Related or unrelated diversification: What is smart specialization?

Abstract

In this paper, we investigate the nature of path dependency in specialization of countries in terms of international trade. Our focus is on the product space density metric, which is employed in the literature on smart specialization and the product space. We find that although density is supposed to capture relatedness between a country's current specialization pattern and potential products that it may diversify into, density also contains a large component of what we call unrelated diversity, i.e., country- and product fixed effects. Together, these fixed effects capture 97 % of the variance of density. We isolate the related variety component in density and then estimate logit regressions that predict gains or losses of specialization. The relative influence of unrelated variety on changes of specialization increases with the level of diversification of the country: only countries that are not already diversified are strongly influences of related variety. We also show that the impact of the country effect in the impact of unrelated diversity in gains or keeps of specializations increases with diversity. This suggests that existing capabilities breed new capabilities, i.e., diversification is a virtuous circle that is largely independent of relatedness, and that the source of path dependency in international specialization patterns lies much more in generic production capabilities rather than relatedness in product space.