School of Communication, Leadership and Marketing, Kristiania University College – Ernst G Mortensen Foundation
Part Time Visiting Professor in Business Performance and Intangible Asset Management
Centre for Business Performance, Cranfield School of Management, Cranfield University
The United Kingdom
Formerly Adjunct Professor
Institute of Economics and Management, Immanuel Kant Baltic Federal University
Kaliningrad, The Russian Federation
During times of rapid technological development and rapid market changes economic growth requires both the absorptive capacity to internalise new knowledge and the ability to convert this new knowledge into products and services that can successfully compete on the market. To understand the growth potential of a given economy under these circumstances an understanding must be gained of the economy’s underlying capabilities in the form of structures that have emerged to capture, hold and combine knowledge enabling an economy to produce output in the form of products and services that are internationally competitive. This can be done by measuring the economic complexity of the economy.
The core concept of economic complexity is that products are produced when knowledge, natural resources and monetary capital come together in a certain way, with each economy having its own combination of the three factors. Economic complexity theory proposes that since natural resources and monetary capital are scarce, it is by increasing the amount of knowledge in an economy that more products can be made available for production, specifically for export. Thus, it is the differentiation of knowledge between economies that shapes each economy’s unique state of economic complexity.
Economic complexity uses the ubiquity and diversity of the economy’s portfolio of traded products and services to understand the capabilities that exist in the economy. The lower the ubiquity the fewer other economies can produce what is produced in the observed economy and the higher the diversity the broader the range of product and service exported from the economy. High economic complexity hence means low ubiquity and high diversity. Examples of economies with high economic complexity are Japan, Chinese Taipei, Switzerland, and Germany. It is also worth noting that economic complexity predicts future economic growth better than other economic indicators.
Capturing the economic complexity of a region is usually very difficult since access to data for trade with both other countries outside the economy and trade with other regions inside the country where the observed economy is located is needed. In the case of Kaliningrad this is enabled by that Kaliningrad being an exclave and statistics are available for export and import as well as transit traffic by origin and destination.
The author led the project that analysed the economic complexity of the Kaliningrad region for the period 2015-2017. We found that 80% of Kaliningrad’s total export originates from seven product categories and one product category (Motor cars and other motor vehicles) made up 60%. Looking at the products for which Kaliningrad holds a revealed comparative advantage and seeing what the minimum level of implied capability density is for each of these in the Kaliningrad economy we find this number to be very low. These findings are an indication that the capability base in the Kaliningrad region is too narrow and too shallow. This means (which is empirically confirmed) that regional companies operating in more complex product categories are dependent on transferred, imported or licensed capabilities from a parent company or from third parties external to the economy. Another conclusion is that local sub-suppliers to these firms provide non-critical products and services and are hence substitutable.
The higher the product complexity and the lower the associated implied capability density, the larger the risk that the economy will lose this product category, unless it is built around an endowment resource, like a raw material with high transportation costs that is difficult to source on the open market or unless there are inducements provided e. g. tax relief.
The detailed analysis showed that there were four medium-high complexity 4-digit HS code product categories exported with a revealed comparative advantage that are critical for the region’s capability base. There were a further eight average-medium complexity products that also underpin the region’s capability base. Based on the analysis we can conclude that for the region’s competitiveness to be increased, the implied capability density in the economy needs to be roughly doubled.
It is unlikely that this will happen by itself in the Kaliningrad region for two reasons: Firstly, a large economy can generate a large range of diverse options and is therefore better able to manage change than a small economy that can only generate a limited number of options. This means that the need for government intervention in the form of industry policy is larger the smaller the economy—or to express it in neo-classical economic terminology: the smaller the economy the more pervasive market failure is as an attribute of the economy as a whole. Secondly, if both access to new knowledge (both direct and embodied in the form of capabilities held by the supply system) and access to lead customers are substantially higher in a different location than the one the firm is presently located in, and even if the cost of doing business in this new location is higher than that of competitors, it is likely that the firm will relocate to this new location. This means that government intervention to secure local presence of firms critical to the economy is justified.
The conclusion is that Kaliningrad needs to implement an active industry policy with the aim of increasing its implied capability density and subsequently increasing the complexity of its products and services exported to other regions of the Russian Federation or exported internationally. If this is not done the economic complexity of Kaliningrad will likely decline since the rest of the world continuously develop new complex products and services for export and this may be further exacerbated if some of the higher product complexity industries exit the economy. This reduces the probability for economic growth in the region. Reduced economic growth will carry with it a large set of negative consequences for the region.
Expert article 3253
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