Traditional measures of economic development, such as GDP, have been criticized for neglecting qualitative dimensions of well-being. The economic complexity index (ECI), introduced by Hidalgo and Hausmann (2009), offers a more nuanced measure of a nation's productive capabilities, capturing the sophistication and diversity of its export basket. While a growing body of research links ECI to various developmental aspects including income, sustainable development, inequality, and health outcomes, the relationship between ECI and overall quality of life (QoL) remains debated. Some studies suggest a positive association, highlighting channels such as increased income, human capital development, and attraction of foreign direct investment (FDI). Others, however, point to potential negative effects like exacerbated income inequality and environmental damage. Existing studies often rely on single indicators of well-being or overlook the non-linear nature of the relationship, and crucially, the role of governance. This study aims to bridge this gap by examining the moderating effect of governance on the link between ECI and QoL, measured comprehensively using the Social Progress Index (SPI). The research focuses on developing countries, which often face challenges in diversifying their economies and are characterized by weak institutions, low ECI, and low QoL. Understanding the interplay of economic complexity, governance, and QoL is crucial for designing effective development policies in these contexts.

The literature on economic complexity and quality of life presents two contrasting perspectives. The first emphasizes the positive effects of higher ECI, pointing to improvements in income, employment, education, health outcomes, and reduced income inequality. Studies cite mechanisms such as increased worker bargaining power, job creation in sophisticated sectors, improved access to public services, and reduced vulnerability to external shocks. The second perspective highlights potential negative consequences, such as increased income inequality due to unequal access to resources and opportunities, the creative destruction process rendering some capabilities obsolete, and environmental degradation due to increased economic activity. This divergence highlights the need for a more comprehensive approach using broader QoL measures and considering potentially non-linear relationships and the role of governance. Few studies have explored the non-linear association between ECI and QoL, and to the authors' knowledge, none have comprehensively examined the moderating role of governance in this relationship. Existing research indicates governance's crucial role in shaping both economic complexity (through its effects on human capital, innovation, and FDI) and QoL (through resource allocation, human capital development, and the creation of inclusive institutions). The study posits that good governance can amplify the positive impact of economic complexity on QoL by creating an environment conducive to innovation and human capital development. This study, therefore, explores the three-way interaction between ECI, governance, and QoL to fill this significant gap in the literature.

The study uses a system-GMM approach to analyze panel data from 75 developing countries over the period 2011-2021 (825 observations). The dependent variable is the Social Progress Index (SPI), a comprehensive measure of QoL. The main independent variable is the economic complexity index (ECI). Governance is incorporated as a moderating variable using six indicators from the World Bank's Worldwide Governance Indicators (WGI), which are aggregated into four composite indices using principal component analysis (PCA): political, economic, institutional, and general governance. Control variables include FDI inflows, government final consumption expenditure, and ICT penetration. The choice of system-GMM is justified by the potential for endogeneity between ECI and QoL, the persistence of the dependent variable, and the characteristics of the dataset (N > T). A two-step SYS-GMM estimation is used to address these econometric challenges. The study tests hypotheses regarding the unconditional positive impact of ECI on QoL, the contingent impact of ECI on QoL based on governance settings, and the significance of governance thresholds in determining the impact of ECI on QoL. Interactive regression and net effects computation are employed to analyze the moderating effect of governance and calculate governance thresholds beyond which complementary policies are needed to maintain the positive impact. Robustness checks are conducted using the LIML method, an alternative QoL measure (HDI), and a sensitivity analysis to account for potential outliers.

The study's findings support the following: (1) Both ECI and governance have consistent and unconditional positive effects on QoL. (2) Governance substantially moderates the ECI-QoL relationship. (3) The interaction effect between ECI and governance is negative, indicating diminishing returns to governance above certain thresholds. (4) Specific governance indicators—government effectiveness, rule of law, and control of corruption—are particularly significant. (5) Threshold analysis reveals critical governance levels beyond which additional complementary policies are necessary to sustain the overall positive effect of ECI and governance on QoL. These thresholds are 0.8435, 1.846, and 1.717 for government effectiveness, rule of law, and corruption control respectively, and 5.59, 3.14, and 3.32 for general, institutional, and economic governance, respectively. (6) Robustness checks using LIML, HDI as an alternative QoL measure, and a sensitivity analysis to remove outliers, largely confirm the main findings. In the LIML analysis, however, the general and other governance dimensions negatively impacted SPI. The negative moderating effects of governance are observed consistently in all specifications.

The findings highlight the importance of considering both economic complexity and governance in promoting QoL in developing countries. The positive unconditional effects of both variables confirm their crucial roles in development. However, the negative interaction effect underscores the limitations of governance as a sole driver of enhanced QoL once certain thresholds are crossed. The calculated thresholds offer valuable insights for policymakers, indicating the levels of governance beyond which complementary policies are crucial to sustain the positive impact of economic complexity. The significance of government effectiveness, rule of law, and control of corruption emphasizes the need for effective institutions that facilitate innovation, protect property rights, and ensure fair competition. The results are consistent with theoretical arguments suggesting that governance plays a vital role in creating an environment conducive to innovation and human capital development, which are key drivers of economic complexity and ultimately QoL. The robustness of the findings across various estimations strengthens the study's conclusions and enhances its policy relevance.

This study offers valuable insights into the complex interplay between economic complexity, governance, and QoL in developing countries. It demonstrates the need for a holistic approach that considers both economic diversification and good governance to achieve sustainable improvements in well-being. Policymakers should focus on building strong institutions and reaching governance thresholds that maximize the positive spillovers of ECI while implementing complementary policies to mitigate negative consequences at higher governance levels. Future research could explore the specific mechanisms through which governance moderates the ECI-QoL link, examine regional variations, and investigate the impact of other factors (financial development, ICT, FDI). Further research that distinguishes countries based on income level may also yield valuable insights.

The study's findings are based on a specific sample of developing countries and a limited time period (2011-2021). The generalizability of the results to other contexts requires further investigation. The reliance on aggregated governance indicators may mask variations in the effects of individual governance aspects. The chosen methodology, while robust, might not capture all nuances of the complex relationships involved. Finally, while robustness checks were conducted, potential unobserved confounding variables could influence the results.