Linking economic complexity, institutions and income inequality

Linking Economic Complexity, Institutions and Income Inequality D. Hartmann1,2*, M. Guevara1,3,4, C. Jara-Figueroa1, M. Aristarán1, C.A. Hidalgo1*† May 28, 2015 Affiliations: 1

Macro Connections, The MIT Media Lab. Chair for Economics of Innovation, University of Hohenheim.

3 Department of Computer Science, Universidad de Playa Ancha.

4 Department of Informatics, Universidad Técnica Federico Santa María.

2

*Correspondence to: hartmado@mit.edu, hidalgo@mit.edu †current address: The MIT Media Lab, 75 Amherst Street, Cambridge, MA 02139.

Abstract: The mix of products that a country exports predicts that country’s subsequent pattern of diversification and economic growth. But does this product mix also predict income inequality? Here we combine methods from econometrics, network science, and economic complexity to show that countries that export complex products— products that are exported by a few diversified countries—have lower levels of income inequality—at comparable levels of GDP per capita and education—than countries exporting simpler products. Using multivariate analysis we show that the connection between income inequality and economic complexity is stronger than what can be explained using aggregate measures of income, institutions, export concentration, and human capital, and also, that increases in economic complexity are accompanied by decreases in income inequality over long periods of time. Finally, we use the position of a country in the network of related products—or product space—to explain how changes in a country’s export structure translate into changes in income inequality. We interpret these results by combining the literature in institutions with that on economic complexity and structural transformations. We argue that the connection between income inequality and economic complexity is also evidence of the co-evolution between institutions and productive activities.

Introduction Is a country’s ability to generate and distribute income partly determined by its productive structure? Pioneers of the literature in development economics, like Paul Rosenstein-Rodan, Hans Singer, and Albert Hirschman, would have argued in favor of a connection between a country’s productive structure and both its income and income inequality. These development pioneers emphasized the economic role of “structural transformations,” the process by which economies diversify from agricultural and extractive industries to more sophisticated industrial sectors (1-3).

Recently the ideas of these development pioneers were revived by empirical work documenting a strong connection between a country’s productive structure and its level of income and growth (4-6). This recent line of work builds on measures of economic complexity that use information on the matrices connecting countries to the

products they export to quantify the industrial sophistication of economies (7,8).

These measures of economic complexity have been repeatedly connected with a country’s level of income and future economic growth (4, 9-12). Nevertheless, the empirical connection between a country’s productive structure and its level of income inequality remains relatively unexplored. Here we leverage tools from economic complexity, network science, and econometrics, to document a robust and stable relationship between a country’s productive structure and its level of income inequality. Our findings provide evidence that the productive structure of countries is not only associated with a country’s level of income, but also, with how that income is distributed.

Connecting Income Inequality with Economic Development Decades ago Simon Kuznets—winner of the 1971 Nobel Prize in economics— proposed an inverse-U relationship describing the connection between a country’s average level of income and its level of income inequality. Kuznets’ curve, as it is now known, suggested that income inequality would rise and then fall as countries’ average income moved from low, to middle, to high. Yet, the empirical work supporting Kuznets’ curve is shaky: the inverse-U relationship fails to hold when Latin American countries (many of which are middle income countries with high levels of inequality) are removed from the sample (13). Additionally, the curve is at odds with the dynamics of many East-Asian economies that have grown from low to middle incomes while reducing income inequality (14). Moreover, in recent decades, the upward side of the Kuznets curve has vanished as inequality in many low-income countries has increased (15). The mounting empirical evidence against Kuznets curve, however, has not meant a complete departure from the connection between economic development and inequality. Rather the evidence has encouraged scholars to revisit the relationship between economic development and income inequality in the light of alternative measures of economic development, pushing them to focus not merely on the rate or stage of growth, but on the type of growth, and also, on a country’s institutions (16-21).

One interpretation of the empirical rejection of Kuznets’ curve is that GDP per capita seems to be an inadequate measure of economic development. If this is the case, the connection between economic development and income inequality should be revealed in the light of better measures of economic development, like those capturing information on the structural aspects of the economy that escape GDP. This idea was already present in Kuznets and his contemporaries, who recognized that average income was a poor proxy for a country’s level of economic development (22-26).

But why should a country’s productive structure explain its level of income inequality better than measures of aggregate output (such as GDP per capita)? Scholars have argued that income inequality depends on a variety of factors, such as an economy’s geography and climate (27,28), the presence of exploitative or inclusive institutions (21), an economy’s colonial past (29), labor displacement and skills premium caused by changes in technology (30,31), rent seeking (32), processes of political capture (28, 33) and differences in the returns to capital vis-à-vis economic growth. Many of these institutional, geographical, and historical factors, however, should be expressed in the mix of products that a country makes because making a particular product requires a specific combination of skills, institutions and technologies, and in some

2

cases—like that of mining and agricultural products—even a specific climate and geography.

As an example, consider the co-evolution between a country’s productive structure and institutions (36), which is an idea that can be traced back to the writings of Adam Smith (37), Alexander Hamilton (38), Harold Innis (29), and Friedrich List (39).

Industrial structures co-evolve with institutions because different industrial structures demand different institutions (21). For a firm to be successful in a sector, and survive, it needs to discover or adopt the institutions that work best in that sector. For instance, sophisticated technological industries—like those involved in the design of portable electronics and advanced manufacturing—require inclusive institutions because these industries thrive when workers contribute their creative input into the activities of the firm. Extractive industries such as mining and agriculture, require discipline and obedience rather than creativity from their workers, and hence, do not demand the inclusive institutions required by sophisticated technological sectors. So measures of a country’s productive structure capture valuable information about a country’s institutional environment that might escape survey-based measures of formal and informal institutions. The co-evolution between industrial sectors and institutions, however, also suggests that measures of a country’s productive structure might work as proxies for other drivers of inequality, such as a country’s level of education and the level of knowledge and knowhow that is embodied in its population (40).

In this paper we use the economic complexity index—a measure of the matrix connecting countries to their exports that is used to quantify the sophistication of a country’s productive structure—to explore the connection between a country’s productive structure and its level of income inequality. The economic complexity index captures information about an economy’s level of development that is different from that captured in measures of income. To illustrate this difference we compare the economies of Chile and Ecuador with those of Malaysia and Thailand. Chile’s average income per capita ($21,044 at PPP in current 2012 US$) is comparable to the income of Malaysia ($22,314). The average income of Ecuador ($10,416) is also similar to that of Thailand ($13,983). But Chile and Malaysia, and Ecuador and Thailand, differ largely in their productive structures (Fig 1, A-D). Chile and Ecuador largely export natural resources—copper, fish, and fruits in the case of Chile and bananas and crude petroleum in the case of Ecuador. In contrast, Malaysia and Thailand export a diverse gamut of electronics and machinery (and relatively few raw materials), signaling that these are more diversified and complex economies. The economic complexity index captures these differences in productive structures that go beyond income. In fact, in 2012 Malaysia and Thailand ranked respectively 24th and 33thin the Economic Complexity Index (ECI) (41) while Chile and Ecuador ranked only 72nd and 95th (see details of the ECI Index construction and a full ranking table SX in SM). Notably, Chile and Ecuador’s levels of income inequality (GINICHL=0.49 and GINIECU=0.47) are significantly higher than those of Malaysia and Thailand (GINIMYS=0.39 and GINITHA=0.38) (see also Fig 1s in the SM). Of course, this is only one illustrative example of the connection between income inequality and economic complexity. The remainder of the paper will be dedicated to statistically testing this relationship, and also, to create a product level index of income inequality.

3

Fig. 1 Export structure of Chile (A), Malaysia (B), Ecuador (C) and Thailand (D) in 2012. Source atlas.media.mit.edu

Data We use international trade data from MIT’s Observatory of Economic Complexity (atlas.media.mit.edu). This dataset combines exports data from 1962 to 2000 compiled by Feenstra et al. (2005) (42) and data extracted from the U.N. Comtrade from 2001 to 2012. Income inequality data comes from two different Gini datasets: a comparative dense panel dataset of Gini coefficients based on regression estimates

4

(“EHII-dataset”) (43) and a sparser dataset based on household survey data (“All the GINIs dataset”) (44). Furthermore we measure economic complexity using the values of the Economic Complexity Index (ECI) available at MIT’s Observatory of Economic Complexity (atlas.media.mit.edu/rankings). These values were calculated according to Hidalgo and Hausmann’s (2009) Economic Complexity formula. The Economic Complexity Index (ECI) is a measure of the diversity and sophistication of a country’s export structure that can be estimated from data connecting countries to the products they export (4,9). The data on GDP per capita, Population, and Average Years of Schooling comes from the World Bank’s World Development Indicators, the institutional variables Corruption Control, Political Stability, Government Effectiveness, Regulatory Quality and Voice Account come from World Bank’s Worldwide Governance Indicators (http://data.worldbank.org).

Because of the sparseness of the Gini datasets we use average values for the time periods 1963-1969, 1970-1979, 1980-1989, 1990-1999, and 2000-2008. We note that Ginis change relatively slowly so averages should be close to the Gini values expected for each year within a decade. Also, we consider only countries with a population larger than 1.5 million and total exports of over 1 billion dollars (removing small national economies that are comparable to medium size cities). The resulting dataset includes 91% of the total world population and 84% of the total world trade between 1963 and 2008. See SM for further information on the construction of the economic complexity index, and descriptive statistics of all variables.

Results We begin by documenting the relationship between income inequality and economic complexity using multivariate regression analysis (for the bivariate case see SM). We use multivariate regression to separate the correlation between economic complexity and income inequality from the correlation between income inequality and average income, population, human capital (measured through schooling), export concentration, and formal institutions (measured using the World Bank’s Worldwide Governance Indicators). We start our multivariate analysis with a pooled regression gathering data for the five decades between 1960s and 2000s, then control for the robustness of these results for each decade, and finally explore the changes over time in a fixed-effect panel regression.

Pooled Regression Table 1 shows the fifty-years pooled regression. Columns 1 to 4 show a sequence of nested models that regress income inequality against economic complexity, GDP per capita at Purchasing Power Parity (PPP) and its square (a.k.a. Kuznets’ Curve), Average Years of Schooling, and Population. Together these variables explain 60% of the variance in income inequality among countries (Column 4), but economic complexity is the variable that is the most significant in the regression analysis, and also, it is the variable that explains the largest fraction of the variance in income inequality after the effects of the other variables are removed. The semi-partial correlation between economic complexity and income inequality—which is the fraction of the variance in inequality explained by economic complexity after the effect of all other variables has been taken into account—is 12.9%. The semi-partial correlation of the other four variables combined is only 3.5%. This means that

5

economic complexity contains most of the information on inequality contained in measures of income, schooling, and population, but also, that it contains a substantial amount of information about inequality that is not contained in these variables.

In tables 2s-4s of the supplementary material we also test the results within each decade and make robustness and benchmark tests with another Gini dataset (The All the GINIs dataset (44) and with a trade dataset where products are coded in a different trade classification (HS instead of SITC) (45). We furthermore repeat the analysis using a variation of the measure of economic complexity proposed in the literature (12), and add a measure of export concentration to show that the variance in inequality captured by ECI is not coming from differences in the concentration of countries exports (see SM table 5s-7s). We find our results are robust to these changes in datasets, methods, and classifications.

Cross-Section Regression Results

ECI

(I)

(II)

(III)

-0.051*** (0.002)

-0.038*** (0.004) 0.007 (0.019) -0.001 (0.001)

-0.037*** (0.004) 0.010 (0.019) -0.001 (0.001) -0.003** (0.001)

0.437*** (0.002)

0.450*** (0.076)

0.439*** (0.075)

-0.040*** (0.004) 0.024 (0.019) -0.002 (0.001) -0.003** (0.001) 0.005*** (0.002) 0.293*** (0.091)

335 0.569 0.568 0.044 (df = 333) 440.030** * (df = 1; 333)

335 0.592 0.588 0.042 (df = 331) 160.183** * (df = 3; 331)

335 0.600 0.595 0.042 (df = 330) 123.557** * (df = 4; 330)

335 0.609 0.603 0.042 (df = 329) 102.420** * (df = 5; 329)

ln(GDP PPP pc) ln(GDP PPPpc) 2 Schooling Ln Population Constant Observations R2 Adjusted R2 Residual Std. Error F Statistic

Note:

Dependent variable: Gini (IV) (V)

(VI)

(VII)

(VIII)

-0.045*** (0.003)

-0.042*** (0.004) 0.021 (0.019) -0.002 (0.001)

-0.037*** (0.004) 0.010 (0.019) -0.001 (0.001) -0.003** (0.001)

0.027 (0.022) -0.003** (0.001) -0.004*** (0.001) -0.001 (0.002) 0.454*** (0.103)

-0.004*** (0.001) 0.005*** (0.002) 0.369*** (0.029)

0.005*** (0.002) 0.306*** (0.091)

0.439*** (0.075)

335 0.481 0.474 0.048 (df = 330) 76.390*** (df = 4; 330)

335 0.604 0.600 0.042 (df = 331) 168.123** * (df = 3; 331)

335 0.601 0.596 0.042 (df = 330) 124.348** * (df = 4; 330)

335 0.600 0.595 0.042 (df = 330) 123.557** * (df = 4; 330)

*

p<0.1; **p<0.05; ***p<0.01

Table 1: Pooled OLS regression models. The regression table explores the effects of economic complexity on income inequality in comparison with other socioeconomic factors, such as a countryâ&#x20AC;&#x2122;s average level of income, population and human capital. Column I starts with a baseline model in which only the Economic Complexity Index (ECI) is included. Column II adds natural Log of GDP PPP per capita and natural Log GDP PPP per capita squared to the equation in order to test the Kuznetsâ&#x20AC;&#x2122; curve hypothesis. Column III includes the average years of schooling to test for the role of human capital.

Column IV adds the natural Log of population, and it includes all variables. Columns V-VIII exclude blocks of variables to explore the contribution of each group of variables to the full model (column IV).

The sharpest drop in R2 (from 0.603 to 0.474) is observed when economic complexity is removed from the regression.

Next, we include data on institutions (Table 2), which only overlaps our Gini dataset for a much shorter time period: between the 1996 and 2008. Instead of the decades 1990-99 and 2000-2008 we consider institutional variables for the time periods 19962001 and 2002-2008.

6

The institutional data contains information on five institutional factors: corruption control, government effectiveness, political stability, voice and accountability, and regulatory quality (Table 2). After controlling for these five institutional variables, however, economic complexity is still highly significant and it explains 8% of the variance in income inequality that is not accounted for by the combination of institutional and macroeconomic variables.

Cross-Section Regression including Institutions Dependent variable: Gini

(I) ECI ln(GDP PPP pc) ln(GDP PPPpc)2 Schooling Ln Population Corruption Control Government Effectiveness Political Stability Regulatory Quality Voice accountability Constant

Observations R2 Adjusted R2 Residual Std. Error F Statistic

Note:

(II)

(III)

(IV)

(V)

(VI)

-0.037*** (0.007)

-0.046*** (0.007) 0.061** (0.029) -0.004** (0.002)

-0.034*** (0.006) 0.057** (0.028) -0.003* (0.002) -0.006*** (0.002)

-0.044*** (0.006) 0.075*** (0.025) -0.004*** (0.001) -0.005*** (0.002) 0.009*** (0.002)

-0.040*** (0.007) 0.068** (0.028) -0.004** (0.002) -0.005*** (0.002) 0.007** (0.003) 0.005 (0.012) -0.003 (0.016) -0.011* (0.006) -0.005 (0.012) -0.001 (0.007) 0.077 (0.130)

0.060* (0.032) -0.004* (0.002) -0.009*** (0.002) -0.00001 (0.003) 0.020 (0.013) -0.027 (0.018) -0.019*** (0.007) -0.011 (0.014) 0.003 (0.008) 0.280** (0.141)

-0.004** (0.002) 0.005* (0.003) 0.001 (0.011) -0.003 (0.016) -0.011* (0.006) 0.0001 (0.012) -0.002 (0.008) 0.393*** (0.050)

0.008*** (0.003) 0.010 (0.012) 0.001 (0.016) -0.010 (0.006) -0.010 (0.012) -0.006 (0.007) 0.061 (0.134)

0.001 (0.012) 0.006 (0.016) -0.018*** (0.006) -0.012 (0.012) 0.001 (0.008) 0.237** (0.114)

0.016 (0.121)

142 0.714 0.693 0.035 (df = 131) 32.783*** (df = 10; 131)

142 0.636 0.611 0.039 (df = 132) 25.618*** (df = 9; 132)

142 0.698 0.679 0.035 (df = 133) 38.359*** (df = 8; 133)

142 0.696 0.676 0.036 (df = 132) 33.643*** (df = 9; 132)

142 0.702 0.682 0.035 (df = 132) 34.527*** (df = 9; 132)

142 0.704 0.693 0.035 (df = 136) 64.656*** (df = 5; 136)

*

p<0.1; **p<0.05; ***p<0.01

Table 2: Pooled OLS regression including institutions. The regression table expands the results presented in Table 1 by including the effect of the institutional variables: corruption control, government effectiveness, political stability, regulatory quality, and voice accountability. Due to the limited availability of institutional data we pool two panels: one from 1996-2001 and another from 2002-2008.

Within countries dynamics Next we explore whether changes in a country’s level of economic complexity are associated with changes in income inequality using a panel regression using data from 1963 to 2008. We note at the outset, however, that unlike cross-sectional results, which exploit between country variation—which is large for both income inequality and economic complexity—fixed-effect panel regressions focus on temporal variations within a country. These variations are small for both income inequality and economic complexity, and thus we should not expect large effects.

7

Yet, despite the low levels of temporal variation in the data, the fixed-effect panel regression still reveals a negative and significant association between a country’s change in economic complexity and a country’s change in Gini (Table 3) that is robust to the inclusion of measures of income and human capital (we do not include institutions as the institutional data is only available for a short time period). Figure 2 illustrates graphically the relationship between changes in economic complexity and changes in income inequality between 1963 and 2008 by plotting the bivariate relationship between these ECI and income inequality.

Panel Regression Results Dependent variable: GINI

ECI ln(GDP PPP pc) ln(GDP PPPpc)2

I

II

III

IV

-0.031*** -0.007

-0.033*** -0.007 -0.038 -0.028 0.003* -0.002

-0.024*** -0.007 -0.042 -0.027 0.002 -0.002 0.010*** -0.002

-0.026*** -0.007 -0.017 -0.029 -0.00003 -0.002 0.014*** -0.003 -0.024** -0.011

-0.032 -0.03 0.0005 -0.002 0.015*** -0.003 -0.016 -0.011

0.010*** -0.002 -0.022** -0.01

0.014* -0.008

338 0.213 0.149 12.80*** (df = 5; 236)

338 0.165 0.116 11.74*** (df = 4; 237)

338 0.196 0.138 19.36*** (df = 3; 238)

338 0.134 0.094 9.15*** (df = 4; 237)

Schooling Ln Population

Observations R2 Adjusted R2 F Statistic

338 338 0.077 0.123 0.055 0.087 20.13*** 11.14*** (df = 1; (df = 3; 240) 238) Note:*p<0.1; **p<0.05; ***p<0.01

338 0.198 0.139 14.63*** (df = 4; 237)

V

VI

VII

-0.030*** -0.007

-0.029*** -0.007 -0.053* -0.03 0.004** -0.002

Table 3: Fixed-effects panel regression. These seven models explore whether changes in a country’s level of economic complexity are associated with changes in income inequality (column I), controlling also for the effects that other socioeconomic factors like income (column II), human capital (column III) and population (column IV) have on income inequality. Columns V-VII control the variance explained by the model when ECI, income, or schooling, are excluded from the analysis.

Fig 2. Change in economic complexity and income inequality between 1963-2008. The lines represent a fitted bivariate regression line and prediction bands.

8

We note that, as expected, the strength of the time varying relationship is substantially weaker than that of the cross-sectional results presented above. We believe this points to limitations on the economic complexity index and on the use of exports data, as none of these capture information on other sectors that have been argued to drive or explain inequality, such as finance and real state (34, 46), and also, may fail to capture information about the globalization of value chains that has been accelerating during the last decades. These additional factors, however, suggest that the economic complexity index may underestimate the effect of the structure of economic activity on income inequality.

Decomposing inequality at the product level In this section we decompose the relationship between economic complexity and income inequality into individual economic sectors, by creating an indicator of the contribution of each product to a countryâ&#x20AC;&#x2122;s overall level of income inequality. We call this product level indicator the Product Gini Index, or PGI. Decomposing income inequality at the product level can be understood in the context of the co-evolution between productive structures, education, and institutions, as discussed in the introduction. Products are the results of industries that need to discover or adopt the institutions that work best for the production of each product.

Hence, the successful production and export of products tells us about the inclusiveness of a countryâ&#x20AC;&#x2122;s institutions and the quality of its human capital. This coevolution suggests that it should be possible to decompose income inequality at the product level.

To decompose income inequality at the product level we build on the synthetic control method used in statistics (47-49). Inspired by this method we define PGI as the average level of income inequality of a productâ&#x20AC;&#x2122;s exporters. For instance, we associate a higher expected level of income inequality to copper than to paper making machine parts, because countries exporting copper have an average Gini of 0.48, whereas exporters of paper making machine parts have an average Gini of 0.33 (Fig 3A and B). Formally, we define the average Gini of the countries that export a product p, or PGI (Product Gini Index) as:

đ?&#x2018;&#x192;đ??şđ??ź! =

1 đ?&#x2018; !

đ?&#x2018;&#x20AC;!" đ?&#x2018; !" đ??şđ?&#x2018;&#x2013;đ?&#x2018;&#x203A;đ?&#x2018;&#x2013;! !

(1) Â

where Ginic is the Gini of country c, đ?&#x2018;&#x20AC;!" is 1 if country c exports product p with revealed comparative advantage and 0 otherwise (see SM), scp is the share of country câ&#x20AC;&#x2122;s exports represented by product p, and Np is a normalizing factor đ?&#x2018; ! = ! đ?&#x2018; !" , that ensures PGIs are the weighted average of the Ginis of the countries that export a product. The share scp is calculated as follows: đ?&#x2018; !" = đ?&#x2018;&#x2039;!" â &#x201E; !! đ?&#x2018;&#x2039;!"! where Xcp is the exports of product p by country c.

Figure 3B shows the top 3, bottom 3 and median 3 products according to the ranking of PGI values between 1995 and 2008 (for all products see SM). We note that the products associated with the highest levels of income inequality (high PGI products)

9

include mostly commodities, such as cocoa beans, inedible flours, and animal hair.

Low PGI products, on the other hand, include more sophisticated forms of machinery and manufactures, such as road rollers, textile machinery and paper making machine parts.

Fig 3. The Product Gini Index (PGI). (A). The product Gini index (PGI) is a weighted average of the Gini coefficients of the countries that export a product. In red we show the Gini coefficients of five copper exporters. In blue, we show the Gini coefficients of exporters of paper making machine parts.

(B). Top three, middle three, and bottom three products by PGI values. The PGI value is indicated with a solid gray diamond. The Gini values of the five countries that contribute the most to each of these PGI is shown using circles. All values are measured using data from 1995-2008.

The Product Space and the Evolution of Income Inequality Next, we use PGIs in combination with the product space—the network connecting products that are likely to be co-exported—to illustrate how changes in a country’s productive structure are connected to changes in a country’s level of income inequality. The product space captures the notion that countries are significantly more likely to diversify towards products that are similar—i.e. connected in the product space—to the products that they currently export (7). Hence, we can use the product space to study the constraints to industrial diversification implied by a country’s productive structure. In this case, we study the constraints that product space brings to the evolution of income inequality by annotating each product in the product space with its respective PGI. Fig 4A colors the product space using PGIs, showing that products associated with low levels of inequality (low PGIs) are located in the center of the product space (which is also where more sophisticated products are located)(7). As expected, PGIs are strongly and negatively correlated with the complexity of the products and the centrality of their position in the product space (see SM for details).

Figures 4B-C and 4D-E compare, respectively, the evolution of the productive structure of Malaysia and Chile (which were discussed as examples in the introduction), and Norway. Malaysia’s economy evolved from high PGI products, like natural rubber, tin and alloys and sawlogs in 1963-69, to low PGI products, such as electronic microcircuits and computer parts in 2000-2008. Chile, on the other hand,

10

developed in a more constrained way, increasing its presence in products, such as frozen fish, fresh fish, and wine, which are also relatively high PGI products.

Consequently, we should have not expected Chile’s movements in the product space to change Chile’s level of income inequality. Finally, Norway represents an example of a country that increased its dependency on a high PGI product (crude petroleum), and also, its income inequality increased during this period. More generally, these results illustrate how the productive structure of a country, as expressed in the position of its exports in the product space, constrains its evolution of income inequality.

Discussion Our results document a strong and robust correlation between the productive structure of countries—as measured by the economic complexity index—and income inequality. Using multivariate regression, we confirmed that this relationship is robust to controlling for measures of income, education, and institutions (when these are available), and that the relationship has remained strong over the last fifty years.

Moreover, we showed using a panel regression that increases in economic complexity tend to be accompanied by decreases in income inequality.

Of course, our findings do not mean that productive structures are a causal factor that solely determines a country’s level of income inequality. A more likely explanation, as we argued in the introduction, is that a country’s productive structure is a highresolution expression of a number of factors, from institutions to education, that coevolve with the mix of products that a country exports. Still, because of this coevolution, our findings emphasize the economic importance of productive structures, since we have shown that these are not only associated with income and economic growth (4), but also with how income is distributed.

Moreover, we advance methods that enable a more fine-grained perspective on the relationship between the mix of products that a country exports and its income inequality, by introducing the Product Gini Index or PGI, an estimator of the level of income inequality expected from a product. Overlaying the PGI values on the network of related products—or product space—allowed us to create maps that we can use to anticipate how changes in a country’s productive structure will affect its level of income inequality. These maps are available at MIT’s observatory of economic complexity (atlas.media.mit.edu/inequality), and provide means for researchers to explore and compare the co-evolution of productive structures, institutions and income inequality in more detail.

Also, both our multivariate analysis and Product Ginis show that the products made by a country provides information about its level of inequality that is not captured by measures of aggregate output, like the GDP per capita used in the original formulation of Kuznets’s curve. Still, they help recover Kuznets’ result by reframing it in the context of measures of economic development that focus on what kind of products countries export rather than on the aggregate output they produce. Together these set of results and techniques provide new tools that policy makers can use to include income inequality considerations in their industrial policy instruments.

11

Fig 4A: The product space and income inequality. (A) In this visualization of the product space nodes are colored according to a product’s PGI as measured in the 1995-2008 period. Node sizes are proportional to world trade between 2000 and 2008. The networks are based on a proximity matrix representing 775 SITC-4 product classes exported between 1963-2008. The link strength (proximity) is based on the conditional probability that the products are co-exported. (B) Malaysia’s export portfolio between 1963-1969. In this figure and the subsequent ones node sizes indicate the share of a product in a country’s export basket (C) Malaysia’s export portfolio between 2000-2008. (D) Norway’s exports between 1963-1969. (E) Norway’s export portfolio between 2000-2008. (F) Chile’s exports between 1963-1969. (G) Chile’s export portfolio between 2000-2008.

12

Acknowledgements DH acknowledges the support by the Marie Curie International Outgoing Fellowship No. 328828 within the 7th European Community Framework Programme. All authors acknowledge support from The MIT Media Lab consortia. MG and CAH acknowledge support from MIT-Chile MISTI fund. MG acknowledges the support of DGIP from University Federico Santa María. We also thank A. Simoes, D. Landry and M. Hartmann for valuable comments. The data reported in this paper are tabulated in the Supplementary Materials and the raw data can be accessed at the following databases: atlas.media.mit.edu, http://data.worldbank.org, Feenstra (2005) and U.N. Comtrade.

References: 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

17.

18.

19.

20.

P. Rosenstein-Rodan, Problems of Industrialization of Eastern and South- Eastern Europe.

Economic Journal 53(210/211), 202–211 (1943).

H. Singer, The Distribution of Gains between Investing and Borrowing Countries. American Economic Review 40, 473–485 (1950).

A. Hirschman, The Strategy of Economic Development (Yale University Press, New Haven, 1958).

C. A. Hidalgo, R. Hausmann, The building blocks of economic complexity. Proceedings of the National Academy of Sciences 106.26, 10570-10575 (2009).

P. P. Saviotti, K. Frenken, Export variety and the economic performance of countries. Journal of Evolutionary Economics 18.2, 201-218 (2008).

Rodrik, D., What's so special about China's exports? China & World Economy, 14(5), 1-19 (2006).

C. A. Hidalgo, B. Klinger, A.-L. Barabási, R. Hausmann, The product space conditions the development of nations. Science 317.5837: 482-487 (2007).

S. Bustos, et al., The dynamics of nestedness predicts the evolution of industrial ecosystems. PloS one 7.11, e49393 (2012).

R. Hausmann, C. A. Hidalgo, S. Bustos, M. Coscia, S. Chung, J. Jimenez, A. Simoes, M. A. Yildirim, The Atlas of Economic Complexity (Puritan Press, Cambridge, MA, 2011).

J. Felipe, Inclusive Growth, Full Employment, and Structural Change: implications and policies for developing Asia (Anthem and Asian Development Bank, London and Manila, 2010).

A. Abdon, J. Felipe, The Product Space: What Does It Say About the Opportunities for Growth and Structural Transformation of Sub-Saharan Africa? (Levy Economics Institute of Bard College, Working Paper No. 670, 2011, http://www.levyinstitute.org/pubs/wp_670.pdf).

M. Cristelli, A. Tacchella, L. Pietronero, The heterogeneous dynamics of economic complexity, PloS one. 10(2), e0117174 (2015).

K. Deininger, L. Squire, New ways of looking at old issues: inequality and growth, Journal of Development Economics. 57(2), 259–287 (1998).

J. E. Stiglitz, Some Lessons From The East Asian Miracle. The World Bank Research Observer 11(2), 151–177 (1996).

J. G. Palma, J. G., Homogeneous middles vs. heterogeneous tails, and the end of the ‘Inverted-U’: the share of the rich is what it's all about. Cambridge Working Papers in Economics (CWPE) 1111 (2011).

G. S. Fields, Distribution and Development, A New Look at the Developing World (The MIT Press, Cambridge, MA, 2001).

M. Ravallion, Pro-poor growth: A primer. World Bank policy research working paper 3242 (2004).

L. de Mello, M. A. Dutz, Promoting inclusive growth: Challenges and policies (OECD publishing, Paris, 2012).

Combating Poverty and Inequality (United Nations Research Institute for Social Development, Geneva, 2010).

D. Hartmann, Economic complexity and human development: how economic diversification and social networks affect human agency and welfare (Routledge, New York, 2014).

13

21. D. Acemoglu, J. Robinson, Why Nations Fail: the origins of power, prosperity and poverty (Crown Publishers, New York, 2012).

22. S. Kuznets, “National Income, 1929–1932” (73rd US Congress, 2d session, Senate document no.

124. (1934).

23. S. Kuznets, “Modern Economic Growth: Findings and Reflections” (Lecture to the memory of Alfred Nobel, December 11, 1971).

24. W. W. Leontief, Input-output economics. Scientific American 185.4, 15-21 (1951).

25. W. W. Leontief, The structure of the US economy. Scientific American 212, 25-35 (1965).

26. J. Stiglitz, A. Sen, J.-P. Fitoussi, The measurement of economic performance and social progress revisited. Reflections and overview. (Commission on the Measurement of Economic Performance and Social Progress, Paris, 2009).

27. J. D. Sachs, The End of Poverty: Economic Possibilities for Our Time (Penguin Books, New York, 2005).

28. P. Collier, The bottom billion: Why the poorest countries are failing and what can be done about it (Oxford University Press, New York, 2007).

29. H. Innis, The Fur Trade in Canada: An Introduction to Canadian Economic History (University of Toronto Press, Toronto, Rev. Ed., 1956) 30. D. H. Autor, Skills, education, and the rise of earnings inequality among the “other 99 percent”.

Science 34.6168, 843-851 (2014).

31. E. Brynjolfsson, A. McAfee, Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy (Digital Frontier Press, Lexington, MA, 2011).

32. G. F. Davis, Managed by the markets: How finance re-shaped America (Oxford University Press, Oxford, 2009).

33. J. E. Stiglitz, The price of inequality (W.W. Norton & Company, New York, 2012).

34. T. Piketty, Capital in the Twenty-First Century (Harvard University Press, Cambridge, MA, 2014).

35. T. Piketty, E. Saez, Inequality in the long run. Science 344.6186, 838-843 (2014).

36. F. Fukuyama, Trust: The social virtues and the creation of prosperity (Free Press, New York, 1995).

37. A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (University Of Chicago Press, Chicago [1776] 1977).

38. Secretary of the Treasury [Alexander Hamilton] of the United States, on the subject of Manufactures. Presented to the House of Representatives, December 5, 1791.

39. List, F. Das Nationale System der Politischen Ökonomie (Kyklos, Basel, 1841).

40. C. Hidalgo, Why Information Grows: The Evolution of Order, from Atoms to Economies (Penguin Press, New York, 2015).

41. see MIT’s Observatory of Economic Complexity: atlas.media.mit.edu/rankings.

42. R. R. Feenstra, H. D. Lipsey, A. Ma, H. Mo, World Trade Flows: 1962–2000, NBER Work. Pap. 11040 (2005).

43. J.K. Galbraith, et al. The UTIP Global Inequality Datasets: 1963-2008. No. UNU-WIDER Research Paper WP2015/019 (2015).

44. B. Milanovic, “Description of all the Ginis database”, (version Summer 2013) (2013).

45. G. Gaulier, Z. Soledad, “Baci: international trade database at the product-level (the 1994-2007 version)”, (2010).

46. M. Rognlie, Deciphering the fall and rise in the net capital share, Brookings Papers on Economic Activity, BPEA Conference Draft, March 19–20 (2015) 47. A. Abadie, A. Diamond, J. Hainmueller, Synthetic control methods for comparative case studies: Estimating the effect of California’s tobacco control program. Journal of the American Statistical Association 105.490, 493-505 (2010). doi:10.1198/jasa.2009.ap08746.

48. A. Abadie, A. Diamond, J. Hainmueller, Comparative politics and the synthetic control method.

American Journal of Political Science 59(2), 495–510, (2015). DOI: 10.1111/ajps.12116 49. S. Gathani, D. Stoelinga, Export Similarity Networks and Proximity Control Methods for Comparative Case Studies. Journal of Globalization and Development 3.2, 1-39 (2013).

14