Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality

50 Pages Posted: 19 Dec 2004 Last revised: 11 Jun 2022

See all articles by Jeffrey A. Frankel

Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Eduardo A. Cavallo

Inter-American Development Bank (IDB) - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: December 2004

Abstract

Openness to trade is one factor that has been identified as determining whether a country is prone to sudden stops in capital inflow, currency crashes, or severe recessions. Some believe that openness raises vulnerability to foreign shocks, while others believe that it makes adjustment to crises less painful. Several authors have offered empirical evidence that having a large tradable sector reduces the contraction necessary to adjust to a given cut-off in funding. This would help explain lower vulnerability to crises in Asia than in Latin America. Such studies may, however, be subject to the problem that trade is endogenous. We use the gravity instrument for trade openness, which is constructed from geographical determinants of bilateral trade. We find that openness indeed makes countries less vulnerable, both to severe sudden stops and currency crashes, and that the relationship is even stronger when correcting for the endogeneity of trade.

Suggested Citation

Frankel, Jeffrey A. and Cavallo, Eduardo A., Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality (December 2004). NBER Working Paper No. w10957, Available at SSRN: https://ssrn.com/abstract=629599

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Eduardo A. Cavallo

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