The Theory of Economic Complexity

TL;DR

This paper develops a mechanistic model for economic complexity, deriving the Economic Complexity Index and explaining differences in activity networks, thereby addressing longstanding puzzles in the field.

Contribution

It provides a theoretical foundation for economic complexity measures and analytically links the index to productive capabilities.

Findings

Economic Complexity Index is a monotonic function of the probability of holding many factors.

The model explains the structure of related activity networks like product and research spaces.

Findings validate economic complexity as a measure of productive capabilities.

Abstract

We provide a mechanistic foundation for economic complexity methods. In our model, an economy's ability to produce an activity depends on the joint presence of required factors. We analytically derive the Economic Complexity Index for this model and show that it is a monotonic function of the probability an economy holds many factors, validating it as an agnostic measure of productive capabilities. We also show that this model explains differences in the shape of networks of related activities, such as the product space or research space. These findings solve long standing puzzles in the literature on economic complexity.