Ricardo Hausmann
Subject: Know-how Drives Wealth Creation
Bio: Nobel Prize Winner in Economics, Professor at MIT, and co-author of Power and Progress: Our Thousand-Year Struggle over Technology and Prosperity
Transcript:
Know-how Drives Wealth Creation
What Happens Next in 6 Minutes - 11.1.2025
Larry Bernstein:
Welcome to What Happens Next. My name is Larry Bernstein. What Happens Next is a podcast which covers economics, politics, and international relations. Today’s topic is Know-how Drives Wealth Creation.
Our speaker is Ricardo Hausmann who is a Professor of International Political Economy at Harvard’s Kennedy School, and he is also the Founder and Director of Harvard’s Growth Lab.
I want to find out from Ricardo why know-how is so important and why additional capital and labor isn’t valuable if workers don’t know what to do.
This podcast was taped at a conference that I hosted in Washington DC. So, you are going to hear questions asked by me as well as by my friends.
Ricardo, please begin with six minutes of opening remarks.
Ricardo Hausmann:
The most important asset that runs the economy is know-how. If you want to do something, you want to make something, you must know how to do it. You must know how to make it. And if you don’t know how to make it, then you don’t. And you can have money, you can have institutions, if you don’t have know-how, you don’t make it right.
The scientific proof of that was Northvolt created by some alumni of Tesla. They got together with Goldman Sachs and Volkswagen, and a bunch of people raised $15 billion in equity. They raised $50 billion in orders. They bought the best technology in China, Korea, and Japan on batteries. They were going to make batteries for the incoming EV revolution. They decided to set themselves up in Northern Sweden where there was a hydro dam, and when it came time to produce, they could never breach 1% of installed capacity because they didn’t know how to operate the plant. They had 7,000 workers from a hundred countries. The Chinese didn’t speak Japanese. The Japanese didn’t speak Korean, none of them spoke Swedish and so on. This is just to say that good institutions, good money, good orders, you still must know how to run things.
That thing that was missing is a super important driver of economic growth, especially in middle income countries, but even in higher income countries. Ideas are hard to conceive, but easy to copy. So that’s the reason why the people at the frontier must spend a lot of money in R&D, but the people behind them can just imitate. By that logic, rich countries should grow more slowly, and poor countries should have it easier to catch up because they just imitate. But the median country is not catching up.
I’ve dedicated my life to answering that question. My short answer is that knowledge is not like information. It’s like tennis. A conversation with Rafael Nadal is not going to improve your tennis game. The problem with know-how is what Malcolm Gladwell says takes 10,000 hours to become good at something. 10,000 hours at 40 hours a week is five years. We don’t have chunks of five years to spread in our lives. That’s one of the reasons why your dentist tends not to be your lawyer. But that’s also a reason why to run a complex business, you need many different skills. It was not one brilliant person who was going to make Northvolt in Sweden work. You need teams of people with that span of knowledge that the operation requires, and that’s hard to achieve.
You don’t move from making coffee to making airplanes in one fell swoop, there’s logic and predictability as to what is feasible. But more on the macro side, markets do a decent job at pricing the value of that knowledge. And that’s why Nvidia is worth what it’s worth. It’s the market trying to assess the economic value of that knowledge.
It’s not the tools, it’s not the hard assets, but macroeconomic accounting does a horrible job at accounting for that. That translates into this problem of the US current account deficit and the global imbalances, which according to standard accounting, the market is trying to price things in real time. The balance of payments is made at book value, not market value. And the difference between book value and market value is an important difference between what is happening and what the accounts suggest. The idea is that the US is running this humongous current account deficit and has been doing so since 1980. And if you accumulate that current account deficit, it adds up to something like $15 trillion. If you remember your accounting, the deficit must equal the change in net assets. It’s just a change in valuation.
How do you cover the deficit? Either by liquidating assets or by issuing liabilities. That’s an accounting identity. So, if you we are servicing a debt of $15 trillion at 4%, that’s $600 billion in interest. So, if you look at the financial income side of the current account, the US isn’t paying anything.
So, what the hell? You borrowed $15 trillion and you’re not paying anything. My argument is that that’s bad accounting. And the bad accounting comes from the fact that the US probably did not borrow $15 trillion. The US borrowed $30 trillion and it used $15 trillion to cover its accounting deficit. And the other $15 trillion it used to invest abroad, but not invest abroad as a passive investor, but invest abroad as foreign direct investment (“FDI”).
If the Chinese buy a US Treasury bond, they just send money. But when you do FDI, you deploy money with your knowledge, and you get a return to the combination of money and knowledge. So, when they do the accounts, it appears that US makes say 8% on FDI, not 4%. So, if you can borrow at 4% and earn FDI at 8%, then you see what happens is that you borrowed $30 trillion at 4%, you invested $15 trillion at 8%, and the net of that is zero. Now, you would ask yourself the question, how long can that last?
And the answer depends on whether you can keep on creating knowledge that will have these excess returns because you’re not counting the return on the knowledge. A lot of Google’s accounting does not appear as a US export. It appears as an export of some subsidiary somewhere. The markets know how much Google is valued, but it never appeared as an export, right? But you would say in an alternative accounting regime that the US sent all that knowledge abroad and put it to work and it made money and the money is being correctly valued by Wall Street, but it’s being miscounted by the balance of payments.
I wrote a paper 20 years ago with Federico Sturzenegger, now the Minister of Deregulation in Argentina, and I’ve updated my numbers this year. So long as the US has kept a structural ability to export knowledge this position is not about to collapse. That said, I’m not an optimist on the fiscal accounts, but on the balance of payments, that’s not worrying me that much.
Larry Bernstein:
I want to go to Americans investing abroad. Luckily in our audience, Sanjay Chheda is here. Sanjay, you had the opportunity to invest money in Asia to apply Microsoft’s knowhow. How did Microsoft think about the problem and were you able to earn excess returns that Ricardo mentioned on that investment?
Sanjay Chheda:
My recent work in Saudi Arabia for Amazon, probably a fresher example in my head where we’re investing in building a GPU cloud in Saudi Arabia in the coming year. Great example of lots of knowhow transfer. That’s why the Saudis are cultivating all the major AI and cloud companies to come there and invest. And likewise, in Microsoft, we’re investing in Asia to expand our business. I don’t know if corporations are thinking about how they capture some excess return from their know-how. I think first and foremost, we were always thinking about how we expand our business and get access to the marketplace. And in this case in Saudi Arabia, the reason we were doing the deal and doing the deal with a sovereign wealth backed company, was to access public sector workloads as well as major industrial companies in the case of Saudi Arabia like Aramco and use the government’s influence to help us get business.
Ricardo Hausmann:
You misunderstood what I meant. First, I would say that data centers are part of your cost, not part of your revenues or you expect to monetize that, but everybody in the world uses Microsoft products. So, the money you get from selling Microsoft everywhere is a financial return on the knowledge that went into designing the product. But the marginal cost of that product is zero. So those are the excess returns you’re making. So, it’s not that you’re sharing your knowledge with other people, you’re using your knowledge, you’re monetizing your knowledge on the revenue side.
Now, I have some views on Saudi Arabia, but PIF is has had some capacity to invest in many assets that have a rate of return south of minus a hundred percent. So, these are not assets, these are liabilities.
For example, Neom (a planned city in Saudi Arabia) is a liability that all the money will need to subsidize whatever until they decide to kill it. Hosting the winter Asian Olympics, so those are minus a hundred percent in the good scenario because in the bad scenario that you try to operate, then they’ll need to be coughing up more money.
Microsoft is smart to get PIF’s money. The core business of Microsoft is developing things and then trying to monetize them globally. And it’s a perfect example of what I was thinking of.
A lot of that doesn’t appear as exports from the US It will be booked from activities from subsidiaries all over the world, and it will appear as repatriated profits at some point in time with some stop in Ireland or in the Caribbean. But the stock market is not fooled. It’s just that the accounting is bad.
Mark Franklin:
It’s Mark Franklin. We met about 15 years ago in Venezuela. When we met, we talked about debt restructuring. It’s still unstructured. Do you have any view on the Maduro regime, what you see happening in Venezuela, what you think will happen with the liabilities of the country?
Ricardo Hausmann:
It’s obviously a binary situation whether it will stay under this regime or whether it’ll be a transition to democracy. The elections last year showed that there is a political constituency for a different direction. Society went socialism, and they now have gotten the results. GDP is probably on the order of ¼ of what it was 12 years ago. There’s a scenario in which these guys stay, not indefinitely, because every two or three years there’s this perception that they’re about to fall, and then maybe they fall, maybe they don’t. There’s a high risk of regime collapse. We’re living in one of those periods of heightened risk of regime collapse. But in this scenario, there’s no value there.
I’ve been saying that the more time passes, the less of a bounce the economy is bound to get. The government had borrowed money like crazy when the price of oil was high. In 2012, when the average price of Venezuelan oil was $108, they ran a current fiscal deficit of 18% of GDP in the year of the last election that Chavez held. So immediately in 2013, oil prices start to weaken. In 2014, they came down, the guys couldn’t keep on borrowing, they lost access to capital markets, and they had no reserves.
And as time passes, you have deterioration in the assets of the country. First, you have 8 million people who are no longer there, and outmigration started from the top. Second, you’ve lived off depreciating capital stock that was there. Your electricity system is not working, your oil system is not working, and so on. And then the whole institutional network of the country will have to be reinvented because they have transformed all the institutions. The banking system went from having assets of $80 billion to having assets of less than $2 billion.
If this is the beginning of the rest of your life, it means that the upside is huge. There’ll be a lot of opportunities for monetizing, but it’s going to put some limits at the speed limit at which you can recover. In that context, I’m imagining that there’s going to be willingness by the international community as expressed by IMF. But they will want a restructuring that would have a very significant haircut that without that haircut there wouldn’t be IMF money. And without IMF money, there wouldn’t be a significant recovery.
You will have the Venezuelan government and the US Treasury convince bond holders that they better take the deal that’s on the table because there’s been massive destruction of value. And it would be very hard for the international community to start putting money into a situation where everybody has lost tons to bail out the old bondholders. I don’t think that there’s going to be a dramatic recovery in the old debt. It will have to be restructured in the context of the recovery.
Daniel:
Six years ago, we began investing in Venezuela when there was no food, no water, no electricity. I don’t know what that definition of unsustainable is, but if you could look it up, this must be it. So, we began buying prime real estate in Caracas. The thesis was that the government policies were changing. They were allowing Dollarization and liberalization. It looks like they were trying to do the right things. And so fast forward to today, we’ve invested in the real estate and the banking sector. My question going back to your first point about knowledge, the one thing that I worry about is we’ve had a massive brain drain, and the institutional framework is completely decimated.
How do you think about the future of Venezuela given the decline in knowledge and human capital, and how do we rebuild? How does that change your view of the country going forward? We have a lot of commodities. We can monetize them quickly, but rebuilding the country, how do you think about that related to your first point about knowledge?
Ricardo Hausmann:
Knowledge is so important that it explains the collapse in oil production. Even commodities need knowledge. You are sitting on top of the largest oil reserves in the world. There’s zero geological risk. The oil is a thousand feet down there. There is well-known technology. No one in their right mind is putting money into that. Not the Chinese, not the Russians. Why? Because the whole apparatus is missing. And even the ones that are putting in money have trouble finding teams that they can send to a field to operate.
Venezuelan oil production was 3.4 million barrels of oil when Chavez got to power. In 2002, he fired 20,000 of the 32,000 oil workers starting from the top. And he thought that he could run the company without them. And in no time, all the refineries blew up. Refining capacity went from 1.3 million barrels to less than 100,000 barrels. But that was the destruction of knowledge. So that in the scenario that you describe where these guys stay, but the policies improve, the human capital situation does not improve, and people keep on leaving because that’s not where you want to live.
But in the alternative scenario, they learned things that they could not have learned in Venezuela because it’s productions, business models, organizations that are not the ones we have in Venezuela. That represents a humongous human asset in a world where some people return it’s going to be a significant human capital shock to the economy. And the ones who don’t return will remain connected. And Venezuela will be one of the most internationalized countries in the world because we have now people everywhere.
So, in a scenario where things change, you’ll make out bandits.
Daniel:
I agree, the Venezuelan diaspora is our biggest asset.
Ricardo Hausmann:
There’s no way to invest in water. There’s no way to invest in electricity. The secret of the market is that you do things for other people and how much you earn depends on how much other people value what you do for them.
In Venezuela, you don’t have the market. People have needs, but you cannot do things for them because it’s not investible, it’s not something you can do.
Real estate is like a collateral appreciation of the activity that happens in the rest of the economy. And that activity that happens to the rest of the economy is unworkable under this regime.
Daniel:
A lot of people worry that if you cause regime change, things are only going to get worse. There are no religious ideological differences. It’s a very simple country. Demographically speaking, I would love to get your thoughts on whether you think it can get worse, if there is a regime change?
Ricardo Hausmann:
Venezuelans have been politically reunified. They are done with ideological battles of socialism. But there’s a criminal economy. They are in cahoots with the government. If there’s a transition in Colombia next year, you would have both governments for once attacking the criminal groups on both sides of the border.
That’s where the risks are. The problem in Colombia is not so much ideological risk, it’s just a criminal economy. And that’s going to be a headache we’ll need to address.
Andy Bluhm:
If you look at the markets, the US won. Market capitalization of the US is by far the largest. You started talking about Northvolt, so I thought you were going to say something that the US is losing their know-how from a manufacturing perspective. But I suppose you believe since knowledge is with people and everyone wants to live in the US because of the opportunities here that we can always attract that know-how and bring them back.
Ricardo Hausmann:
I am going to put it in past tense. The US had an incredible system that guaranteed a set of international rules, a currency that everybody wanted to use as their reserve currency, an open immigration policy that took all the talent from the world. 56% of the STEM workers in Silicon Valley are foreigners. And the other 46% are not Californians, only 18% are Californian. The secret of the US has been an incredible ability to attract talent coupled with this incredible state supported R&D effort organized through universities.
And that was an incredible system of assets that underpinned this success. Each one of them is now under review.
Europe is discovering that they may not have a US security umbrella. The EU has 27 armies with 27 budgets. They say that the EU was built one crisis at a time, but right now it catches them in a very uncomfortable situation where I don’t know that they can create a military union. It’s a big challenge for them. You might see fireworks in Europe beyond Ukraine.
Immigration policy is now very seriously harmed. I run the Growth Lab at Harvard and it’s a group of 50 people. We have 35 people on visas. I’m opening at the London School of Economics, at Vienna, Canada and Mexico, et cetera, because I have a surplus of projects and a deficit of visas. And that’s Harvard. The funding of science is in peril and universities are under attack.
In 1945, the US had the atomic bomb with 99% European talent and 1% Oppenheimer, who was a child of immigrants. Talent can move quickly because they have options. There are a bunch of professors that have gone to University of Toronto. There are initiatives in Britain and Europe to attract talent.
Colin Teichholtz:
My name is Colin Teichholtz, lower- and middle-income countries that have a lot of minerals or other resources underground have become more valuable.
Ricardo Hausmann:
The basic problem with minerals is a property rights problem that it’s very hard for policies to get right. There’s very little correlation between how many mineral resources you have and how much you produce. The largest deposits of lithium in the world are in Bolivia, and they have yet to extract their first ton.
Australia has a small fraction of the reserves of Bolivia, but they are the largest producer. So, it has a lot to do with the mining policy. And mining policy is made politically difficult because you don’t have credible regulatory authority. So people don’t trust that environmental regulations will be respected, and they don’t trust that taxes will be paid. Working on mining policy and mining supervisors is a humongous potential investment for developing countries and finding ways to maximize how they can extract value and monetize those assets.
Copper is going to be underproduced relative to expected demand because before you had to be an optimist in the green transition. Now you just need to be an optimist on AI because electricity demand is going to be skyrocketing and anything correlated with electricity demand will be in high demand.
Mark Franklin:
When you think about Trump’s tariffs, do you know what the ultimate end game is?
Ricardo Hausmann:
There are several goals of these tariffs, but the main goal is fiscal. They want the tax revenues, and it will be hard for them to renege. The big shock to the US economy is that we are going from 150,000 jobs a month to a world of 50,000 jobs a month. That difference is immigration, and that’s going to show up in the potential rate of growth of the US. It is going to show up on a shortage of lower skilled labor. And all the tariffs that are being put on are on low-skill jobs. I don’t foresee many people substituting imports for US production. I don’t think that there’ll be that space in the American labor market. US producers are going to have higher costs under their inputs relative to foreign producers. So, while everybody’s asking what’s going to happen to US imports, I asked myself, what’s going to happen to US exports? US companies that want to export, the US is not the place to export from. You can move your know-how to another place that doesn’t have the US tariffs. So, I don’t think it’s good for US growth.
Larry Bernstein:
Is it inflationary?
Ricardo Hausmann:
Yes, because it’s a negative supply shock. And so, for whatever level of aggregate demand, it will have to be accommodated by higher price level. But a lot of these things are going to be probably dwarfed by whatever you think happens to AI. Fluctuations on what AI does to growth are going to be bigger than fluctuations of what tariffs do to growth.
The US has broken up the whole international trading regime, and you must think about how other countries are going to play this game going forward. So, for example, there is apparently a group of relatively free traders that are going to try to coalesce between Canada, EU, and Eastern Pacific.
Conversations with EU, Canada, Australia, New Zealand, they’re going to try to create a block that’s independent of the US and China and see if they can try to set some rules in the world. Everybody will have to de-risk from the US. The US is a highly unreliable partner. It also creates incentives for Europe to get its act together because Europe has been shamed into accepting a deal where they impose zero tariffs on the US. The US imposed 15% tariffs on Europe. And the reason why they accept it is because they’re thinking Ukraine. They were not thinking trade. Which means that the US is monetizing its security umbrella. This US-led world will no longer be there because the US has created incentives for other countries to play a different game.
Larry Bernstein:
You started today about the centrality of knowledge, and I want to go back to that theme. Joel Mokyr won the Nobel Prize the other day. He spoke to our book club several times previously, and one of the great questions that he tried to ask is how did it come to pass that we were living for a millennium with no productivity growth? And then in the 18th century something happened in England and then the United States that had an explosion of growth. He mentions institutions, laws and other phenomena to allow know-how to be productively used. Tell us what Joel Mokyr added to that question of centrality of knowledge.
Ricardo Hausmann:
We’re all in his debt. I like very much a distinction he made between propositional knowledge and prescriptive knowledge. Propositional knowledge is knowledge about the nature of the world. And prescriptive knowledge is knowledge about how to do things in the world.
Propositional knowledge is what you might want to call science and prescriptive knowledge engineering or technology. These two things were separate. The scientists were in London, the tinkerers were in Manchester, and they were not necessarily talking to each other.
At the beginning of the industrial revolution, there was very little that the tinkerers could learn from the scientists. The marriage of these two things happened in the 19th century. At the end of the civil war in the US there was this whole idea of land grant universities and incorporating knowledge and technology into production. And they came to Harvard and they said, now we have Maxwell’s equations, and we have chemistry and so on. We need technologists that know science, so open a school of engineering.
And engineers were apprentices who did not do their A-levels in Britain. They did not finish high school. They did O levels and then they went to apprenticeships, and they had dirty hands. Harvard said, over our dead body, we are an institution of higher learning. This is not what Harvard is for. And that’s why you have MIT on the same Massachusetts Avenue a few miles down because that was the mindset. Well, it’s overcoming that mindset that was very much behind the technological revolutions that we have been seeing. It’s an idea that technology advances because of science and science advances because technology develops more powerful tools for them to do science. You’re now seeing the fruits of AI and technologies come from a long process of collaboration, of innovations in math, innovations in computing, innovations in things that now can become productized, but that were impossible to imagine ahead of time.
Larry Bernstein:
Thanks to Ricardo for joining us.
If you missed the last podcast, the topic was AI is a Mixed Blessing. Our speaker was Daron Acemoglu who was awarded the Nobel Prize in Economics. Daron is a Professor at MIT and is also the co-author of a book entitled Power and Progress: Our Thousand-Year Struggle over Technology and Prosperity.
I want to learn about how AI will improve productivity as well as its effect on inequality. We will compare AI’s impact with the industrial revolution to understand better how the choices that we make will alter work and our society.
You can find our previous episodes and transcripts on our website
whathappensnextin6minutes.com. Please follow us on Apple Podcasts or Spotify. Thank you for joining us today, goodbye.
Check out our previous episode, AI is a Mixed Blessing, here.
