A Simple Measure of Economic Complexity

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.