ECONOMIC COMPLEXITY

As a group, people living in modern societies can produce the most amazing things: from radios to toothpaste to daily TV weather forecasts. Still, no single person knows how to predict the weather, how to produce a TV broadcast, how to make a camera or how to create animated weather maps, let alone all of these disparate things. Each of these tasks involves much more knowhow than any person can master. Only by combining knowhow from different people can any product be made. However, products differ enormously in the amount of knowhow they require: wood-based panels are easier to make than robots or airplanes. But the secret to producing complicated things is not having smarter people: it is having many people who each come to the table with different and complementary knowhow. Richer societies have more collective knowhow and use it to make a greater variety of more complex products. Poor countries are able to make few simple products.

Economic complexity is a term we use to refer to the network structures that societies form in order to embed productive knowledge in different individuals and then bring it back together in productive organizations and in the networks these organizations form. Since some products (like computers or jet engines) can only be made in very complex societies and others (like T-shirts or cereals) can be made almost anywhere, the mix of things that a country can produce says something about the knowhow it possesses and can use effectively. Generally, the more complex the web of human interaction is in a country, the more prosperous the country. So how do we know how much knowhow is in a country? We examine two characteristics of a country’s productive output:

  • Diversity of a country: Simply, how many products does a country make? Countries that make many distinct products are likely to be more complex

  • Ubiquity of a product: Simply, how many countries are able to make a product? Products that are made by very few countries are likely to be more complex
     

We can combine these two characteristics and iterate them. For example, we can calculate how ubiquitous are the products that a country makes or how diversified are the countries that make a product. We can keep at it, by calculating how diversified are the countries that make the products that a particular country makes or how ubiquitous are the products that are made by the countries that make a particular product. We can iterate this process an infinite number of times and calculate a measure of each country’s economic complexity: its Economic Complexity Index (ECI). We can do the same for products and calculate the Product Complexity Index (PCI).

As one would expect, there is a connection between ECI and GDP per capita: complex countries are generally richer. But more interesting is the fact that the disparity between the actual GDP per capita of a country and the GDP it would be expected to have, given its ECI, is a strong predictor of economic growth. In fact, complexity-based economic variables contain much more predictive information than other commonly used variables such educational attainment, the quality of institutions, the depth of the financial system or the competitiveness of a country as measured by the World Economic Forum. How and why Economic Complexity impacts growth is the subject of ongoing research.

Tags:

Economic complexity; Productive knowledge

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