The Theory of Economic Complexity

Abstract

Economic complexity estimates rely on eigenvectors derived from matrices of specialization to explain differences in economic growth, inequality, and sustainability. Yet, despite their widespread use, we still lack a principled theory that can deduce these eigenvectors from first principles and place them in the context of a mechanistic model. Here, we calculate these eigenvectors analytically for a model where the output of an economy in an activity increases with the probability the economy is endowed with the factors required by the activity. We show that the eigenvector known as the Economic Complexity Index or ECI is a monotonic function of the probability that an economy is endowed with a factor, and that in a multi-factor model, it is an estimate of the average endowment across all factors. We then generalize this result to other production functions and to a short-run equilibrium framework with prices, wages, and consumption. We find that our main result does not depend on the introduction of prices or wages, and that the derived wage function is consistent with the convergence of economies with a similar level of complexity. Finally, we use this model to explain the shape of networks of related activities, such as the product space and the research space. These findings solve long standing theoretical puzzles in the economic complexity literature and validate the idea that metrics of economic complexity are estimates of an economy being endowed with multiple factors.

Reference

César Hidalgo, and Viktor Stojkoski, “The Theory of Economic Complexity”, TSE Working Paper, n. 1648, June 2025.