Trade, Innovation, and Development: The Role of Diversification in Driven Economic Systems

Abstract

This note seeks to shed light on how economies develop by reconciling the apparent conflict between diversification and specialization as the path to development, and alternative conceptions of an economy as an equilibrium system of optimizing agents versus a driven system dependent on underlying sources of economic “energy”. Diversity and specialization are two sides of the same coin: diversity at the system level enables specialization at the individual agent level. We can observe the potential for a positive feedback loop with increased specialization reflected in increased diversity of specialized agents and specialized products, which in turn enable a further additional expansion of diversity through recombination. The greater the diversity of existing capabilities, the greater the number of possible recombinations. Trade between progressively larger sets of individuals – grouped within a firm, within a city, within a country, within the global economy – intensifies these positive feedbacks. Mainstream economics, couched in terms of optimizing agents in an equilibrium setting, describes the structure at any point in time; however, to describe the trajectory of a system over time requires a driven model where the scale is determined by the power of the driving force. The economic system, like the biosphere in which it is embedded is a driven system. Based on this understanding, the note draws inferences for trade policy.