse. It is twice as large as the U.S. Great Depression, three times larger than the largest crisis Latin America has ever seen, and twice as large as the recent Greek crisis. It has led to a poverty rate of 94% and an exodus of some 5 million people, in a country that should have had 33 million. Annual inflation is over 1 million percent.

Our diagnostic suggests that two elements are critical to understand such a dramatic collapse. The first is the destruction of the market mechanism—the invisible hand—through massive expropriations across the whole economy, including 6 million hectares of land, agro-service companies, oil companies, oil service companies, steel, cement, super-markets, banks, telecoms, electricity, and manufacturing plants that produced dairy products, coffee and dairy products, among others. All saw spectacular collapses in productivity.

In addition, the remaining private economy was subjected to controls on prices, imports, exchange rates, wages, interest rates, and even on the right to move merchandise around the country without a permit detailing the truck’s destination. In essence, all of these controls were about disempowering society vis-à-vis the state. These controls, adopted after 2003, but especially after 2006, led to a collapse in agriculture, manufacturing, and oil production in the middle of the largest and longest oil price boom in history. In fact, as oil boomed, Hugo Chávez radicalized his policies. But society was sheltered from the consequences of this collapse through a massive increase in imports, financed by high oil prices, but also by very high borrowing abroad. The public external debt went from US$ 25 billion in 2004 to over US$ 150 billion by 2012, making Venezuela today the most over-indebted country in the world, with a debt-to-export ratio over 500%. In 2012 the country was spending as if the price of oil was at US$ 200 per barrel, when it was only US$ 104. By 2013, financial markets cut Venezuela off and in 2014 the price of oil collapsed.

The government responded to this collapse by administratively cutting imports by over 80% in a vain attempt to keep servicing the huge foreign debt (they eventually defaulted in November 2017, [but] not before issuing debt at sky-high interest rates). That left the country with a shortage of imported intermediate inputs—raw materials, spare parts, seeds, fertilizers, etc., causing the collapse in output. If you think that production requires installed capacity, skilled workers, and imported intermediate inputs, the binding constraint became the latter. So I needed a metaphor to express this production function: I used the case of the taxi driver that had his car and willingness to work, but he could use neither in the absence of the missing intermediate input: gasoline.

To turn the Venezuelan situation around, four critical areas need to be addressed: first, we need to re-establish economic rights so that people are empowered to organize production in order to serve the needs of their fellow citizens. Second, we need to address the shortage of imported intermediate inputs and spare parts to recover production. This will require international financial assistance and debt restructuring. Third, we need to assure that people have the calories, the proteins, and the medicines that they need to survive. This will require a coordinated and rapid increase in the supply of these goods and a mechanism to transfer money to those in need so that they can purchase them. Finally, we need to recover the capacity of the state to provide basic security, power, water, and social services, which have all collapsed in this crisis.

Growthpolicy.org. In a recent op-ed, “China’s Malign Secrecy,” you have called attention to the opacity of China’s lending practices in international public-sector finance, stating: “China’s practice of keeping financing terms secret from the society that is ultimately responsible, and often from that society’s government, is beyond the pale.” I have two questions. First, what are the risks of such practices, if any, to American investors in China, since most of these development-finance deals, as you point out, are made with the governments of developing countries? Second, a policy-related question: China expert Michael Pillsbury’s bestselling book, The Hundred-Year Marathon (2016) has argued, some may say polemically, that China has a long-term plan to replace America as a global hegemon. Do you believe China’s secrecy in international development-finance practices conceals something larger, perhaps more politically motivated?

Ricardo Hausmann: I am no expert on China’s long-term plans. I think that China is a closed society and its government does things without informing its people about what they are doing. When it deals with an open society it wants to do so in secret, but it is often unable to do so. For example, the South African constitution requires that all public debt contracts be public. So, in South Africa the contracts are public. But they are not in Ecuador, Ethiopia, Zambia, or Venezuela. I am told that there is even a clause that considers the terms of the contract secret and a violation of this clause as an act of default. As a consequence, societies are in the dark about what they are signing on to. This is incompatible with an open society. Moreover, it allows for all sorts of dishonesty without oversight. Such financing rules promote corruption. I understand that China is aware of this and has been changing its development finance policies. Xi Jinping has prioritized the fight against corruption. I hope they take a look at their international financial practices as part of that campaign.

Growthpolicy.org. You teach a very popular course on development policy at the Kennedy School, “DEV-130: Why Are So Many Countries Poor, Volatile, and Unequal?” What answers have you found to this question that are common to all developing countries? What policy lessons can the developed world learn from your answers?

Ricardo Hausmann: I guess that one of the main messages of the course is that the answers are not common to all countries and what we need are methods to diagnose each country. Development requires many complementary things, but a few may be in particular short supply, thus becoming the binding constraint on progress. Paraphrasing Leo Tolstoy’s Anna Karenina, all advancing countries are the same. Each problem country is in trouble in its own way.

But more generally, development is about the adoption of technology that can enhance social productivity. Technology is composed of three things: embodied knowledge in tools, codified knowledge in recipes, protocols, patents and to-do manuals, and know-how also known as tacit knowledge which exists only in brains. Tools and codes are easy to move around. Know-how can move with enormous difficulty from brain to brain, through a long process of imitation and repetition. Malcolm Gladwell says that it takes 10,000 hours to become good at something. But modern technology requires not just one brain, but teams of brains with different and complementary knowledge. A heart surgeon cannot do his work without an anesthesiologist and a large support team. A modern firm requires people with knowledge of procurement, production, human resource management, accounting, finance, taxes, contracts, marketing, branding, sales, corporate social responsibility, etc. Putting such a complex team together is challenging. As a consequence, development starts with smaller teams that are less diverse and grows towards larger, more complex teams. Know-how grows in a society not because the average person knows more, but because persons know different. A diverse team allows production to use more know-how than fits in a head. So the diversification of know-how is the way social know-how grows.

Poor countries are poor because they have little know-how (due to the lack of its diversity) and it supports few industries that make relatively simple products (i.e., products that require small teams). They are also volatile because, as I just said, they have few industries and few options to redeploy resources when those industries are affected by shocks. They are unequal because the growth of these know-how networks is easier in places that already have diverse know-how, leading to a spatial concentration of technological possibilities. As I said earlier, the driver of inequality in developing countries is a huge inequality in productivity, which requires a strategy of inclusion. Inclusion empowers people with the capacity to be more productive and, as a consequence, it is good for growth. Unless it promotes inclusion, redistribution can be just a way to compensate the excluded, which is a distant second best.