The new paradigm of economic complexity

Balland P.A., Broekel T., Diodato D., Giuliani E., Hausmann R., O’Clery N., Rigby D.

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Research Policy 51 (2022)

Presented by: Simone Romano – 21/03/2024

What is economic complexity?

Economic complexity is the feature of an economic system in which many individual agents operate independently in a highly interconnected and interdependent web of relationships.

Why do we study it?

It gives us new ways to reduce the dimensionality of problems.

It helps us draw more solid connections between the outcomes that we observe and their underlying causes

The forms of knowledge

Embodied knowledge

Codified knowledge

Tacit knowledge

or know-how

Implications

At any given time, the three forms of knowledge are strongly complementary.

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Know-how is the limiting factor!

As more people specialize in different fields, the overall society diversifies, leading to an increase in the variety of available

know-how.

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Division of knowledge.

With more variety, new connections become more likely, leading to the creation of new knowledge.

The key principles of economic complexity

Different products require a different amount of knowledge. Therefore, the more variety there is, the more likely it is that the product will be made.

Developed countries have a more varied pool of know-how. Therefore, they are capable of supplying more complex products.

The general framework of analysis

Diversity of production: how varied is the country’s overall production.

Ubiquity of the product: how common is the country across the dataset.

Relatedness: how similar are two countries’ productions / two products’ distributions.

Country space: how similar the ability endowments of two countries are.

Product space: how similar the ability requirements of two products are.

Measures of diversity and ubiquity

Most common approach:

• Economic Complexity Index (ECI) 🡪 A country is complex if it produces many different products (high diversity), and especially products that are particularly rare (low ubiquity).
• Product Complexity Index (PCI) 🡪 A product is complex if it is rare (low ubiquity), and it is only found in highly diversified countries (high diversity).

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Other approaches:

• Fitness / Quality scores 🡪 A refined version of ECI / PCI that puts more weight on exports.
• GENEPY score 🡪 A composite indicator that combines both the ECI / PCI and the Fitness / Quality approaches

Open streams of research

• These metrics are computed from cross-sectional data, meaning that they don’t provide any information about the dynamical evolution of the system over time. Efforts are being made to incorporate these aspects as well.
• There is a stream of literature that is trying to develop models based on spatial patterns of production and innovation, tackling issues like patenting, employment concentration and skill content of jobs.
• Another stream of literature is instead focusing on estimating the combinatorial complexity of technology through patent data and network theory.

Issues of performance (1/2)

• Economic growth 🡪 By studying the difference in productivity levels across sectors and countries, attempts are being made at understanding how a productive system moves towards complexity. There is convergence at the intensive margin but not at the extensive margin due to the spatial distribution of capabilities.
• Inequality and sustainability 🡪 By their very nature, complex systems tend to become more unequal, which can manifest in different ways (e.g., uneven urban development, with the consequent social issues associated with it).

Issues of performance (2/2)

• Environmental impact 🡪 Some suggest that economic complexity improves the environmental performance of a country by making production processes more efficient. Also, low inequality seems to be associated with greater complexity of green technology.
• Migrations 🡪 Because tacit knowledge is hard to communicate, migrations and students / workers mobility are also being investigated to understand their effects on a country’s endowment of capabilities and production decisions.

Geographical distribution and clusters

Complex economic activities tend to concentrate in space, meaning that large cities have the advantage over rural areas.

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Economic complexity alone can explain 40-80% of the variance in urban concentration of occupations, industries, scientific fields, and technologies.

Relatedness

Issues related to division of knowledge

• Trade 🡪 In an open economy, market pressures tend to push against diversification, because of resource scarcity and opportunity costs. Early research shows that a growing economy will have variety at the individual level, but will also specialize on fewer, more complex products, gradually abandoning simpler ones, which incentivizes trading.
• Coordination costs 🡪 The more diversified a country is, the more expensive it will be to coordinate all the different capabilities that it has available.
• Automation and employment 🡪 As technology advances, automation promises to transform know-how into embodied or codified knowledge. Research is being done to understand the potential effects on labor markets.

Policy implications

In order to achieve higher complexity, countries should invest in building more complex capabilities, instead of simply chasing high-priced goods, as it is a more stable approach in the long run.

Inequality concerns are serious and call for a rethinking of capitalist mechanisms to avoid excessive concentration of political and economical power.

Less developed countries can take advantage of relatedness to leverage their existing capabilities and start diversifying their knowledge pool.

Warnings

More specialization also implies a higher degree of interdependencies in the economic system, raising concerns in terms of resilience to external shocks. Complex systems are generally good at tackling crises, but investments need to be planned correctly.

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Higher complexity implies higher volumes of trade and mobility of goods and people, which can have important environmental and social consequences.

Thank you