Interpreting Economic Complexity

Abstract: Two network measures known as the Economic Complexity Index (ECI) and Product Complexity Index (PCI) have provided important insights into patterns of economic development. We show that the ECI and PCI are equivalent to a spectral clustering algorithm that partitions a similarity graph into two parts. The measures are also related to various dimensionality reduction methods and can be interpreted as vectors that determine distances between nodes based on their similarity. Our results shed a new light on the ECI's empirical success in explaining cross-country differences in GDP/capita and economic growth, which is often linked to the diversity of country export baskets. In fact, countries with high (low) ECI tend to specialize in high (low) PCI products. We also find that the ECI and PCI uncover economically informative specialization patterns across US states and UK regions.