Economic complexity and income inequality: New evidence of a nonlinear effect

Abstract

Intro: The literature indicates that economic complexity (the geography of economic activities) is an important explanatory factor in income inequality; however, empirical evidence is still inconclusive. This study addresses this gap by considering the nonlinear influence of economic complexity on income inequality. Methods: Panel quantile regression with fixed effects is applied for a global sample of 121 countries from 1995 to 2018, showing robust findings. Results: Economic complexity appears to have an inverted-U-shaped effect on income inequality. That is, economic complexity likely increases income inequality up to a threshold, beyond which economic complexity helps to reduce income inequality. This inverted-U-shaped effect is found consistently in low-income, lower-middle-income, and upper-middle-income countries, while the opposite effect is found in high-income countries. Evidence of an inverted-U-shaped effect is also documented in most regions except the Middle East & North Africa and South Asia. Interestingly, the study finds that improvements in economic complexity appear to have U-shaped effects on the income share of the bottom earners and inverted-U-shaped effects on the income share of the top earners. Conclusion: These effects explain the inverted-U-shaped effect of economic complexity on income inequality. The results are robust across different quantiles, proxies of income inequality, and various control variables