Relatedness and economic complexity as tools for industrial policy: Insights and limitations

The use of relatedness and economic complexity (REC) to advise on industrial policy is expanding. Typically, it leads to the recommendation to (not) support activities that are (un)related to a region’s comparative advantages. Yet, the implications of such use remain largely unaddressed. Drawing on developmental state and innovation studies, I identify two reasons for caution when using REC for policy purposes. First, technological and economic catch-up may require diversification toward unrelated activities. Second, REC focuses exclusively on domestic supply, ignoring demand and international competition. In addition, I highlight conceptual and methodological limitations that are likely to affect REC’s policy implications. Most notably, REC literature might overestimate the magnitude and significance of relatedness, while overlooking the contribution of policy to past diversification outcomes. This paper shows that while REC metrics can provide valuable insights into patterns of structural change, their use in industrial policy requires the concurrent assessment of other crucial elements, including the environmental footprints of diversification options and the dynamics of international supply and demand. • Evidence from REC literature is insufficient to draw strong normative conclusions. • Unrelated diversification may be less common because it is not tried as often. • Relatedness may not adequately reflect the feasibility of diversification options. • Unrelated diversification may be required for catching-up and other key challenges. • Demand and competition are also key for diversification outcomes.