Medium-Term Business Cycles in Developing Countries

58 Pages Posted: 20 Apr 2016

See all articles by Diego A. Comin

Diego A. Comin

Harvard Business School - Business, Government and the International Economy Unit

Norman Loayza

World Bank - Research Department

Farooq Pasha

Boston College

Luis Servén

World Bank - Development Research Group (DECRG)

Multiple version iconThere are 3 versions of this paper

Date Written: December 1, 2009

Abstract

Empirical evidence - including the current global crisis - suggests that shocks from advanced countries often have a disproportionate effect on developing economies. Can this account for the fact that aggregate fluctuations are larger and more persistent in the latter than in the former economies? And what are the mechanisms at play? This paper addresses these questions using a model of an industrial and a developing economy trading goods and assets, with (i) a product cycle shaping the range of intermediate goods used to produce new capital in each country, and (ii) investment adjustment costs in the developing economy. Innovation by the advanced economy results in new intermediate goods, at first produced at home, and eventually transferred to the developing economy through direct investment. The pace of innovation and technology transfer is driven by profitability. This process of technology diffusion creates a medium-term connection between both economies, over and above the short-term link through trade. Calibration of the model to match Mexico-United States trade and foreign direct investment flows shows that this mechanism can explain why shocks to the United States economy have a larger effect on Mexico than on the United States itself, and hence why Mexico shows higher volatility than the United States; why business cycles in the United States lead to medium-term fluctuations in Mexico; and why consumption is not less volatile than output in Mexico.

Keywords: Economic Theory & Research, Political Economy, Emerging Markets, Debt Markets, Markets and Market Access

Suggested Citation

Comin, Diego A. and Loayza, Norman and Pasha, Farooq and Servén, Luis, Medium-Term Business Cycles in Developing Countries (December 1, 2009). World Bank Policy Research Working Paper Series, Vol. , pp. -, 2009. Available at SSRN: https://ssrn.com/abstract=1527336

Diego A. Comin

Harvard Business School - Business, Government and the International Economy Unit ( email )

Cambridge
United States

Norman Loayza

World Bank - Research Department ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

Farooq Pasha

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Luis Servén

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

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