Trade Openness and Volatility
Centro Studi Luca d'Agliano Development Studies Working Paper No. 219
42 Pages Posted: 29 Aug 2006
Date Written: July 2006
This paper examines the mechanisms through which trade openness affects output volatility using an industry-level panel dataset of manufacturing production and trade. The main results are threefold. First, sectors more open to international trade are more volatile. Second, trade leads to increased specialization. These two forces act to increase aggregate volatility. Third, sectors which are more open to trade are less correlated with the rest of the economy, an effect that acts to reduce overall volatility. The point estimates indicate that each of the three effects has an appreciable impact on aggregate volatility. Added together they imply that the overall effect of trade openness on overall volatility is positive and economically significant. This impact also varies a great deal with country characteristics. We estimate that the same increase in openness raises aggregate volatility five times more in developing countries compared to developed ones. Finally, we find that the marginal impact of openness on volatility roughly doubled in the last thirty years, implying that trade exerts a larger influence on volatility over time.
Keywords: Trade, Output Volatility, Specialization, Comovement, Sector-Level Data
JEL Classification: F15, F40
Suggested Citation: Suggested Citation