THE EFFECT OF ECONOMIC COMPLEXITY ON INNOVATION AND HUMAN DEVELOPMENT

Abstract

This paper examines the effect of economic complexity on innovation in 114 countries using the data for the period 1998-2019. We will also analyze whether economic complexity affects human development directly or through innovation by using the fitted values of innovation that are obtained after estimating the effect of economic complexity on innovation. Patent applications are used as a proxy for innovation and the Two-Step System Generalized Method of Moments (GMM) technique is used to estimate the equations. Results of the estimation reveal that economic complexity has a positive and significant relationship with innovation, which shows that a high level of complexity paves the way for the achievement of a high level of innovation. Furthermore, another estimation is conducted to analyze whether economic complexity affects human development directly or through innovation. The results show that economic complexity has a more pronounced effect on human development through innovation as compared to the effect of economic complexity on its own. To account for the differences between the economies of the countries chosen, all the countries are classified into two categories, that is, developing and developed. The estimations are then conducted separately for each category, and it is observed that the effect of economic complexity through innovation is more pronounced as compared to that of the direct effect of economic complexity on human development in both developing and developed countries. Our estimation results imply that countries should adopt policies in accordance with their levels of complexity and promote different types of diversification by switching towards efficient technologies that augment human skills and capabilities which ultimately leads to rapid innovation and improvement in the overall well-being and human development of a country.