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Natural disasters and the effect of trade on income: A new panel IV approach

  • Felbermayr, Gabriel
  • Gröschl, Jasmin

Natural disasters affect bilateral trade. We use this fact to generalize the instrumental variables strategy of Frankel and Romer (1999) to a panel setup. This allows revisiting an old question: Does openness cause per capita GDP? We work with a modified gravity framework in which we interact foreign natural disasters with geography. Predicting the exogenous component of bilateral trade flows and aggregating over trade partners, we obtain a time-varying instrument for multilateral openness of a country. Controlling for constant determinants of income (history, geography) by means of fixed effects, we find a robust positive effect of trade on income. Averaging 0.74, the estimated elasticity is substantially smaller than the one obtained in the cross-section. Poor or non-OECD countries feature a larger elasticity.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 58 (2013)
Issue (Month): C ()
Pages: 18-30

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Handle: RePEc:eee:eecrev:v:58:y:2013:i:c:p:18-30
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