Are External Shocks Responsible for the Instability of Output in Low-Income Countries?

Abstract

External shocks, such as commodity price fluctuations, natural disasters, and the role of the international economy, are often blamed for the poor economic performance of low-income countries. This paper quantifies the impact of these different external shocks using a panel vector auto-regression approach and compares their relative contributions to output volatility in low income countries vis-a-vis internal factors. We find that external shocks can only explain a small fraction of the output variance of a typical low-income country. Internal factors are the main source of fluctuations. From a quantitative perspective, the output effect of external shocks is typically small in absolute terms, but significant relative to the historic performance of these countries.