Industrial Diversification in Emerging Economies: The Role of Human Capital, Technological Investment, and Institutional Quality in Promoting Economic Complexity

This study examines the role of human capital, technological investment, and institutional quality in promoting economic complexity in South Africa, with implications for sustainable development and the strategic role of Small and Medium Enterprises. Motivated by the growing importance of productive sophistication for long-term development in emerging economies (notably SDG 8 and SDG 9), the study examines both long-run and short-run dynamics using the Autoregressive Distributed Lag approach, with robustness checks via Fully Modified Least Squares, Dynamic Least Squares, and Canonical Cointegration Regression. Structural Vector Autoregression is employed to assess the persistence of shocks, while the Toda–Yamamoto causality test evaluates causality. The results reveal that institutional quality significantly enhances economic complexity in the long run, while technological investment exhibits a negative long-run impact, potentially indicating absorptive capacity constraints within industries. Though human capital and income per capita do not influence complexity in the long run, they have short-term effects, with income per capita having the most immediate influence. Variance decomposition shows that shocks to technological investment are essential for economic complexity, and are the most persistent, followed by human capital and institutional quality. These findings show the need for institutional reforms that lower entry barriers for SMEs in industries, targeted innovation policies that support upgrading, and human capital strategies aligned with driven industrial transformation. The study offers insights for policymakers striving to influence structural drivers to advance sustainable industrial development and achieve the SDGs.