Resolving the complexity puzzle: economic complexity and positions in global value chains jointly explain economic development

It is now well established that complex economies with sophisticated export specialization experience higher income and economic growth levels. A group of countries, including those in Central and Eastern Europe (CEE), have pursued a distinctive and arguably successful economic development strategy, focusing on foreign direct investment and embedding in global value chains (GVCs) in manufacturing. However, while these countries now appear to have a high degree of economic sophistication after considerable modernization, they also face significant challenges in catching up with more developed economies in terms of prosperity. In this paper, we propose that considering the coordination of local and non-local capabilities in the same theoretical framework and empirical application helps to resolve this apparent complexity puzzle. Using a panel dataset covering 67 territories and 45 sectors from 1995 to 2018, we first show that measuring countries’ economic complexity based on value-added trade adjusts the resulting country ranking and reduces the measured complexity gap favoring CEE countries. Second, we argue that value-added-based economic complexity needs to be complemented by measures of positions in GVCs to account for access to non-local capabilities. Our results from benchmark regression analyses show that economic complexity and positions in GVCs together offer improved predictive power for income and economic growth. Finally, we show that GVC positions in services are particularly important for economic development but that a related pattern of diversification, whereby CEE countries and factory economies more broadly strengthen their GVC positions in manufacturing activities, is likely to limit their future opportunities for functional upgrading and for achieving highly complex economic structures that would be rooted in local capabilities.