February 19, 2009

Specialization versus Diversification

I was discussing the other day with another fellow young economist, Mitch Abdon, about this concept of product space. She is part of the team here in the Asian Development Bank that applies Ricardo Hausmann's product space theory and methodology for the country of Pakistan (project headed by Dr. Jesus Felipe). She brought up an interesting point. If at first it may seem that the product space theory compliments one of the basic tenets of international economics (specially from Adam Smith) which is that specialization is the key to economic growth--you are wrong. On the contrary, the product space theory espouses more and more diversification of products--not specialization in any one or two--because this is the only way that you can get to more sophisticated products. And as indicated in my previous posts, the level of sophistication of products is one characteristic of developed nations.

My only reservation with this new insight is that, diversification is not the only route to more sophisticated products. The fact is, specialization on one type of product can also lead to more sophisticated products. I think the iPhone is a perfect example. It is today's most sophisticated cellular phone--but it is not far away different from the old and less-sophisticated analog celphones that we had before. But frequent research and specialization on cellular phone technology has led to improvements and developments, and the latest one is the iPhone. I wouldn't be surprised if in two year's time, more developments on the technology (a.k.a. specialization) might give us the next generation of cellular phones that would make the iPhone significantly obsolete.

Diversification does lead to more sophisticated products. But so does specialization.