Comparative Advantage and the Cross-Section of Business Cycles

Abstract:     
Business cycles are different in rich and poor countries-because the industries in which each group of countries specialize respond differently to domestic and foreign shocks.

Business cycles are less volatile in rich countries than in poor ones. They are also more synchronized with the world cycle. Kraay and Ventura develop two alternative but noncompeting explanations for those facts.

Both explanations proceed from the observation that the law of comparative advantage causes rich and poor countries to specialize in the production of different commodities. In particular, rich countries specialize in high-tech products produced by skilled workers and poor countries specialize in low-tech products produced by unskilled workers.

Cross-country differences in business cycles then arise as a result of asymmetries among the industries in which different countries specialize. Kraay and Ventura focus on two such asymmetries.

The first, which they label the competition bias hypothesis, is based on the idea that cross-country differences in production costs are more prevalent in high-tech industries, sheltering producers from foreign competition and therefore making them large suppliers in the markets for their products.

The second, which they label the cyclical bias hypothesis, is based on the idea that production costs in low-tech industries may be more sensitive to the shocks that drive business cycles.

This paper-a product of Macroeconomics and Growth, Development Research Group-is part of a larger effort in the group to study open-economy macroeconomics.

Number of Pages in PDF File: 45

working papers series