The Structural Determinants of External Vulnerability

33 Pages Posted: 20 Apr 2016

See all articles by Norman Loayza

Norman Loayza

World Bank - Research Department

Claudio E. Raddatz

University of Chile, School of Economics and Business

Multiple version iconThere are 2 versions of this paper

Date Written: December 2006


The authors examine empirically how domestic structural characteristics related to openness and product- and factor-market flexibility influence the impact that terms-of-trade shocks can have on aggregate output. For this purpose, they apply an econometric methodology based on semi-structural vector auto-regressions to a panel of 90 countries with annual observations for the period 1974-2000. Using this methodology, the authors isolate and standardize the shocks, estimate their impact on GDP, and examine how this impact depends on the domestic conditions outlined above. They find that larger trade openness magnifies the output impact of external shocks, particularly the negative ones, while improvements in labor market flexibility and financial openness reduce their impact. Domestic financial depth has a more nuanced role in stabilizing the economy. It helps reduce the impact of external shocks particularly in environments of high exposure - that is, when trade and financial openness are high, firm entry is unrestricted, and labor markets are rigid.

Keywords: Pro-Poor Growth and Inequality, Free Trade, Economic Theory & Research, Inequality, Macroeconomic Management

Suggested Citation

Loayza, Norman and Raddatz, Claudio E., The Structural Determinants of External Vulnerability (December 2006). World Bank Policy Research Working Paper No. 4089, Available at SSRN:

Norman Loayza (Contact Author)

World Bank - Research Department ( email )

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

Claudio E. Raddatz

University of Chile, School of Economics and Business ( email )

Diagonal Paraguay 257, Of. 1206
Santiago, R. Metropolitana 7520421


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