The Economic Complexity Index (ECI) and Output Volatility: High vs Low Income Countries

In this study we explore whether more complex economies are better shielded against exogenous shocks. We contribute to the empirical literature on determinants of output volatility by introducing a relatively new index on productive capabilities of export goods, the Economic Complexity Index (ECI), developed by Hausmann et al. (2014). The ECI measures the productive capabilities of countries by explaining the knowledge accumulated in a population based on the goods they produce and export and to which countries they export. As such, not only does this measure capture diversification but also the technology embedded in the products. Using panel data analysis for a cross section of countries from 1984 to 2016, we find variations in the effects of ECI on output volatility between high and low income countries. For high income countries, increases in ECI reduce output volatility in the short to medium term (under 3 years), whereas we observe a longer delay in output volatility moderation for low income countries. The findings suggest that low income countries have less diversified and less complex export goods which leave them open to external shocks and reduce their ability to adjust quickly to the shocks. Furthermore, disaggregation by regions reveals that economic complexity in Asia is relatively more effective at reducing output volatility than in Africa. The difference between the two regions could be due to Africa’s primary production and exports being in relatively homogenous goods with no differentiation and subject to the volatility of world markets.