A reasoning of economic complexity based on simulated general equilibrium international trade model

Abstract

By simulating a multi-country general equilibrium international trade model, we investigate how the economic complexity index (ECI) and fitness index (FI) are related directly to economic fundamentals with a clear basis in theory. The model is based on Eaton and Kortum (2002 Econometrica 70 1741–79) and combines factor endowment (Heckscher-Ohlin) and technological (Ricardian) reasons for specialization, which further determines economic complexity across countries. First, we find that FI performs better than ECI in explaining the real-world specialization pattern, where successful countries not only produce complex products due to the comparative advantage but also tend to produce a wide range of possible products due to the absolute advantage. Second, we highlight that the predictive power of various economic complexity measures for income is crucially sensitive to other factors that shift marginal cost from its efficient level in manufacturing sectors. The essence of such an issue lies in the assumption that the revealed comparative advantage (RCA) correctly reflects a country’s real capability of specialization across different goods. However, there would exist a gap between the core idea of learning the national complexity from RCA and the fact that the revealed specialization pattern in data may not necessarily suggest a country’s actual capability in the presence of distortions, the latter of which is ubiquitous across developing countries.