A Simple Measure of Economic Complexity

TL;DR

This paper introduces Log Product Diversity (LPD), a simple measure of a country's knowhow based on product variety, which better explains economic differences than complex indices like ECI or fitness.

Contribution

It proposes LPD as a straightforward, theoretically grounded alternative to complex economic complexity measures, improving cross-country economic analysis.

Findings

LPD correlates strongly with GDP and GDP per capita.

LPD outperforms ECI and fitness in explaining economic disparities.

Theoretical model links LPD to product diversity and capabilities.

Abstract

Contrary to conventional economic growth theory, which reduces a country's output to one aggregate variable (GDP), product diversity is central to economic development, as recent 'economic complexity' research suggests. A country's product diversity reflects its diversity of knowhow or 'capabilities'. Researchers proposed the Economic Complexity Index (ECI) and the country Fitness index to estimate a country's number of capabilities from international export data; these measures predict economic growth better than conventional variables such as human capital. This paper offers a simpler measure of a country's knowhow, Log Product Diversity (or LPD, the logarithm of a country's number of products), which can be derived from a one-parameter combinatorial model of production in which a set of knowhows combine with some probability to turn raw materials into a product. ECI and log-fitness can be interpreted theoretically (using the combinatorial model) and empirically as potentially noisy estimates of LPD; moreover, controlling for natural resources, the simple measure better explains the cross-country differences in GDP and in GDP per capita.