The New Paradigm of Economic Complexity, Balland, P.-A., Broekel, T., Diodato, D., Giuliani, E., Hausmann, R., O’Clery, N., & Rigby, D. (2022). The new paradigm of economic complexity. Research Policy, 51(104450). https://doi.org/10.1016/j.respol.2021.104450

Key Takeaways

• Economic complexity measures the diversity and sophistication of an economy's productive capabilities and knowledge networks.

• The New Paradigm of Economic Complexity explains why economic complexity is important. Anyone in local government, economic development or higher education should be aware of these concepts.

• The objective is a modern, resilient, future-proofed economy and improved quality of life for citizens.

• “Specialization and diversification are, in fact, two aspects of the same phenomenon seen from two different scales. If individuals specialize, firms, cities, and countries diversify.”

• “The whole knows more because individuals know different, which is to say that the growth of know-how happens thanks to specialization.”

• Includes practical, accomplishable steps for municipalities.

A Shorthand Definition of Economic Complexity

Economic complexity measures the diversity and sophistication of an economy's productive capabilities and knowledge networks.

The greater the level of diversity and sophistication of an economy's productive capabilities and knowledge networks, the stronger, more resilient, more future-proofed and more attractive to talent it becomes.

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The Paper’s Main Argument

Economic complexity is a way of understanding interactions influencing growth, development, technological change, income inequality, spatial disparities, and resilience.

It’s useful for policy and investment decisions regarding the accumulation and utilization of productive knowledge. Productive knowledge is the main input of complex economies.

How Are Economic Complexity and Knowledge Connected?

Creating economic complexity requires the right ingredients. The most important ingredient is productive knowledge.

• Knowledge Forms: Productive knowledge can be categorized into three parts: embodied (tools and materials), codified (books and manuals), and know-how (tacit knowledge we carry with us). Specialized individuals possess productive knowledge based on these three ingredients.

• Division of Knowledge: Modern technological progress is too big and too complicated for any one person. Progress therefore relies on the division and coordination of knowledge among specialized individuals. Specialized individuals working together on complex problems lead to economic diversification.

• Specialization and Diversification: Individual specialization leads to city, region and national economic diversification.

  Specialization and diversification are, in fact, two aspects of the same phenomenon seen from two different scales. If individuals specialize, firms, cities, and countries diversify.

  — The New Paradigm of Economic Complexity

• Dynamic Effects: Specialization and diversification enable societies to accumulate and create new productive knowledge, leading to economic complexity.

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The Challenge For Smaller Cities

• Complex activities require a deep division of knowledge, which in turn creates high coordination costs that big cities and technology clusters help solve by providing infrastructure and opportunities for talent and ideas to collide. This has a systematic, reinforcing effect: a virtuous cycle of specialization and diversification leading to greater degrees of economic complexity.

• This can trigger the movement of people, who are critical for the transfer of know-how and technology diffusion. Migration might be a key strategy for knowledge sharing but can also lead to talent draining from less built-up areas.

Responding to the Challenge

Fostering a diverse set of specialized knowledge and skills can lead to greater collective know-how and innovation. In turn, this creates opportunities for a modern, resilient, future-proofed economy and improved quality of life for citizens.

• Core Principles:

  • Leverage local capabilities and existing industries to build complexity.

  • Encourage related diversification to create more complex activities.

  • Utilize decentralization to empower local decision-making and foster dynamic capabilities. Less command control, and more creating the conditions to accumulate more productive knowledge.

• Managing Complexity and Specialization:

  • Develop place-based policies that consider the unique attributes and strengths of the local area.

  • Support the movement of skilled individuals and the co-location of complementary businesses to enhance knowledge transfer.

• Mechanisms for Local Knowledge Creation and Economic Complexity:

  • Invest in local education and training to build a modern, skilled workforce.

  • Create networks and partnerships among local businesses, educational institutions, and government to facilitate collaboration.

  • Invest in creating networking events, innovation meetups, and collaborative spaces where individuals from different sectors can come together to exchange ideas, knowledge, and experiences.

  • Implement smart diversification strategies that align with local strengths and global market opportunities.

  • Avoid over-specializing at the municipal level too quickly. Leave the door open to greater diversification down the road.

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• Transfer of Knowledge Types:

  • Promote local learning and the development of worker know-how. Learning to validate concepts is an important skill to partner with subject matter expertise.

  • Foster innovation hubs or clusters that concentrate related industries to facilitate knowledge spillovers.

  • Encourage the use of digital platforms and technology to bridge the physical distance and connect local actors with wider networks.

• Leveraging Local Strengths:

  • Identify and build upon niche areas where the local region has existing or potential competitive advantages.

  • Encourage local entrepreneurship and the development of small and medium-sized enterprises (SMEs) that contribute to economic diversification.

  • Facilitate connections with larger urban centers and global markets to enable knowledge exchange and economic opportunities.

Conclusion

The whole knows more because individuals know different, which is to say that the growth of know-how happens thanks to specialization.

— The New Paradigm of Economic Complexity

Economic complexity might be best thought of as a continuum along which every nation, region and municipality progresses. That process can be fast or slow, with consequences for employment and quality of life.

Given the tendency of complex activities to cluster in existing centers and hubs, non-centers must respond in order to maintain and improve quality of life for their citizens. National and regional policy and investment are crucial. Likewise, independent, practical, accomplishable steps are immediately available to municipalities.

Observations

Not every population center is Silicon Valley or global tech hub. Nor should they necessarily want to be. Most places don’t want to abandon what makes them unique in favour of pursuing different goals. However, when people are looking for attractive places to live, rewarding work is critically important. For this reason every city, town and region should build economic complexity into their planning.

Almost by definition economic complexity is hard to spark, manage and grow. Innovation ecosystems have emerged as a solution, unifying the key actors within municipalities: government, economic development, chamber of commerce, business community, entrepreneurs and, in many places, higher education institutions.

Virtually every municipality possesses these economic complexity building blocks, but there is great variance in infrastructure, coordination, scale, intensity, location, investment, and existing technological expertise. Information sharing and partnerships aid in levelling the playing field.

If the objective is a modern, resilient, future-proofed economy and improved quality of life for citizens, then fostering a diverse set of specialized knowledge and skills is of fundamental importance. Start with an accurate assessment of your current position; begin the levelling-up process by leveraging existing local capabilities and industries.

Twenty-first century economies could hardly be subject to more pressure and more change than now. These pressures extend beyond interest rates and trading block competition into the roots of invention and the future of society.

New categories of technology are powering emerging industries while radically transforming traditional ones. Talented people both drive these changes while also developing new skills and responding to different sets of incentives. The overall effects are felt at national, regional and municipal levels, with massive future consequences for quality of life.

Taken as a whole, significant opportunities await astute local governments, businesses, economic development groups, and educational institutions.

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In Simple Terms, What Is Economic Complexity?

The physical location of research, innovation, production and industry is observable and measurable. Technologies and products emerging from these places — in terms of their range and sophistication — are also measurable. It is these outputs that economic complexity measurements capture, in two ways:

• Production: The range and sophistication of technologies and products produced by an economy.

• Knowledge: The range and sophistication of the knowledge required to produce said technologies and products.

Why Does It Matter?

When high levels of know-how combine with advanced infrastructure the result is cutting-edge innovation, new products and services, a resilient, advanced economy and a powerful attractant to others with know-how.

Conversely, the relative absence of these factors renders an economy vulnerable to change and less able to retain talent.

When economic complexity is measured, interesting observations emerge:

• A strong economy is not the same as an economically complex economy. A strong economy today may not be strong tomorrow as new pressures and changes are brought to bear.

• People leave less complex economies for more complex ones. Economic complexity exacerbates the tendency of research, technology and business to geographically cluster, to the potential detriment of places outside those hubs.

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A Front Burner Issue For Municipalities

Economic complexity is often measured at the national level but of course nations are the aggregate of a wide range of places and economic performance. Cities and regions must include economic complexity in their thinking in order to future proof their citizens’ future well-being and quality of life.

Resources

Understanding the precise set of factors making one place more complex than another is the subject of intense study, from policy to practice.

• The Atlas of Economic Complexity

  • Extremely useful data visualization tool. A country on the rise? Vietnam.

• The Growth Lab at the Harvard Kennedy School

  • Check out “Pathways to Prosperity in Wyoming”

• The Observatory of Economic Complexity (OEC)

  • Blends trade, technology and research metrics to build up a picture of national economies

• The New Paradigm of Economic Complexity

  • Foundational article explains economic complexity and its importance. “…the growth of know-how happens thanks to specialization”

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Research Summaries

Unsurprisingly, economic complexity is itself a complex subject. For municipal, economic development, and higher education leaders, economic complexity touches on a huge number of important topics, from innovation ecosystems more broadly to specifics like infrastructure, specialization, partnerships and the design of place.

To address your need to stay up to speed while recognizing that your time is limited, The Groundbreakers now includes a new section, Research Summaries. For local leaders in higher education, government and economic development, it is designed to present need-to-know information from key research: what the research is about, why it’s important, and what you should do.

Every paper is referenced so that you can find read the full text. (Note that some papers are paywalled.)

For example, The New Paradigm of Economic Complexity is summarized here.

The Groundbreakers innovation ecosystem definition:

An innovation ecosystem is (1) a designed region featuring: (2) specialized actors (e.g. researchers, innovators and entrepreneurs, universities, government, business, economic development, capital providers, mentors, chambers of commerce/boards of trade, civil society and the media); (3) an intentionally high rate of actor interactivity (e.g., knowledge creation and transfer, competition and collaboration); and is measured by (4) successive, evolving, dynamic waves of increasingly diverse and economically complex products and solutions; (5) quality of life improvements (culture, health and wellness, employment) for actors, their community and their fellow citizens; while (6) contributing to and supported by relevant external and internal built environment infrastructure (such as communication networks, transportation systems, research facilities, incubators, collaborative workspaces and more).

Specific definitions of innovation ecosystems–and there are many– vary for good reasons. One of these is the straightforward observation that people’s roles and perspectives vary; correspondingly their needs and priorities vary. From your perspective, for the work you do, the community you serve and are part of, the most applicable definition should answer basic questions as usefully as possible. For instance, should innovation ecosystems prioritize a specific domain of expertise or a geographic region?

For that reason this post supplies several definitions with observations about their utility. It also includes The Groundbreakers definition, which draws upon existing definitions and represents this publication’s philosophy while offering considerations absent from many definitions. 

Key Questions.

While definitions vary, the following questions must be addressed:

1. The components and structure of the innovation ecosystem: What are the main elements and relationships that constitute the innovation ecosystem?

2. The dynamics and evolution of the innovation ecosystem: How does the innovation ecosystem change over time and respond to external factors?

3. The outcomes and impacts of the innovation ecosystem: What are the main benefits and challenges of the innovation ecosystem for its actors and stakeholders?

Applying these to geographically-based innovation ecosystems, the effectiveness of physical, social and economic connections among the key actors—researchers, innovators and entrepreneurs, universities, government, corporations, chambers of commerce and boards of trade, capital providers, mentors, research parks, civil society and the media—become critically important.  

The reason for this is obvious: a well-designed and resourced geographic innovation ecosystem encourages collaboration and problem-solving among the key actors while reducing local barriers and impediments. A direct consequence of this is a high level of collaboration and interaction among specialized individuals with the know-how to solve the sorts of complex problems societies worldwide increasingly value. 

When considering domain innovation ecosystems, where the key actors may not be located in the same area, the emphasis shifts to the need for communication and coordination, featuring robust networks, and tight yet flexible integration and stellar information sharing processes.

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Four Innovation Ecosystem Definitions.

With those factors in mind here are some definitions to consider:

1. In their article, Innovation ecosystems: A conceptual review and a new definition, Grandstrand and Holgersson define an innovation ecosystem as the “evolving set of actors, activities, and artifacts, and the institutions and relations, including complementary and substitute relations, that are important for the innovative performance of an actor or a population of actors.” 

   • The seven key components:

     • Actors: The individuals or organizations that participate in or influence the innovation process, such as entrepreneurs, researchers, customers, investors, policymakers, etc.

     • Activities: The actions or processes that contribute to the creation and dissemination of innovation, such as research and development, prototyping, testing, marketing, etc.

     • Artifacts: The tangible or intangible outputs or outcomes of innovation, such as products, services, patents, publications, etc.

     • Institutions: The formal or informal rules and norms that shape the behaviour and interactions of the actors, such as laws, regulations, standards, culture, etc.

     • Relations: The connections or linkages among the actors that enable or constrain the exchange of resources and information, such as collaboration, competition, complementarity, substitution, etc.

     • Complementary relations: The relations that enhance the value or performance of an actor or an artifact by providing additional or missing capabilities or resources, such as partnerships, alliances, networks, etc.

     • Substitute relations: The relations that reduce the value or performance of an actor or an artifact by providing similar or alternative capabilities or resources, such as rivals, competitors, substitutes, etc.

2. Elizabeth Hoffecker of MIT D-Lab focuses explicitly on the geographic perspective to define innovation ecosystems as “place-based communities of interacting actors engaged in producing innovation and supporting processes of innovation, along with the infrastructure, resources, and enabling environment that allow them to create, adopt, and spread more effective ways of doing things.”

   • This definition is rooted in complex adaptive systems theory to encompass the unpredictable and potentially outsized outcomes produced by innovation ecosystems’ actors, resources and enabling environment.

   • Hoffecker also notes that innovation ecosystems vary dramatically, from nascent to established, and feature significant regional differences. Guadalajara and Kampala have features and needs distinct from Boston.

3. McKinsey opens their definition by defining an innovation ecosystem subset, the innovation hub: “geographic areas that bring together R&D institutions (such as tech-enabled corporations, universities, and medical facilities), as well as venture capital, incubators, and start-ups.” They go on to note that innovation ecosystems usually encompass one or more hubs which usually feature well-developed built environment components such as “robust mobility options (including public transit), as well as a strong technological infrastructure and accessible spaces to play, connect, and live. All this promotes inclusive and equitable economic growth, innovation, and productivity.”

   • This definition explicitly notes the value and interconnectedness of the surrounding built environment to the purpose and success of innovation ecosystems.

4. The World Economic Forum defines innovation ecosystems as the “complex process that spans the generation of ideas, their translation into products, and the commercialization of these products to a large scale"​.

   • WEF notes factors such as a “business culture that rewards entrepreneurship, risk-taking and a will to embrace change, a set of regulations and administrative norms that incentivize this attitude, a strong knowledge-generation sector (universities, research centres and laboratories), and collaboration between these knowledge centres and commercial businesses. Innovation can be successfully steered towards applications particularly valuable to society (e.g. green energy).”

   • Note that WEF focuses more on the system—“complex process”—than the elements comprising the system.

Grandstrand and Holgersson capture the practical ingredients of innovation ecosystems extremely well. Hoffecker incorporates place and notes the role of complex adaptive system theory.  McKinsey’s Davis, Safran, Schaff, and Yayboke identify the layered depth and complexity of well-established innovation ecosystems and their link to external infrastructure. And the WEF focuses on process, highlighting the dynamism that exists within innovation ecosystems.

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These are all excellent examples. Suggesting they be modified in some way isn’t the goal of publishing our own definition; people may well feel ours is less helpful than those previously described.

In The Groundbreakers’ case, there is a bias toward place. Innovation ecosystems aren’t apart from the rest of the world: health, happiness and opportunity are universal desires absent in too many places, and difficult to acquire and preserve at the best of times. We can’t all live south of San Francisco; should we not therefore motivate Grandstrand and Holgersson’s actors to build and participate in innovation ecosystems anywhere–including where they are now–consistent with what makes that place unique or offers it the most advantage and the best prospects? What would that take? What would it look like?

For that reason, The Groundbreakers favours definitions that situate innovation ecosystems in place, integrated into the local community, contributing to the improvement of the surrounding built environment and, of course, relying on that infrastructure to help it thrive and succeed. Note that place-based definitions do not exclude domain specialization or deep linkages to groups not located in a given innovation ecosystem.

We also focus on a concept that emerges loudly and clearly from our interviews and research. Existing definitions sometimes include the concept of evolution in the output of products and services, sometimes it is implied. But they rarely address one of the truly important concepts within evolution: succession. The term originates from biology and refers to “the process by which natural communities replace (or “succeed”) one another over time. A close business term is “creative destruction” in which constant processes of innovation lead to the new replacing the old, more evolved forms succeeding prior versions. This is to suggest, if an innovation ecosystem is not producing consistent, successive waves of innovation, demonstrating increasing degrees of complexity and product diversification, it is an innovation ecosystem in name only.

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This leads us directly to the final element within The Groundbreakers definition, economic complexity. Here is why that is important: 

“Developing the capabilities to create and produce complex products is a viable path to secure long-run growth as these capabilities tend to evolve in self-reinforcing processes of recombination.” 

The New Paradigm of Economic Complexity

Long-run growth. Self-reinforcing processes of recombination. These are the outcome and the input of creative destruction or, if you prefer, succession. An innovation ecosystem sustains and grows based on its ability to evolve, creating successively more complex and diversified products. It thrives when it does this at increasing scale and complexity.

The Groundbreakers Innovation Ecosystem Definition 

Note that our definition is active. Innovation ecosystems are often described as emergent and adaptive, nor are they managed by any single entity, but this does not mean they cannot be directed or influenced. Economic development professionals particularly should note that municipal economic development strategy, objectives, processes, and community connection are all available to adjustment and optimization. Our active definition leaves room for any town or region, anywhere, to design and initiate their own innovation ecosystem. This is an important consideration because, in an increasingly digitally transformed world, existing innovation ecosystems, and leading cities and regions, threaten to further drain talent from less resourced areas. The Groundbreakers definition obviously doesn’t answer this problem but perhaps it provides a hopeful starting point. 

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What do you think? Is there a definition you particularly favour? Why?